Fed Chair Janet L. Yellen addressed the Committee on Financial Services, U.S. House of Representatives on Banking Sector Supervision. She said that before the crisis, their primary goal was to ensure the safety and soundness of individual financial institutions. A key shortcoming of that approach was that they did not focus sufficiently on shared vulnerabilities across firms or the systemic consequences of the distress or failure of the largest, most complex firms. Although changes have been made, substantial compliance and risk-management issues remain.
There has since been a significant shift in focus has led to a comprehensive change in the regulation and supervision of large financial institutions. These reforms are designed to reduce the probability that large financial institutions will fail by requiring those institutions to make themselves more resilient to stress. However, recognising that the possibility of a large financial institution’s failing cannot be eliminated, a second aim of the post-crisis reforms has been to limit the systemic damage that would result if a large financial institution does fail. This effort has involved taking steps to help ensure that authorities would have the ability to resolve a failed firm in an orderly manner while its critical operations continue to function.
They created the Large Institution Supervision Coordinating Committee (LISCC). The LISCC is charged with the supervision of the firms that pose elevated risk to U.S. financial stability. Those firms include the eight U.S. banking organizations that have been identified as GSIBs, four foreign banking organizations with large and complex U.S. operations, and the four nonbank financial institutions that have been designated as systemically important by the Financial Stability Oversight Council (FSOC).
With regard to capital adequacy, the Federal Reserve’s Comprehensive Capital Analysis and Review (CCAR) is designed to ensure that large U.S. bank holding companies, including the LISCC firms, have rigorous, forward-looking capital planning processes and have sufficient levels of capital to operate through times of stress, as defined by the Federal Reserve’s supervisory stress scenario. The program enables regulators to make a quantitative and qualitative assessment of the resilience and capital planning abilities of the largest banking firms on an annual basis and to limit capital distributions for firms that exhibit weaknesses.
The financial condition of the firms in the LISCC portfolio has strengthened considerably since the crisis. Common equity capital at the eight U.S. GSIBs alone has more than doubled since 2008, representing an increase of almost $500 billion. Moreover, these firms generally have much more stable funding positions. The amount of high-quality liquid assets held by the eight U.S. GSIBs has increased by roughly two-thirds since 2012, and their reliance on short-term wholesale funding has dropped considerably. The new regulatory and supervisory approaches are aimed at helping ensure these firms remain strong. Requiring these firms to plan for an orderly resolution has forced them to think more carefully about the sustainability of their business models and corporate structures.
Nevertheless, while they have seen some evidence of improved risk management, internal controls, and governance at the LISCC firms, they continue to have substantial compliance and risk-management issues. Compliance breakdowns in recent years have undermined confidence in the LISCC firms’ risk management and controls and could have implications for financial stability, given the firms’ size, complexity, and interconnectedness. The LISCC firms must address these issues directly and comprehensively.
Their examinations have found large and regional banks to be well capitalized. Both large and regional banking organizations experienced dramatic improvements in profitability since the financial crisis, although these banks have also faced challenges in recent years due to weak growth in interest and noninterest income. Both large and regional institutions have seen robust growth in commercial and industrial lending.
Finally, community banks are significantly healthier. More than 95 percent are now profitable, and capital lost during the crisis has been largely replenished. Loan growth is picking up, and problem loans are now at levels last seen early in the financial crisis.
