Treasury's Lew on Volcker, Systemic Threshold and the State of Regulation

WASHINGTON — Many are pushing for a higher asset threshold to determine which banks face new prudential supervisory standards, but Treasury Secretary Jacob Lew cautioned Tuesday that raising the cutoff is not a panacea.

The state of the $50 billion-asset threshold, which now defines a "systemically important financial institution," was one of a host of issues Lew addressed in his annual testimony before lawmakers.

Appearing before the House Financial Services Committee, he also downplayed the effects of a key Dodd-Frank Act rule in driving recent market volatility and praised progress by international regulators to create regimes that can resolve failing behemoths.

Below are three key things Lew said about the state of financial regulatory policy.

Raising SIFI Threshold Not the 'Only Solution'

A higher asset cutoff to decide which institutions face the tougher supervisory regime — managed by the Federal Reserve Board — has been the subject of intense congressional debate. Dodd-Frank also allows the Financial Stability Oversight Council, which Lew chairs, to recommend raising the threshold for certain supervisory standards.

While Lew signaled that raising the threshold has been part of conversations among FSOC officials, he said the cutoff was only one issue. Lew emphasized instead regulators' ability to tailor the effects on institutions subject to certain rules based on their sizes. For example, a Wall Street behemoth might be treated differently than a medium-sized bank that still exceeded the $50 billion line.

"We have been very much trying to stay focused on making sure that the burdens on medium-sized institutions are appropriate to those institutions," Lew said.

Rep. Randy Neugebauer, R-Texas, repeatedly asked Lew about whether the Treasury secretary was willing to see the threshold raised, and whether FSOC is seriously looking at such a change.

Lew said he "wasn't aware of a formal review," but he did suggest that raising the threshold has been part of regulatory discussions and he wasn't "ruling out" action.

Neugebauer pointed to a recent study by the Office of Financial Research that evaluated the most systemically important institutions based on factors like interconnectedness and complexity.

"Interestingly enough, the results demonstrate a huge variation in systemic importance between the largest banks and the regional banks," the Texas Republican said.

But Lew largely focused on the flexibility regulators already have in setting the prudential standards.

"I don't think there's any question that a $50 billion institution has different characteristics than a money center bank, and I don't think that the only solution is to move the limit — it's to look at what are you doing to make sure that you're appropriately looking at institutions of different sizes," he said.

Lew's position is similar to that expressed by Federal Reserve Board Chair Janet Yellen when she testified before Congress last month. Meanwhile, other top officials, including Fed Gov. Daniel Tarullo, have previously signaled support for raising the threshold.

Volcker Rule Didn't Cause Market Volatility in October

Lew pushed back on claims that banking rules, particularly the Volcker Rule ban on banks' proprietary trading, were at the root of market volatility in October.

Traders saw intense fluctuations Oct. 15 in the yields on Treasuries and other securities. Some financial institutions and traders have said that such volatility can be blamed in part on tighter regulation, which have reduced market liquidity.

"Do you think that is at all connected to diminished liquidity provided by those that institutions that have gotten out of prop trading in anticipation of Volcker?" Rep. Patrick McHenry, R-N.C., said, addressing Lew.

But Lew defended the trading ban, saying other news developments that day could have been involved. He noted that it was "generally an off-risk kind of mood in the market that day."

"We are concerned about making sure that we maintain the most liquid markets in the world" but "I do think it's a mistake to attribute to regulatory policy what happened on October 15," he said.

Lew also pointed to other changes in the financial markets that could have a role determining the availability of liquidity, like greater participation by hedge funds and other firms not subject to the Volcker Rule.

"The evolution of the market is being driven by a lot of factors at the same time, so I'm reluctant to attribute causality to any one thing," he said. "You have different players in the market, a different mix of where the velocity is coming from — many of whom are not covered by Volcker. So I think this is something that requires a lot of analysis."

New "Loss Absorbing" Rules for Big Banks Key

The Treasury secretary defended ongoing work by international regulators to develop new balance sheet standards designed to avert another financial crisis.

The Financial Stability Board issued its proposed "total loss-absorbing capacity" measure in November, which requires big banks to hold sufficient capital and convertible debt that could be used to recapitalize a bridge bank in the event of an institution's failure. U.S. companies will not be subject to the standard until a version is implemented by the Fed.

"The United States has played a leadership role in pushing towards having TLAC be adopted — this is a preliminary step," Lew said.

Rep. Jeb Hensarling, R-Texas, chairman of the banking panel, raised concerns about the FSB's proposed exemption for three large Chinese financial institutions, including the Industrial and Commercial Bank of China, the largest bank in the world. He pressed Lew on whether the U.S. had signed off on those exemptions.

"The FSB acts by consensus," Lew said, noting that he was not familiar with the specifics of the exemptions.

Of the TLAC proposal, Lew added, "What was put forward was a preliminary document that I think would very much strengthen the financial stability of the global system, but it's not yet in place."