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115th Congress   }                                      {      Report
                        HOUSE OF REPRESENTATIVES
 2d Session      }                                      {     115-574

======================================================================

 
  TO PLACE REQUIREMENTS ON OPERATIONAL RISK CAPITAL REQUIREMENTS FOR 
  BANKING ORGANIZATIONS ESTABLISHED BY AN APPROPRIATE FEDERAL BANKING 
                                 AGENCY

                                _______
                                

 February 23, 2018.--Committed to the Committee of the Whole House on 
            the State of the Union and ordered to be printed

                                _______
                                

Mr. Hensarling, from the Committee on Financial Services, submitted the 
                               following

                              R E P O R T

                             together with

                             MINORITY VIEWS

                        [To accompany H.R. 4296]

      [Including cost estimate of the Congressional Budget Office]

    The Committee on Financial Services, to whom was referred 
the bill (H.R. 4296) to place requirements on operational risk 
capital requirements for banking organizations established by 
an appropriate Federal banking agency, having considered the 
same, report favorably thereon with an amendment and recommend 
that the bill as amended do pass.
    The amendment is as follows:
  Strike all after the enacting clause and insert the 
following:

SECTION 1. OPERATIONAL RISK CAPITAL REQUIREMENTS FOR BANKING 
                    ORGANIZATIONS.

  (a) In General.--An appropriate Federal banking agency may not 
establish an operational risk capital requirement for banking 
organizations, unless such requirement--
          (1) is based primarily on the risks posed by a banking 
        organization's current activities and businesses;
          (2) is appropriately sensitive to the risks posed by such 
        current activities and businesses;
          (3) is determined under a forward-looking assessment of 
        potential losses that may arise out of a banking organization's 
        current activities, businesses, and exposures, which is not 
        solely based on a banking organization's historical losses; and
          (4) permits adjustments based on qualifying operational risk 
        mitigants.
  (b) Definitions.--For purposes of this section:
          (1) Appropriate federal banking agency.--The term 
        ``appropriate Federal banking agency''--
                  (A) has the meaning given such term under section 3 
                of the Federal Deposit Insurance Act; and
                  (B) means the National Credit Union Administration, 
                in the case of an insured credit union.
          (2) Banking organization.--The term ``banking organization'' 
        means--
                  (A) an insured depository institution (as defined 
                under section 3 of the Federal Deposit Insurance Act);
                  (B) an insured credit union (as defined under section 
                101 of the Federal Credit Union Act);
                  (C) a depository institution holding company (as 
                defined under section 3 of the Federal Deposit 
                Insurance Act);
                  (D) a company that is treated as a bank holding 
                company for purposes of section 8 of the International 
                Banking Act; and
                  (E) a U.S. intermediate holding company established 
                by a foreign banking organization pursuant to section 
                252.153 of title 12, Code of Federal Regulations.

                          PURPOSE AND SUMMARY

    Introduced by Representative Luetkemeyer on November 8, 
2017, H.R. 4296 restricts federal banking agencies from 
establishing operational risk capital requirements for banking 
organizations unless they are sensitive to, and based on, an 
organization's current activities or businesses; are determined 
by a forward-looking assessment of an organization's potential 
losses and not based solely on its historic losses; and allow 
for adjustments based on qualifying operational risk mitigants.

                  BACKGROUND AND NEED FOR LEGISLATION

    In response to the 2008 financial crisis, the Basel 
Committee on Banking Supervision (Basel Committee), of which 
the United States is a member, agreed to modify internationally 
negotiated bank regulatory standards known as the Basel Accords 
to increase bank capital requirements and other regulatory 
measures. The Basel Accords are international banking 
regulations negotiated between participating regulators, but 
they rely on local implementation to take effect in a nation's 
financial regulatory regime.
    The Dodd-Frank Wall Street Reform and Consumer Protection 
Act (P.L. 111-203) codified the Basel III capital standards and 
the U.S. federal banking regulators--including the Federal 
Deposit Insurance Corporation (FDIC), Board of Governors of the 
Federal Reserve System (Federal Reserve), and Office of the 
Comptroller of the Currency (OCC)--promulgated rules to 
implement these standards on July 9, 2013.
    As defined by the Basel Committee, operational risk refers 
to ``. . . the risk of loss resulting from inadequate or failed 
internal processes, people and systems or from external events 
. . . [t]his definition includes legal risk, but excludes 
strategic and reputational risk.''\1\ In other words, a bank's 
own direct actions or relationships could lead to losses, and 
therefore should be accounted for by regulators when 
establishing capital requirements to ensure financial 
stability.
---------------------------------------------------------------------------
    \1\https://www.bis.org/publ/bcbs195.pdf.
---------------------------------------------------------------------------
    In October 2013, the OCC, FDIC, and Federal Reserve, in 
conjunction with the Treasury Department, published a final 
rule ``. . . that requires some and permits other qualifying 
banks to use an internal ratings-based approach to calculate 
regulatory credit risk capital requirements and advanced 
measurement approaches to calculate regulatory operational risk 
capital requirements.''\2\ The rule took effect on January 1, 
2014.
---------------------------------------------------------------------------
    \2\https://www.federalreserve.gov/reportforms/formsreview/
BaselIII_20131011_ffr.pdf.
---------------------------------------------------------------------------
    Because operational risk capital requirements substantially 
dictate a bank's capital levels, it is important that any 
future Basel approach-turned-U.S. rule does not unnecessarily 
increase capital requirements at the expense of consumers' 
credit needs. Unreliable and under-calibrated calculations 
could result in hundreds of billions of dollars in capital that 
could be more efficiently deployed to meet consumers' credit 
needs.
    All banking organizations should adopt policies and 
procedures to identify and manage operational risk that are 
appropriate based on their size, activities, and product 
offerings in order to ensure a stable and resilient financial 
industry. But, requiring banking organizations to ``look back'' 
and hold operational risk capital against discontinued business 
activities or products distorts the risk environment and may 
force misguided over-retention of capital. This over-retention 
of capital is a problem because it reduces a bank's lending 
capacity, which in turn harms both consumers and businesses of 
all sizes as it drastically limits the amount of available 
credit in the marketplace.
    H.R. 4296 limits the imposition of operational risk capital 
requirements to a bank's current activities and businesses and 
permits adjustments for operational risk mitigants. Doing so 
will ensure that banks have the proper incentives financial to 
mitigate operational risk, and if a bank exits one or more 
business lines, the regulatory response does not increase 
complexity and retain the backward-looking nature of current 
operational risk capital requirements. H.R. 4296 will ensure a 
vibrant consumer credit market.

                                HEARINGS

    The Committee on Financial Services held a hearing 
examining matters relating to H.R. 4296 on April 26, 2017 and 
April 28, 2017.

                        COMMITTEE CONSIDERATION

    The Committee on Financial Services met in open session on 
November 14, 2017, and November 15, 2017, and ordered H.R. 4296 
to be reported favorably to the House without amendment by a 
recorded vote of 43 yeas to 17 nays (Record vote no. FC-108), a 
quorum being present.

                            COMMITTEE VOTES

    Clause 3(b) of rule XIII of the Rules of the House of 
Representatives requires the Committee to list the record votes 
on the motion to report legislation and amendments thereto. The 
sole recorded vote was on a motion by Chairman Hensarling to 
report the bill favorably to the House without amendment. The 
motion was agreed to by a recorded vote of 43 yeas to 17 nays 
(Record vote no. FC-108), a quorum being present.


                      COMMITTEE OVERSIGHT FINDINGS

    Pursuant to clause 3(c)(1) of rule XIII of the Rules of the 
House of Representatives, the findings and recommendations of 
the Committee based on oversight activities under clause 
2(b)(1) of rule X of the Rules of the House of Representatives, 
are incorporated in the descriptive portions of this report.

                    PERFORMANCE GOALS AND OBJECTIVES

    Pursuant to clause 3(c)(4) of rule XIII of the Rules of the 
House of Representatives, the Committee states that H.R. 4296 
will restrict banking regulators from establishing operational 
risk capital requirements for banking organizations unless they 
are sensitive to, and based on, an organization's current 
activities or businesses; are determined by a forward-looking 
assessment of an organization's potential losses and not based 
solely on its historic losses; and allow for adjustments based 
on qualifying operational risk mitigants.

   NEW BUDGET AUTHORITY, ENTITLEMENT AUTHORITY, AND TAX EXPENDITURES

    In compliance with clause 3(c)(2) of rule XIII of the Rules 
of the House of Representatives, the Committee adopts as its 
own the estimate of new budget authority, entitlement 
authority, or tax expenditures or revenues contained in the 
cost estimate prepared by the Director of the Congressional 
Budget Office pursuant to section 402 of the Congressional 
Budget Act of 1974.

                 CONGRESSIONAL BUDGET OFFICE ESTIMATES

    Pursuant to clause 3(c)(3) of rule XIII of the Rules of the 
House of Representatives, the following is the cost estimate 
provided by the Congressional Budget Office pursuant to section 
402 of the Congressional Budget Act of 1974:

                                     U.S. Congress,
                               Congressional Budget Office,
                                 Washington, DC, February 21, 2018.
Hon. Jeb Hensarling,
Chairman, Committee on Financial Services,
House of Representatives, Washington, DC.
    Dear Mr. Chairman: The Congressional Budget Office has 
prepared the enclosed cost estimate for H.R. 4296, a bill to 
place requirements on operational risk capital requirements for 
banking organizations established by an appropriate Federal 
banking agency.
    If you wish further details on this estimate, we will be 
pleased to provide them. The CBO staff contacts are Kathleen 
Gramp and Sarah Puro.
            Sincerely,
                                                Keith Hall,
                                                          Director.
    Enclosure.

H.R. 4296--A bill to place requirements on operational risk capital 
        requirements for banking organizations established by an 
        appropriate Federal banking agency

    Summary: H.R. 4296 would direct federal banking regulators 
to revise one of the formulas used to calculate the minimum 
amount of capital held by certain large, systemically important 
banks. Specifically, the bill would change the method banks use 
to estimate operating risk--the risk of losses stemming from 
inadequate or failed internal controls, fraud or errors caused 
by people and systems, or external events such as cyberattacks. 
Regulators currently require banks to estimate operating risk 
based in part on historical experience. Under the bill, such 
risk would be calculated largely on the basis of forward-
looking models that reflect each bank's business activities.
    CBO estimates that enacting H.R. 4296 would increase the 
deficit by $22 million over the 2018-2027 period. That figure 
includes an increase of $26 million in direct spending and an 
increase of $4 million in revenues. Because enacting the bill 
would affect direct spending and revenues, pay-as-you-go 
procedures apply.
    CBO estimates that enacting H.R. 4296 would not increase 
net direct spending or on-budget deficits by more than $2.5 
billion in one or more of the four consecutive 10-year periods 
beginning in 2028.
    H.R. 4296 contains no intergovernmental or private-sector 
mandates as defined in the Unfunded Mandates Reform Act (UMRA).
    Estimated cost to the Federal Government: The estimated 
budgetary effect of H.R. 4296 is shown in the following table. 
The costs of the legislation fall within budget function 370 
(advancement of commerce).

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                       By fiscal year, in millions of dollars--
                                                             -------------------------------------------------------------------------------------------
                                                               2018   2019   2020   2021   2022   2023   2024   2025   2026   2027  2018-2022  2018-2027
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                              INCREASES IN DIRECT SPENDING
 
Estimated Budget Authority..................................      0      1      2      3      4      4      3      3      3      3        10         26
Estimated Outlays...........................................      0      1      2      3      4      4      3      3      3      3        10         26
 
                                                                  INCREASES IN REVENUES
 
Estimated Revenues..........................................      0      0      0      0      0      0      1      1      1      1         0          4
 
                                       NET INCREASE IN THE DEFICIT FROM INCREASES IN DIRECT SPENDING AND REVENUES
 
Effect on the Deficit.......................................      0      1      2      3      4      4      2      2      2      2        10         22
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Basis of estimate: The budgetary effects of the bill stem 
from the small chance that the Federal Deposit Insurance 
Corporation (FDIC) would incur additional costs to resolve 
failed financial institutions. For this estimate, CBO assumes 
that the bill will be enacted near the end of 2018.
    CBO's estimates for H.R. 4296 are based on the analysis 
underlying the projections for deposit insurance in its June 
2017 baseline. Those projections incorporate a small 
probability of a financial crisis in any given year during the 
projection period and the more likely scenario of an average 
number of bank and credit union failures in any given year. As 
a result, the estimated cost of this legislation represents a 
weighted probability of outcomes--including some cases for 
which the probability is very low but for which the costs to 
the Deposit Insurance Fund (DIF) or the Orderly Liquidation 
Fund (OLF) are much larger than in average years. Costs 
incurred by the DIF are recovered over time by assessments on 
insured depository institutions (IDIs). Fees paid to recover 
costs incurred by the OLF are classified in the budget as 
revenues. Both funds are administered by the FDIC.
    CBO anticipates that the directives in H.R. 4296 would 
apply to around 10 bank holding companies and their insured 
depository subsidiaries that currently estimate capital 
requirements using what the FDIC refers to as advanced 
approaches. The net effect of implementing the bill would vary 
among those institutions because the measure that reflects 
operating risks is only one of many methods used by federal 
regulators to determine how much capital a bank must hold.\1\ 
CBO estimates that in fiscal year 2017, the advanced-approaches 
formula was used to determine capital requirements for 
companies that accounted for about 20 percent of the assets 
held by bank holding companies subject to that standard and for 
about 5 percent of the assets held by IDIs.
---------------------------------------------------------------------------
    \1\Regulators use several other methods of assessment, including 
information on a bank's standard measure of risk-weighted assets, a 
bank's assets adjusted for off-balance sheet activities, and the level 
of assets needed to absorb losses during times of stress.
---------------------------------------------------------------------------
    Using studies by the Federal Reserve and others, CBO 
anticipates that changing to forward-looking models as required 
by H.R. 4296 probably would lower firm's estimates of their 
operating risks, thereby lowering the amount of capital they 
would be required to hold.\2\ Although there is considerable 
uncertainty surrounding the magnitude of such changes, CBO 
expects that the net change would be limited to the difference 
in capital identified by the new method and that identified by 
existing regulatory formulas. On balance, CBO estimates that, 
relative to current practice, enacting the bill would reduce 
the total capital held by the all of the large bank holding 
companies by less than 2 percent and for the IDIs subject to 
the standard by less than 0.5 percent.
---------------------------------------------------------------------------
    \2\See Marco Migueis, Forward-Looking and Incentive-Compatible 
Operational Risk Capital Framework, Finance and Economics Discussion 
Series 2017-087 (Federal Reserve Board, May 2017), https://doi.org/
10.17016/FEDS.2017.087 (PDF, 383 KB).
---------------------------------------------------------------------------
    Changes in a bank's capital requirements may affect its 
probability of failure or the magnitude of future losses, which 
in turn may affect costs incurred by the DIF or the OLF. Most 
of the costs of enacting the legislation would be incurred by 
the OLF, CBO estimates, because enacting the bill would have a 
greater effect on the capital held by bank holding companies. 
(The OLF is authorized to resolve financial difficulties for 
large, systemically important financial firms that become 
insolvent or are in danger of becoming insolvent.) CBO 
estimates that enacting the bill would increase the deficit by 
$22 million, or by roughly 0.03 percent of CBO's June baseline 
projection of the 10-year cost of the FDIC's programs. That 
amount includes an increase in direct spending of $26 million 
and an increase of revenues of $4 million. CBO estimates that 
most of those costs would be offset after 2027 by increases in 
fees paid by financial firms.
    Pay-As-You-Go considerations: The Statutory Pay-As-You-Go 
Act of 2010 establishes budget-reporting and enforcement 
procedures for legislation affecting direct spending or 
revenues. The net changes in outlays and revenues that are 
subject to those pay-as-you-go procedures are shown in the 
following table.

       CBO ESTIMATE OF PAY-AS-YOU-GO EFFECTS FOR H.R. 4296, AS ORDERED REPORTED BY THE HOUSE COMMITTEE ON FINANCIAL SERVICES ON NOVEMBER 15, 2017
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                       By fiscal year, in millions of dollars--
                                                             -------------------------------------------------------------------------------------------
                                                               2018   2019   2020   2021   2022   2023   2024   2025   2026   2027  2018-2022  2018-2027
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                          NET INCREASE IN THE ON-BUDGET DEFICIT
 
Statutory Pay-As-You-Go Impact..............................      0      1      2      3      4      4      2      2      2      2        10         22
Memorandum:
    Changes in Outlays......................................      0      1      2      3      4      4      3      3      3      3        10         26
    Changes in Revenues.....................................      0      0      0      0      0      0      1      1      1      1         0          4
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Increase in long-term direct spending and deficits: CBO 
estimates that enacting the legislation would not increase net 
direct spending or on-budget deficits by more than $2.5 billion 
in any of the four consecutive 10-year periods beginning in 
2028.
    Mandates: H.R. 4296 contains no intergovernmental or 
private-sector mandates as defined in UMRA.
    Previous CBO estimate: On May 18, 2017, CBO transmitted a 
cost estimate for H.R. 10, the Financial CHOICE Act, as ordered 
reported by the House Committee on Financial Services on May 4, 
2017. H.R. 4296 is identical to section 152 of H.R. 10. The CBO 
cost estimates are different for this provision, however, 
because H.R. 10 also would eliminate the OLF. As a result, 
CBO's cost estimate for section 152 of H.R. 10 did not include 
any costs to the OLF.
    Estimate prepared by: Federal costs: Kathleen Gramp and 
Sarah Puro; Mandates: Rachel Austin.
    Estimate approved by: H. Samuel Papenfuss; Deputy Assistant 
Director for Budget Analysis.

                       FEDERAL MANDATES STATEMENT

    This information is provided in accordance with section 423 
of the Unfunded Mandates Reform Act of 1995.
    The Committee has determined that the bill does not contain 
Federal mandates on the private sector. The Committee has 
determined that the bill does not impose a Federal 
intergovernmental mandate on State, local, or tribal 
governments.

                      ADVISORY COMMITTEE STATEMENT

    No advisory committees within the meaning of section 5(b) 
of the Federal Advisory Committee Act were created by this 
legislation.

                  APPLICABILITY TO LEGISLATIVE BRANCH

    The Committee finds that the legislation does not relate to 
the terms and conditions of employment or access to public 
services or accommodations within the meaning of the section 
102(b)(3) of the Congressional Accountability Act.

                         EARMARK IDENTIFICATION

    With respect to clause 9 of rule XXI of the Rules of the 
House of Representatives, the Committee has carefully reviewed 
the provisions of the bill and states that the provisions of 
the bill do not contain any congressional earmarks, limited tax 
benefits, or limited tariff benefits within the meaning of the 
rule.

                    DUPLICATION OF FEDERAL PROGRAMS

    In compliance with clause 3(c)(5) of rule XIII of the Rules 
of the House of Representatives, the Committee states that no 
provision of the bill establishes or reauthorizes: (1) a 
program of the Federal Government known to be duplicative of 
another Federal program; (2) a program included in any report 
from the Government Accountability Office to Congress pursuant 
to section 21 of Public Law 111-139; or (3) a program related 
to a program identified in the most recent Catalog of Federal 
Domestic Assistance, published pursuant to the Federal Program 
Information Act (Pub. L. No. 95-220, as amended by Pub. L. No. 
98-169).

                   DISCLOSURE OF DIRECTED RULEMAKING

    Pursuant to section 3(i) of H. Res. 5, (115th Congress), 
the following statement is made concerning directed 
rulemakings: The Committee estimates that the bill requires no 
directed rulemakings within the meaning of such section.

             SECTION-BY-SECTION ANALYSIS OF THE LEGISLATION

Section 1. Operational risk capital requirements for banking 
        organizations

    This section prohibits a Federal banking agency from 
establishing an operational risk capital requirement for 
banking organizations, unless such a requirement:
          (1) is based primarily on the risks posed by a 
        banking organization's current activities and 
        businesses;
          (2) is appropriately sensitive to the risks posed by 
        such current activities and businesses;
          (3) is determined under a forward-looking assessment 
        of potential losses that may arise out of a banking 
        organization's current activities, businesses, and 
        exposures, which is not solely based on a banking 
        organization's historical losses; and
          (4) permits adjustments based on qualifying 
        operational risk mitigants.
    This section also defines the various terms utilized within 
the Act.

         CHANGES IN EXISTING LAW MADE BY THE BILL, AS REPORTED

    H.R. 4296 does not repeal or amend any section of a 
statute. Therefore, the Office of Legislative Counsel did not 
prepare the report contemplated by clause 3(e)(1)(B) of rule 
XIII of the Rules of the House of Representatives.

                             MINORITY VIEWS

    H.R. 4296 would place new, statutory conditions on how 
regulators implement a specific capital requirement relating to 
operational risk, and if the conditions are not satisfied, then 
the capital requirement would be prohibited. Operational risk 
capital is required to be held by a dozen or so of our largest, 
internationally-active megabanks. And, it relates to 
operational risks, such as legal liability and operational 
breakdowns of these megabanks. These operational failures 
include JPMorgan's ``London Whale'' trades and Wells Fargo's 
long list of violations that have ripped off millions of 
consumers, including those harmed by their fraudulent account 
scandal.
    These same large Wall Street banks would benefit from 
changes to this capital requirement, which cause harm not only 
to consumers but the broader economy. According to Stanford 
professor, Anat Admati, ``the fines banks paid in the past may 
well be indicative of future risk. There are enormous rates of 
recidivism in corporate misconduct.''
    According to a letter submitted to the Committee opposing 
H.R. 4296 as a big bank giveaway, Americans for Financial 
Reform wrote, ``operational risk capital is a new capital 
protection instituted at banks with over $250 billion in 
assets, to protect against the possibility that poor risk 
management or illegal behavior by bank employees will cause 
significant losses.'' These critical areas, include past and 
present cyber risk, rogue traders, risk management, and legal 
judgements. In conclusion, AFR wrote, ``HR 4296 is a 
transparent attempt to pressure regulators to reduce capital 
protections at the nation's largest banks, and must be 
rejected.''
    Furthermore, according to bank regulators and the Treasury 
Department, efforts have been underway internationally to make 
administrative and technical refinements to the operational 
risk capital requirement, and we should expect changes in the 
near future. Congress should closely monitor these developments 
to see if regulators strike the right balance, and if not, then 
consider a legislative response.
    Thus, H.R. 4296 is premature and possibly short-sighted to 
enact statutory conditions regarding the operational risk 
capital requirement. This framework would diminish, instead of 
strengthen, the incentive for megabanks to maintain stronger 
internal controls and risk management systems.
    After all, there has been tremendous progress since the 
financial crisis of 2007-2009 to create a far better 
capitalized banking system. As required by the Dodd-Frank Act--
and in implementing the international Basel III capital 
accords--our banking regulators have required banks to maintain 
more and higher quality capital. Republicans have long argued 
that these financial reforms would crush lending and harm banks 
and the broader economy. However, the facts tell a different 
story. Bank profits reached an all-time record high in 2016 and 
business lending is up 75 percent since 2010. All this has 
happened while U.S. banks added more than $700 billion in 
capital to absorb potential losses. According to Third Way, 
these reforms, including capital rules that have made our 
financial system safer, are estimated to add $351 billion to 
the U.S. economy over 10 years.
    For these reasons, we oppose H.R. 4296.

                                   Maxine Waters.
                                   Stephen F. Lynch.
                                   Michael E. Capuano.
                                   Vicente Gonzalez.
                                   Emanuel Cleaver.
                                   Al Green.
                                   Gwen Moore.
                                   Daniel T. Kildee.

                                  [all]