Federal Reserve Chair Janet Yellen Wednesday pushed back on key elements of House Financial Services Committee Chairman Jeb Hensarling's proposed overhaul of banking regulations.
In response to a question from a lawmaker at a committee hearing, Yellen was critical of doing away with the 2010 Dodd-Frank law's "orderly liquidation authority," the option that regulators have to manage the failure of a bank outside of bankruptcy. She also rejected an over-reliance on setting bank capital requirements through simple capital-to-asset ratios.
Both were part of Hensarling's proposal this month to scrap major parts of the Dodd-Frank law. Yellen's criticism is important because, while his plan has no chance of being adopted this year, it could serve as a blueprint for remaking financial regulations if the Republicans win the White House and keep control over Congress.
The Fed chair said repealing orderly liquidation authority would be a mistake since it is a "very important" backup for regulators. Hensarling's alternative to Dodd-Frank also included a proposal that banks could choose to accept a 10 percent leverage ratio to escape other post-crisis rules.
In response to another question from Rep. Gwen Moore, Yellen defended the practice of regulators applying certain risk weights to bank assets to determine capital requirements. She said it was a "very bad idea to only have a leverage ratio."
"That would encourage banking organizations to take on risk by loading up their balance sheets with riskier assets, and that happened prior to the financial crisis," she said. "It's why we went to risk-weighting. So I think it's useful to have such a ratio as a backup measure but not sufficient."
In a speech earlier this month, Hensarling said risk-weighting as a means to set minimum capital levels at banks was not as effective as a simpler leverage ratio. That's because it is "far too complex," gives a competitive advantage to large financial institutions that can navigate its "mind-numbing complexity," and that regulators "get the risk weights tragically wrong."
Later in the hearing, Rep. Sean Duffy referred to Hensarling's proposal and asked Yellen whether she opposed the idea of trading a higher leverage ratio and higher capital for regulatory exemptions elsewhere.
"I do think that for community banks it would be worthwhile to put in place a simplified capital regime," she said. Later she added that exchanging higher capital for a lighter regulatory touch would not work for the largest, systemically important banks.