Fed's Powell faces Wall Street firing line on Capitol Hill

Federal Reserve Chair Jerome Powell is getting a stark warning from top lawmakers as he prepares to testify on Capitol Hill this week: Back off the big banks.

It's a message that Wall Street executives and lobbyists have been trying to gin up for weeks leading up to Powell's congressional hearings Tuesday and Wednesday. The appearances are ostensibly about monetary policy but they allow lawmakers to ask anything they want of the Fed chief.

Big banks have been cultivating Capitol Hill allies as they try to head off what they fear will be a significant hike in the amount of funding they're required to have to absorb losses during economic downturns. Big bank leaders were in Washington making the case as recently as last week.

It's clear the push is already getting traction. Sen. Tim Scott (R-S.C.), joined by nine other Republicans who will be in a position to grill Powell this week, told the Fed chair in a letter Friday that there's no reason to hike capital requirements for the banks.

"Nobody is going to miss the point of this letter, which is hammering Jay Powell to testify the way Wall Street's biggest banks want him to testify, with the suggestion that there will be political consequences if he doesn't do that," said Dennis Kelleher, president and CEO of the watchdog group Better Markets.

In a financial policy space where crypto has become the bright, shiny object for Congress, the hearings are poised to reveal how much juice the big bank lobby still has in Washington. For Powell, it's a test of whether he wants to take on Wall Street in addition to the battle he's waging on inflation. The banks have framed the potential increase in regulation as a threat to the economy because they say it would force them to retrench in the services they provide — a familiar lobbyist talking point that may have new political salience as the U.S. stares at a potential recession.

"In response to higher capital requirements, banks have two choices," JPMorgan Chase CFO Jeremy Barnum said last week, summing up the banks' case at a Washington symposium hosted by the Bank Policy Institute trade association. "We can charge higher prices or we can do less lending. Both of those choices are ultimately bad for consumers and businesses."

Barnum's appearance in Washington was part of a broad lobbying effort by the industry to grab the attention of policymakers. The Bank Policy Institute, the Financial Services Forum and the Securities Industry and Financial Markets Association have been flooding email inboxes for weeks with arguments against raising capital requirements, in addition to closed-door meetings with lawmakers and their staffs. It's the industry's top issue in Washington this year.

The calibration of bank capital requirements has major ramifications for the economy. It requires regulators to strike a balance between preventing a financial crisis — which could be triggered by an unforeseen event, like a pandemic — while not limiting banks so much that it crimps economic growth.

“Every decision a bank makes first factors capital costs or benefits,” Federal Financial Analytics managing partner Karen Petrou, who advises lenders on policy, wrote last month.

The largest banks in the U.S. were subject to higher capital requirements after the 2008 global financial crisis, as regulators around the world sought to protect taxpayers from having to bail out the industry again during a future meltdown. Banks survived the depths of Covid-19, armed with bigger capital buffers and buoyed by a flood of government rescue money across the economy.

The issue is returning to the top of banks' agenda again because U.S. regulators are in the process of finalizing the last piece of the post-2008 capital rules, with a proposal expected by the summer.

But the Fed in the last couple of months has upped the ante.

Fed Vice Chair for Supervision Michael Barr, a Biden-appointed official who is the central bank's point man on regulation, triggered the banking lobby late last year when he announced plans for a "holistic" review of bank capital. He also signaled that he already had a view that the current rules aren't strong enough.

"History shows the deep costs to society when bank capital is inadequate, and thus how urgent it is for the Federal Reserve to get capital regulation right," Barr said in December. "In doing so, we need to be humble about our ability, or that of bank managers or the market, to fully anticipate the risks that our financial system might face in the future."

The lenders are complaining that Barr should be more transparent about the process, though he has taken time to speak with bank executives. Barr said in December that any rule changes would be subject to public notice and comment.

“It is an internal process," said Kevin Fromer, who represents executives of the largest U.S. banks as CEO of the Financial Services Forum. "We, as well as the rest of the public, are outside looking in.”

Barr isn't the only threat. Banks expect the Federal Deposit Insurance Corp., which is also led by a Biden appointee, is going to push for stricter rules as well. Senate Banking Chair Sherrod Brown (D-Ohio), who leads Congress's Fed oversight, has long argued for higher capital requirements and may provide political cover.

Now the big banks and their allies in Congress want to know whether Powell plans to defer to his colleagues or will intervene.

Scott, who is seen as a likely 2024 GOP presidential candidate, told Powell with fellow Republicans Friday that it was "incumbent on you" to oversee the capital review launched by Barr. They warned Powell against violating a 2018 law that eased bank regulations. And they echoed points made by the banking industry about the potential impact on borrowing costs, investment and the competitiveness of U.S. markets.

“We have received the letter and plan to respond," a Fed spokesperson said.

It’s unclear where Powell will come down on the issue. But during the Trump administration, he responded to calls by big banks to lower their capital requirements by saying that the levels were “about right,” and he dismissed suggestions that strict regulations were hurting their ability to compete with foreign banks. He supported moves to loosen rules around the edges.

The Republican-led House has made the issue a priority as it ramps up scrutiny of the Biden administration. Rep. Andy Barr (R-Ky.), who leads the subcommittee overseeing the Fed, said in a statement that he is planning "vigorous oversight" of the capital review. He will be one of the lawmakers grilling Powell this week.

"I am particularly focused on preventing regulators from imposing excessive requirements that would sideline capital as we continue to battle forty-year high inflation," Barr said.

Kelleher's group Better Markets is pushing back, arguing that capital standards should be raised to protect the economy from bank failures and taxpayer-funded bailouts.

"Congress's job is to ask questions," he said. "But their job isn't to try and basically work the refs by trying to bully them into an outcome that is not actually data-driven or risk-driven."