This is normally a sleepy time of year, but the last week has been unusually eventful. Below is a roundup of BPI’s recent publications and other notable events as we head into the next Administration and Congress, followed by our top 10 most read posts of 2024.
Happy holidays!
- The CFPB announced legal action against Early Warning Services and several of its owner banks. The Bureau wrongly alleges that Zelle failed to protect its users from fraud. BPI’s response highlights how the announcement is emblematic of the Bureau’s track record of stretching UDAAP beyond its statutory bounds to advance narratives that have no basis in law.
- The economics of synthetic risk transfers. A BPI post this week explains how synthetic risk transfers, or SRTs, allow banks to manage their lending and balance sheets more efficiently by transferring the credit risk of loans to investors while keeping loans on their books. SRTs, increasingly popular in the U.S. as capital requirements significantly exceed the underlying risk of certain loans and other assets, can increase credit availability.
- The CFPB’s Section 1033 rule isn’t “open banking.” The CFPB’s recently finalized rule on consumer financial data sharing attempts to create a framework for consumer data-sharing but fails to fulfill the key principles of “open banking,” such as critical security and oversight elements and clear rules for apportioning liability, a BPI blog post explains.
- Trump and the Fed. A Wall Street Journal editorial this week recommended how President-elect Donald Trump could remake the Federal Reserve’s leadership without firing Jerome Powell – dismissing Michael Barr, Vice Chair for Supervision, based on “his regulatory failures.” The editorial cites the Basel Endgame proposal and the Silicon Valley Bank supervisory failure as evidence of Barr’s failed tenure.
- FDIC on capital distributions, AML. The FDIC at a meeting this week released two “discussion drafts.” The first, led by CFPB Director and FDIC member Rohit Chopra, articulates a policy that the FDIC views bank dividends or buybacks as “unsafe and unsound” during times of economic stress, such as when the Fed establishes an emergency lending program under Section 13(3). This proposal would hurt banks’ ability to raise capital, contradict assumptions in the Fed’s stress tests and disadvantage FDIC-supervised banks over those overseen by the OCC and Fed, Vice Chair Travis Hill said in a statement. It would also create other problematic, arbitrary discrepancies. The draft was presented by Director Chopra for discussion only, and he did not request a vote by the FDIC board, so it does not have any legal effect. BPI has published several pieces on the problems with restricting banks’ capital distributions. The FDIC discussion draft on AML – also presented by Chopra and not put out for a vote, therefore having no legal effect – suggests that the FDIC could terminate a bank’s deposit insurance if a bank is convicted of offenses related to money laundering activity.
Other developments:
- The Wall Street Journal published a column on Sunday examining how pressure from the government for bank account closures is contributing to the problem of “debanking.” Nick Anthony from the Cato Institute also circulated a reminder on the origins of “Operation Choke Point.”
- The OCC released its semiannual report highlighting key risks in the banking system, emphasizing cyber risk.
- The CFPB issued a circular warning that credit card programs “devaluing” rewards like airline miles and points may be violating the law. The CFPB simultaneously launched a new biased credit card comparison tool with messaging designed to discourage consumers from exploring diverse and competitive credit card offerings.
- BITS, BPI’s technology policy division, commented this week on the Financial Stability Board’s initiative to standardize global cyber incident reporting efforts. The “Format for Incident Reporting Exchange” seeks to improve coordination between regulators and the private sector by ensuring that the data required for incident reporting are more consistent across jurisdictions. “BPI welcomes the FSB’s effort to develop a more uniform framework for cyber incident reporting,” Patrick Warren, Vice President of Regulatory Technology for BITS, said in a statement. The press release highlights that the next question that global regulators should confront is whether the existing bank examination regime adds any value to bank cyber defenses or instead serves as a distraction and misallocation of resources.
- A planned Senate vote on two nominations – Democratic SEC Commissioner nominee Caroline Crenshaw and Financial Stability Oversight Council nominee Gordon Ito – was scrapped this week.
- BPI published a summary of a recent money markets symposium and an explainer of how blockchain’s customizability and programmability can make it a useful tool in banking.
BPI Holiday Highlights: Top 10 Most Read Posts of 2024
1) 4 Key Fixes to the Banking Agencies’ Long-Term Debt Proposal
Jan. 25, 2024
The banking agencies proposed to require regional banks to issue long-term debt to bolster their resilience. However, the proposal’s costs outweigh its benefits. Four key fixes could improve it.
2) The Bank Examination Problem, and How to Fix It
July 17, 2024
Bank examination is in an unseen crisis. The examination regime is failing at its core mission and driving good assets and good people out of the banking industry. It is also degrading banks’ ability to support the growth of the U.S. economy. The crisis plays out unseen by the public because the examination regime operates in secret. While regulations like capital and liquidity requirements are visible, the sheer scale and scope of the banking examination force represent the rest of the iceberg beneath the water’s surface. Unaccountable, ineffective examination comes at the cost of banks’ innovation and efficiency and their ability to drive economic growth.
The banking agencies have increasingly used unaccountable, secret “supervision” rather than public orders and regulation to enforce change at banks. This fundamental problem must be resolved. Three steps could improve the broken system:
- Eliminate the vague and unaccountable “Management” part of the CAMELS rating system.
- Direct examiners’ focus onto material risks.
- Rethink staffing in the examination workforce.
3) A Helpful Federal Reserve Board Statement on Bank Liquidity
Aug. 21, 2024
On Tuesday, Aug. 13, the Federal Reserve Board brought some helpful clarity to a key part of bank liquidity regulation. The Fed published an FAQ stating that, as part of banks’ internal liquidity stress tests, banks can point to their capacity to borrow against their highly liquid assets at the Fed’s discount window, the Fed’s standing repo facility or Federal Home Loan Banks as a means to convert those highly liquid assets to cash, or “monetize” them. This statement brings more clarity to a question in focus after the failure of SVB.
The public FAQ release is a constructive step and will enhance transparency and financial stability, but further questions warrant clarification.
4) Deep Dive: DFAST 2024 Stress Test Scenarios
Feb. 22, 2024
The Federal Reserve on Feb. 15, 2024, released the scenarios for this year’s stress tests. These include:
- The severely adverse scenario and global market shock component, which are used to calculate large banks’ stress capital charge. The former evaluates a bank’s ability to withstand a severe macroeconomic recession and is designed to set a bank-specific capital buffer. The latter is imposed on banks with major trading operations and results in additional losses that feed into the bank’s stress capital charge.
- Four additional exploratory scenarios to evaluate banks’ resilience to funding stress combined with rising interest rates and a global recession. The results of these scenarios will not be used to calculate a capital charge and the Fed will only release the aggregate results.
This year’s scenario: Overall, the 2024 stress scenario appears to be somewhat more severe than last year’s scenario, especially with respect to the assumed path of equity prices and corporate bond spreads. In addition, some of the GMS risk factors are more severe than last year’s scenario. While many banks begin the exercise with a robust level of net interest income, potentially mitigating the heightened stress severity, the initial higher level of noninterest expenses could offset the anticipated improvement in pre-provision net revenue in this year’s stress tests. Like last year, banks are expected to see an increase in the fair value of their available-for-sale securities driven by the decrease in interest rates in the severely adverse scenario.
BPI projections suggested that this year’s stress test will result in a slightly higher reduction in projected bank capital ratios than last year’s stress test for banks in Categories I through IV. The greater severity of market shocks and a rise in provisions for loan and lease losses drive the higher aggregate decline in banks’ capital ratios.
5) How the Federal Reserve Got So Huge, and Why and How It Can Shrink
Feb. 7, 2024
In a paper published in the Southern Economic Journal and as a BPI staff working paper, BPI Chief Economist Bill Nelson describes the Fed’s evolution from a monetary policy framework using only the necessary level of reserves to its current excessive-reserves framework. For decades, the Fed borrowed from banks only the amount of reserve balances – banks’ deposits at the Fed – that the banks considered necessary for payment purposes and to satisfy reserve requirements. But in the wake of the Global Financial Crisis, the central bank shifted to borrowing more reserves than banks needed to satisfy reserve requirements and payment clearing needs. As Nelson details, this fundamental change in approach has led to a sprawling balance sheet, a dried-up interbank lending market and a massive central bank entangled in the economy. Furthermore, the excessive-reserves system has not produced its purported benefits, according to the paper. Nelson describes how the Fed can shrink and return to normal without causing market turmoil.
6) The Credit Card Market is Not Even Close to Being Overly Concentrated
April 18, 2024
Some critics of the proposed merger between Capital One and Discover claim the credit card market is overly concentrated and the merger would harm competition – but the reality shows otherwise. A BPI blog post illustrates the high level of competition and choice that consumers actually experience in this market.
7) Basel III Endgame: Why a Comprehensive Quantitative Impact Analysis and Reproposal are Essential
May 14, 2024
The Basel proposal has important implications for the cost of loans, market liquidity, custody, the role of banks in the financial system and the overall growth of the U.S. economy. Parsing the proposal’s specific impacts — not just on banks, but on the households and businesses that use their products — is essential and required by law. But a QIS alone isn’t sufficient to address the proposal’s ripple effects on the economy, satisfy legal requirements and remedy the procedural missteps in the process so far. The banking agencies must undertake both a comprehensive impact study of the proposal’s costs and a reproposal of the rule.
8) Making Sense of the Federal Reserve’s Report on Supervisory Developments
Nov. 19, 2024
The Federal Reserve’s latest report on supervision and regulation paints a paradoxical picture. While it asserts the banking system is “sound and resilient,” it also asserts that two-thirds of large financial institutions were rated less than satisfactory in the first half of 2024 — despite these firms holding 85% of bank assets under Fed supervision.
With two-thirds of LFIs rated unsatisfactory — and therefore not “well-managed” — apparently based on governance and controls component downgrades, it is time to consider whether this is truly the intended outcome under the rating system. If it’s not, it is time for the Federal Reserve to consider appropriate adjustments. The Fed’s supervisory ratings need clearer standards and disclosures to ensure they reflect genuine risks to the financial system. The troubled federal banking examination regime is a Matter Requiring Immediate Attention.
9) 10 Pitfalls to Avoid When Designing Any New Liquidity Requirements
Feb. 26, 2024
The bank failures in spring 2023 have increased recognition of the importance of the discount window for liquidity risk management. The focus on discount window preparedness is a welcome development, but any new liquidity requirement should be developed thoughtfully and with input from all stakeholders. This note describes 10 pitfalls the banking agencies should seek to avoid when making changes to liquidity regulations. Those include:
- Be Clear on the Objective
- Do Not Repeat the Mistakes of the Past
- Please, No More Ratio
- Repos Provide Their Own Collateral if They Don’t Roll
- Reduce the Stigma Associated With Using the Discount Window
- Don’t Use Liquidity Requirements to Fix Other Problems
- Give Notice and Seek Comment Through an Advance Notice of Proposed Rulemaking
- Don’t Create an Inferior Rule Just So It Can Be Applied Uniformly to Institutions of All Sizes
- Make Conforming Changes to the Rest of the Liquidity Assessment Framework
- Eventually, Revisit the International Standard for the LCR
10) Is the Subprime Segment of the Credit Card Market Concentrated?
May 31, 2024
A recent criticism of the proposed Capital One acquisition of Discover Financial Services is that the deal would raise the concentration of the credit card market to a level that is potentially anti-competitive, if subprime borrowers were considered in a separate category. According to this view, subprime borrowers – those with lower credit scores and higher-risk credit profiles – would be more vulnerable to price increases through higher fees and interest rates because they would have fewer options available to them than borrowers presenting lower credit risk. A BPI analysis examines the proposed merger’s impact on concentration in the subprime and prime segments of the credit card market.
What BPI found: BPI’s analysis provides a fuller picture of the subprime segment of the consumer credit card market compared to previous commentary on the issue and finds that it would remain competitive following this merger. The analysis more fully accounts for card issuers with a major presence in the subprime market and shows that even if subprime is considered a separate market (although there is little reason to think it should be) for evaluating the competitive effects of the proposed merger, concentration would not rise to a level that raises competitive concerns.
