BPInsights: April 9, 2022

Stories Driving the Week

It’s Time to Close the ILC Loophole

A broad coalition of bank and credit union associations and consumer organizations, including BPI, submitted a letter this week to the U.S. House Committee on Financial Services urging passage of the Close the ILC Loophole Act, introduced by Representatives Chuy Garcia (D-IL) and Lance Gooden (R-TX).

The ILC loophole allows large technology companies — such as Japanese e-commerce firm Rakuten, whose primary business is monetizing consumer data — and other commercial firms to own and operate what is essentially a full-service FDIC-insured bank, and do so entirely free from the regulatory oversi­ght, activity limitations and prudential safeguards that apply to every other person who owns or operates a federally insured depository institution.

“Although ILCs have the powers of a commercial bank, their corporate owners — unlike the owners of commercial banks — are not subject to consolidated supervision and regulation by a federal banking agency, which can allow risks to build up in the organization outside the view of any federal supervisor. Simply put, this regulatory loophole creates safety and soundness risks for the institution, risks to the financial system and additional risks for consumers and taxpayers,” the groups wrote. “ILC owners should not have the ability to sell their status rights to the highest bidder and therefore exploit consumer data, undermine trust in our banking system and otherwise put our financial system at risk.  To put it more simply, allowing existing ILCs to transfer their rights to an unaffiliated party would be the legislative equivalent of attempting to close the barn door but leaving the side of the barn wide open.”

To learn more, click here.

Hsu Wants Large Regional Banks’ Resolution to Look More Like Big Banks’

Acting Comptroller Michael Hsu recently called for key changes that would force large regional banks to reduce deposit funding in favor of long-term debt by making their resolution resemble that of a Global Systemically Important Bank. “The failure of a large regional should not automatically create a more systemic GSIB. We need options,” Hsu said in a speech late last week.

In his view, a large regional bank should have:

• Single point of entry resolution: Only the parent company files for bankruptcy or is taken into receivership if the firm fails, to avoid the chaos of multiple bankruptcies at different units.
• TLAC: A minimum amount of long-term debt that could be “bailed in” in the case of failure is held at the parent company level.
• Separability: Ability to break off different business lines or large portfolios and sell them quickly.

M&A: Hsu alluded to the bank M&A environment in his speech. “Without the resolvability safeguards discussed today, I have concerns that [mergers involving large regional banks] could result in new TBTF firms, which would add to financial stability risk,” he said. “At the same time, prohibiting such mergers could shield the GSIBs from competition, potentially helping to solidify their dominance in various markets.” The OCC is currently considering a requirement for banks to commit to the three resolvability components noted above as a condition of granting large bank merger approvals, he said.

What’s New in Crypto

Treasury Secretary Janet Yellen previewed the Administration’s ongoing work on digital assets stemming from a recent executive order in a speech this week. She expressed support for “responsible innovation” that benefits working families and appropriately manages risks. She called for a consistent regulatory framework for stablecoins, warning of their potential illicit finance, systemic risk and run risk. She said regulation should be “tech neutral,” including enforcement of tax, AML and sanctions rules. Yellen also mentioned the important questions raised by a potential U.S. CBDC. BPI released a statement on the speech expressing support for the Administration’s commitment to obtaining adequate facts, data and research to guide its efforts on digital assets.

• On Capitol Hill: At a House hearing, several lawmakers pressed Yellen to crack down on sanctions evasion via digital assets. Yellen said Treasury has not detected “significant” crypto sanctions evasion so far, but is carefully monitoring any attempts.
• New stablecoin bill: Senate Banking Committee Ranking Member Pat Toomey (R-PA) unveiled a discussion draft of legislation that provides a regulatory framework for stablecoins. The bill would create a new license for stablecoins issued by the OCC. License holders would be precluded from other lines of business, including extending lines of credit, but they would have access to Federal Reserve accounts and services. The licensed stablecoin issuers would be required to maintain reserves in cash and assets easily converted to cash equivalent to 100 percent of their outstanding tokens, and attest monthly to the composition of those reserves. The bill would allow companies to opt for a state-level money transmitter license instead, and banks would be able to issue stablecoins with the option of segregating that business from other accounts, according to POLITICO.
• Gensler speech: SEC Chairman Gary Gensler outlined views on crypto platforms, stablecoins and crypto tokens in a speech at a Penn Law conference this week. Crypto platforms resemble traditional regulated exchanges and should be subject to the same oversight, he said. The CFTC and SEC are working to determine how they might jointly oversee platforms that trade both crypto-based securities and commodity tokens. The SEC is also weighing whether crypto platforms should segregate out market making or custody functions. He raised concerns about stablecoin risks related to financial stability, illicit activity and investor protection, and said most crypto tokens are securities.
• FDIC: The FDIC released a Financial Institution Letter stating that any FDIC-supervised institution intending to engage in crypto-related activities should notify the agency.
• Hsu remarks: Acting Comptroller of the Currency Michael Hsu weighed in on Friday during remarks at an Institute of International Economic Law event at Georgetown University Law Center asserting that he was not convinced that cryptocurrencies will survive the test of time. Hsu remarked that it would be more sensible to apply bank regulations to stablecoin products rather than regulating these products under money market regulations and emphasized the importance of designing any new system to be inclusive at inception.

Russia, Beneficial Ownership: Yellen’s House Testimony

Treasury Secretary Janet Yellen testified at a House Financial Services Committee hearing this week on the state of the international financial system. Here are some key points from her testimony.

• ‘Maximum pain’: Yellen said the Administration’s goal is to inflict “maximum pain” on the Russian economy while shielding the U.S. as much as possible. In response to a bill sponsored by Rep. Andy Barr (R-KY) to bar Russian banks from making energy-related transactions, Yellen said it was a “constructive suggestion.” Yellen also said the U.S. will not participate in some G-20 meetings if Russia attends.
• Beneficial owners: Reps. Carolyn Maloney (D-NY) and Brad Sherman (D-CA) pressed for details on the timeline to set up the FinCEN directory on company beneficial ownership created by anti-money laundering legislation passed last year. The deadline for finalizing the rules for implementing the bill was more than three months ago. Maloney warned that Russian oligarchs could use anonymous shell companies to move money into the U.S. Yellen declined to commit to proposing the beneficial ownership database access rule by the end of April, but said it would happen within the coming months. Rep. Barry Loudermilk (R-GA) said the proposed definitions for certain levels of ownership interest are overly complicated and urged Treasury to coordinate with state governments to help small businesses understand how to comply with disclosure requirements.

Key Takeaways from Jamie Dimon’s Shareholder Letter

JPMorgan Chase CEO Jamie Dimon released his letter to shareholders this week. Here are some high-level takeaways.

• New global landscape: The U.S. must prioritize competent, bipartisan policymaking as it navigates a changing global order, Dimon said. He emphasized the value of free enterprise and the importance of uniting with allies. He also discussed the shifting global landscape amid Russia’s war in Ukraine and U.S. competition with China. The confluence of the war in Ukraine and subsequent sanctions, the dramatic COVID recovery and the need for rapidly raising interest rates and QE reversal could increase the risks ahead, he said.
• Regulatory: Basel IV could increase capital requirements for banks in ways that are unnecessary, Dimon wrote. “If done properly, bank regulations could be recalibrated, adding virtually no additional risk, to make it easier for banks to make loans, intermediate markets and finance the economy,” he said. He also said the GSIB calculation is not-risk based and drives illogical decisions. “Being a large, diversified company, with strong revenue and profit streams, is normally a source of strength in troubled times, but this is a negative in regard to G-SIB capital.”
• Bank-FinTech competition: Banks are facing intense competition, including from FinTech and Big Tech, Dimon wrote. The letter featured a chart showing the long roster of nonbank competitors in the market for banking services, and banks’ size and market cap have diminished relative to their nonbank counterparts. “Regulations have consequences, both intended and unintended — but many regulations are crafted with little regard for their interplay with other policies and their cumulative effect,” he said. “As a result, regulations often are disconnected from their likely outcomes. This is particularly true when trying to determine what products and services will remain inside the regulatory system as opposed to those likely to move outside of it.”
• M&A: Dimon said he “would expect to see many mergers among America’s 4,000+ banks – they need to do this, in some cases, to create more economies of scale to be able to compete.”

He also discussed several issues important to JPMorgan, including cyber vigilance, diversity and inclusion, community investment, sustainability and the evolution of the workplace.

Rubles, Ransomware Hub, Investment Bans: What’s New in Russia Sanctions

The Treasury Department this week banned Russia from using dollar reserves at U.S. banks to pay its debts, the latest action against the country as the war in Ukraine rages. Here’s what else is new in Russia sanctions.

• Investment ban: The President imposed a ban on new investments in Russia through an executive order this week. The move accompanied expanded U.S. sanctions against Sberbank and new sanctions against Alfa-Bank and family members of President Vladimir Putin and Foreign Minister Sergey Lavrov.
• Darknet: The U.S. and Germany collaborated to shut down Russia’s Hydra Market, the world’s largest “darknet” marketplace that facilitated ransomware, drug deals and other illicit activity using cryptocurrency.
• Oligarch charged: The Department of Justice charged Russian oligarch Konstantin Malofeyev with violating U.S. sanctions.
• Europe: The European Union announced a fresh round of sanctions on Russia, including measures targeting Oleg Deripaska and Putin’s daughters as well as a ban on the purchase, import or transfer of Russian coal and other solid fossil fuels after August 2022.
• Ruble payment: Russia made payments in rubles to holders of its dollar-denominated Eurobonds maturing in 2022 and 2042, according to Reuters. The question of Russia’s ability to pay debts denominated in foreign currencies is raising the prospect of a default.

Close Read: The Fed Minutes

BPI’s Bill Nelson joined CNBC’s Power Lunch this week to discuss the Fed’s recently released meeting minutes and its potential path forward. Watch his segment here. Below are some especially bank-relevant takeaways from the minutes.

• The Fed is focused on the possibility that the ON RRP facility could rise when interest rates go up because of flights out of deposits.
  “There was uncertainty around how ON RRP usage might evolve in the near term as money market rates increased. If banks lifted their deposit rates by less than the increase in returns available on alternative investments, depositors could shift funds into these alternatives, leading to downward pressure on rates and increased ON RRP take-up. If instead deposit rates moved up in line with net yields on alternative investments, ON RRP takeup could remain relatively steady.”
• The Fed is eager to expand the Standing Repo Facility.
  “The Desk had onboarded four depository institutions as counterparties and noted that a number of additional banks were currently under review. The Desk planned to adjust the counterparty eligibility requirements in early April to make the SRF accessible to a broader range of banks, in line with the Committee’s intention to expand eligibility over time and with efforts to ensure that Desk counterparty policies promote a fair and competitive marketplace.”
• More on the SRF:
  “A couple of participants noted that the establishment of the SRF, which did not exist in the previous runoff episode, could address unexpected money market pressures that might emerge if the Committee adopted an approach to balance sheet reduction in which reserves declined relatively rapidly, but several others noted that the facility was not intended as a substitute for ample reserves.”
• Financial markets have been illiquid:
  “Liquidity conditions became strained in some financial markets during the intermeeting period. Market depth—a gauge of the ability to transact in large volumes at quotes posted by market makers—deteriorated in U.S. Treasury, U.S. equity, and crude oil markets. Trading volumes generally remained within normal ranges in most markets and increased above normal levels in Treasury markets later in the period. Bid–ask spreads did not increase notably in most markets. However, investors reported that strained liquidity at times amplified the volatility of price moves and may have contributed to the particularly large swings in Treasury yields and equity prices late in the intermeeting period.”
• Regarding monetary policy: 
  The minutes are considerably more hawkish than Powell was in the press conference but aligned with his tone a few days later at the NABE conference.  The minutes note explicitly that 50-bp hikes are on the table as is raising rates above neutral (to a position that restrains rather than encourages growth).  The press conference focused on the model outlook of 25 bp per meeting.  The minutes also indicate that “many” participants would have supported a 50-bp increase had it not been for the war in the Ukraine.  That’s interesting to keep in mind when considering Powell’s decision to pre-announce the March policy action in his Humphrey-Hawkins testimony a week earlier.

In Case You Missed It

Are Liquid Asset Buffers Useful if Banks Don’t Feel Free to Use Them?

Liquidity buffers help ensure that banks have sufficient liquidity to continue operations through periods of stress, however a liquidity buffer is limited in its usefulness if banks are hesitant to use it. That’s the conundrum with maintaining minimum amounts of high-quality liquid assets and the subject of a recent Bank of England discussion paper.  The paper draws on evidence from the 2019 Liquidity Biennial Exploratory Scenario stress testing, the pandemic experience, and a BPI blog post based on interviews with bank treasurers, to demonstrate banks’ reluctance to use their HQLA. Like the BPI blog post, the paper highlights concerns about how regulators, supervisors, and the market would react if banks dip into their HQLA buffers. It also includes questions about banks’ perceived constraints on their ability to use HQLA for unusual liquidity demands and how greater HQLA usability could be achieved. The usability of HQLA was further explored in another BPI blog earlier this year.

BPI’s Nancy Guglielmo Recognized for Contribution to FDIC, FinCEN Digital Identity Tech Sprint

The Federal Deposit Insurance and Financial Crimes Enforcement Network recognized Nancy Guglielmo, senior vice president, fraud reduction program for BITS, among the three teams of experts commended for their contributions to the Digital Identity Tech Sprint. Participants in the tech sprint were selected from a competitive pool of 200 candidates and engaged in one of eight teams. The objective of each team was to help measure how financial institutions collect, validate and verify information about customers to improve account security and prevent fraud, specifically focusing on one of three categories: creativity, effectiveness or impact and market readiness.

Manchin, Senate Republicans Warn on SEC Climate Proposal 

Sen. Joe Manchin (D-WV) expressed concern about the SEC’s recent climate disclosure proposal, which would require public companies to provide extensive information on climate risk in their business and supply chains. The proposal sends “a signal of opposition to the all-of-the-above energy policy that is critical to our country right now,” Manchin wrote in a letter. He also questioned the need for mandating climate risk disclosures when a large swath of companies already disclose climate risk data. “In that sense, one could argue that the proposed rule aims to solve a problem that does not exist,” he said.

Separately, a group of Senate Republicans on the Banking and Energy and Public Works Committees, led by Sen. Kevin Cramer (R-ND), urged the SEC to withdraw the proposal. “We believe devising climate policy is the job of elected lawmakers, not unelected regulators at the SEC,” they said in a letter. They also said the agency lacks authority to issue a climate change rule.

GOP Lawmakers Take Aim at CFPB Fees Inquiry 

A group of Republican lawmakers on the House Financial Services Committee sent a letter to the CFPB raising significant concerns with the Bureau’s recent “junk fees” request for information. The letter pointed out that there is “always a cost associated with providing financial services and access to credit” including “the risk to the offering firm for such product and credit extensions, which may be offset in part by certain fees for service.” They noted that financial institutions are subject to laws and regulatory requirements to disclose such fees, including measures issued by the CFPB, and that the Bureau had failed “to outline any illegal activity taking place regarding fees by financial institutions that would require the CFPB to exercise “its enforcement, supervision, regulatory, and other authorities.” The letter also poses a series of questions to the Bureau about the RFI.

Short Sellers Bet Tether is on Shaky Ground 

Short sellers are laying bets against stablecoin issuer Tether, which has refused to disclose precisely what assets comprise the “reserves” backing its coins, according to the Wall Street Journal. Some investment firms have raised concerns that Tether’s reserves include risky assets like commercial paper, potentially including that of Chinese real estate developers. BPI’s Bill Nelson and Paige Pidano Paridon wrote an op-ed in December breaking down the dangers of opaque, risky stablecoin reserves.

Wells Fargo Taps New Sustainability Chief

Wells Fargo elevated Robyn Luhning, head of environmental and social risk management, to be its first-ever chief sustainability officer. Luhning will lead the bank’s climate plans and ESG disclosures and oversee its environmental philanthropy and advocacy efforts.