BPInsights: August 6, 2022

Stories Driving the Week

The Bank of England Just Released Its Plan for Getting Smaller. The Fed Could Learn from it.

What’s happening: The Bank of England this week provided new details on its plan to shrink its balance sheet. While press reports have been focused on the BoE’s plans to sell assets, the critical difference between the BoE plan and the Fed’s plan is how the central banks will determine their minimum size. The BoE intends to shed assets until it is as small as possible in the short term, and get smaller over time. In contrast, the Fed plans to maintain a huge balance sheet and may continue to grow bigger.

What’s different: The key distinction between the two plans is how each central bank plans to determine its minimum size.

  • The Fed does not know the minimum level of reserve balances necessary to maintain its “ample reserves” policy. The Fed wants to stop a bit before it achieves the minimum level, leaving a buffer to absorb volatility in reserve balances – it’s walking toward a wall blindfolded and trying to stop as close as possible without bumping into it.
  • The Bank of England plans to shrink its portfolio to a level where there is some scarcity in the market for reserve balances and where banks regularly borrow from the BoE in open market operations. The BoE plans to lend to banks at the same interest rate it pays on reserve balances.

Implications of these approaches: The Fed’s plan incentivizes banks to demand high levels of reserve balances, so the Fed will stay big and get bigger. The BoE’s approach would push market rates a bit higher on average than the rate it pays on reserve balances – encouraging banks to economize on their reserve balance holdings, and allowing the BoE to shrink further.

The BoE approach, exported to America: The Fed could adopt a normalization plan similar to the BoE’s, with some key modifications.

  • Maintain a small spread between the interest rate it charges on its loans and the interest rate it pays on reserve balances. This invigorates the interbank market, an important part of how banks manage their liquidity.
  • Take much more aggressive steps to encourage banks to be willing to borrow from its standing lending facilities.

Another key change: The Fed could also consider offering banks Committed Liquidity Facilities (CLFs) – central bank facilities to provide commercial banks guaranteed, collateralized lines of credit for a fee, with the interest rate on draws on the line set above market rates. This would enable banks to comply with liquidity requirements in a way that frees them up to make more loans to businesses and families.

To learn more, access BPI’s new blog post here.

Fed Releases Large-Bank Capital Requirements

The Federal Reserve on Thursday announced the capital requirements for large banks. The requirements take effect on Oct. 1, 2022. The Fed also announced that it affirmed the results of two firms that had requested reconsideration. Common equity tier 1 capital requirements consist of the minimum capital requirement of 4.5 percent, the stress capital buffer of at least 2.5 percent (based on the stress test results) and a GSIB surcharge for the largest global banks. The latest capital requirements are significantly higher for some banks, mainly reflecting the decline in the allowance for credit losses at the start of the stress tests and increases in bank size tied to influx of deposits during the pandemic. Very little—if any—of the increase reflects actual increased risk in the portfolios of banks. Overly high and volatile capital requirements can threaten economic growth, BPI has noted in its research.

Consumers Have Choice in Credit Cards, Including Late Fees

BPI responded this week to a Consumer Financial Protection Bureau review of credit card late fees. The request sought large quantities of complex data ranging from how late fees are determined to the costs incurred from violations while initially providing just 30 days to respond. The CFPB has previously acknowledged that the CARD Act and its implementing regulations, in place for over a decade, effectively reduced the cost of credit for consumers. Nonetheless, it issued an advance notice of proposed rulemaking in June 2022 criticizing late fees charged by credit card issuers and discounting the effectiveness of the existing regulations in limiting late fees while providing appropriate disincentives to consumers to make late payments.

What BPI is saying: “The request reflects a serious misconception about how markets work and fails to acknowledge significant competition that helps to preserve consumer choice and maintain low-cost access to credit. The CFPB should prioritize real harms facing consumers, such as crypto and unregulated fintechs, rather than revisiting issues already addressed by Congress through the CARD Act, which has been lauded by the CFPB — both Democratic- and Republican-led — as effective in protecting consumers from excessive late fees.” – Paige Pidano Paridon, senior vice president and senior associate general counsel.

To learn more, click here.

Cyber Legislation in NDAA Would Put Banks at Risk of Hacks 

A cyber reporting provision in the National Defense Authorization Act would expose banks to new risks, giving hackers a roadmap of their defenses. It would also duplicate the stringent cyber reporting requirements banks already face. Learn more from these recent stories:

Complex, Sweeping CRA Proposal Would Undercut Law’s Mission of Serving Communities

BPI this week commented on the banking agencies’ joint Community Reinvestment Act proposal. BPI strongly supports the CRA and its core mission of supporting communities, including low- and moderate-income and underserved areas, and parts of the proposal would helpfully provide some certainty about what activities qualify for CRA credit, particularly with respect to banks’ partnerships with Minority Depository Institutions; however, the proposal in other respects would stray far beyond the agencies’ statutory mandate to the point of credit allocation, and would undermine the law’s core mission by allowing CRA ratings to be driven subjectively by behavior unrelated to community development.

What BPI is saying: “The proposal presents the worst of two worlds:  its hundreds of pages of requirements dictate how banks are to allocate credit, yet at the end of the day the agencies reserve the right to downgrade a bank’s rating regardless of its compliance with the agencies’ dictates, based on any of a wide range of factors unrelated to community development.” — Paige Pidano Paridon, BPI senior vice president and senior associate general counsel.

To learn more, click here.

Stablecoins, CBDC: BPI’s Greg Baer Discusses ‘Future of Payments’ at Philly Fed Conference

BPI President and CEO Greg Baer participated in a panel discussion this week on the “future of payments” at the Philadelphia Fed’s Sixth Annual Fintech Conference.  BPI’s Brian Allen also participated in a panel discussion on bank partnerships with fintech crypto platforms.

  • Where commerce is going: The future of payments hinges on the future of commerce, Baer said. DeFi entails entering into contracts with pseudonymous counterparties drafted by coders and without recourse to courts or a standard of good faith and fair dealing in case of mistake or ambiguity; that prospect is not appealing for most commercial transactions.
  • Unbanked: The unbanked population is small and shrinking, partly due to the Bank On program, Baer said. No one has presented any use case for how a stablecoin or CBDC would bring unbanked consumers into the banking system, as it wouldn’t resolve reasons for being unbanked, like not trusting financial institutions or the government, not wanting to report cash income or not having a form of identification.
  • The reality of real time: Real-time payments are widely available now, Baer said, through The Clearing House’s RTP network. But the demand for instant payments may not be as massive as predicted, he said; otherwise their use would be even more ubiquitous. Panelists also discussed the tension between seamless payments and necessary fraud protections, sanctions screening and AML/KYC safeguards – sometimes “frictions” are needed.
  • CBDC and lending: CBDC could siphon lending – and therefore growth for businesses and households – out of the banking system and provoke “flights to quality” in times of market stress, Baer said.  Benefits to offset these dramatic financial stability and economic costs have not been identified.
  • Growth areas: Banks offering credit card rewards for travel and restaurants are experiencing rapid growth, driven by the youngest generations, Baer observed. Meanwhile, stablecoin market cap is shrinking.
  • Bitcoin vs. Ethereum: Ethereum, which is akin to a computing platform with its own programming language, is fostering innovation, including in the banking space, where DLT technology is being used or developed for many back office functions. Meanwhile, Bitcoin offers no real promise as a means of exchange for most transactions, as it is slow and expensive.  Its primary use case in payments may be the facilitation of illicit finance.

In Case You Missed It

The Crypto Ledger

Here’s what’s new this week in cryptocurrency.

  • The latest hack: Hackers targeted Solana crypto wallets this week following an attack on crypto “bridge” Nomad. Bridges enable transfers of crypto tokens across different blockchains. The Solana hack damage spanned from potentially $5.2 million in crypto to $8 million, according to different estimates.
  • Pyramid scheme: The SEC charged 11 people over a crypto pyramid scheme amounting to $300 million. The Forsage scheme persuaded investors to recruit others into the program. An SEC official called it a “fraudulent pyramid scheme launched on a massive scale.”
  • Unconventional donor? A recent POLITICO piece profiled FTX chief Sam Bankman-Fried and his “trial-and-error approach to political giving.” The piece includes commentary that Bankman-Fried uses palatable causes like pandemic preparedness as “a handy shield to obscure an interest in shaping crypto regulation to the benefit of him and his industry.”

Joint Trades Call for Clarity, Consistency on Climate Disclosures Measure

BPI and GFMA in a recent letter to the International Sustainability Standards Board called for clarity, consistency and practicality in climate disclosure proposals. The trades were responding to exposure drafts of two global standards documents, one on climate disclosures and one on sustainability disclosures, which are aiming to set the global baseline for climate and sustainability disclosure standards. They urged the Board to ensure terms of such proposals are clear, consistent and usable; to consider the time it takes to produce climate data and only call for data that companies can accurately produce on a consistent, comparable and reliable basis; and to limit the disclosure of Scope 3 (indirect) emissions.

The ON RRP Conundrum

The multitrillion-dollar buildup at the Fed’s ON RRP facility could “turn into a major headache for banks that could squeeze their balance sheets,” a recent Reuters analysis noted. As the Fed shrinks its balance sheet, an outflow of deposits from banks into money market funds could reduce reserve balances. One important element in the backdrop: the Fed still hasn’t made any changes to the supplementary leverage ratio, as observed in the analysis.

To learn more about the ON RRP facility, click on these resources:

U.S. Imposes New Sanctions on Russian Elites

The U.S. Treasury Department announced new sanctions on several Russian individuals and a major firm this week. The move, which came in coordination with the State Department, expands the long list of sanctioned entities in the wake of Russia’s Ukraine invasion. This round of sanctions targeted individuals close to the Kremlin, including Alina Maratovna Kabaeva, Vladimir Putin’s alleged girlfriend.

Food for Thought: The 20-Year Experiment Holding America Back 

A law meant to crack down on accounting fraud in the wake of Enron and WorldCom has instead blocked entrepreneurs and mom-and-pop investors from accessing the benefits of the public capital markets, John Berlau and Josh Rutzick wrote in a recent Wall Street Journal op-ed. The Sarbanes-Oxley Act’s expensive mandates have discouraged startups from going public early in their lifecycles, which deprives these companies of growth and retail investors of the opportunity to share in it.

TD’s ‘All of the Above’ U.S. Expansion Strategy 

A recent American Banker article profiled TD Bank’s broad-based strategy for expanding its U.S. foothold. The bank, which is currently awaiting regulatory approval for its acquisition of First Horizon, recently agreed to buy U.S. brokerage Cowen. The article features an interview with Glenn Gibson, vice chair and regional head of TD Securities.

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Disclaimer:

The views expressed do not necessarily reflect those of the Bank Policy Institute’s member banks, and are not intended to be, and should not be construed as, legal advice of any kind.