BPInsights: August 7, 2021

Stories Driving the Week

Charters, Capital and CRA: Takeaways from Bank Regulator Hearing 

The heads of the OCC, FDIC and NCUA testified before the Senate Banking Committee on prudential regulation this week. Here are some key takeaways from their testimony.

  • OCC charter and digital asset review: Acting Comptroller Michael Hsu emphasized “coordination” between banking agencies on digital assets and FinTech charters. The agency is currently conducting a regulatory review of previous OCC policies, including novel charters, and is also leading a “sprint” initiative on digital assets with the other federal banking agencies. “The purpose of the review is to make sure we are taking a holistic approach to both chartering and to the regulatory perimeter to ensure that there is not regulatory arbitrage across different agencies, and that there is not a race to the bottom in the shadow banking system,” Hsu said in response to Ranking Member Pat Toomey’s (R-PA) questions about an OCC-chartered digital asset custody firm. Toomey suggested the OCC should encourage “innovative financial institutions” to enter the regulated banking system as a way to increase oversight of such firms.
  • CRA: Hsu committed to retaining clarity, objectivity and transparency in the Community Reinvestment Act rulemaking that the OCC and other banking agencies recently announced they will work on together. The announcement came as the OCC said it would withdraw its standalone CRA rule. He also said the OCC is working very quickly on the CRA effort. “We want to make sure we do it right,” he said.
  • Capital: “Maintaining strong capital requirements is an imperative,” Hsu said in response to criticism from Chairman Sherrod Brown (D-OH) of the Federal Reserve’s approach in recent years to capital rules and a question about supporting higher capital requirements for the biggest banks. Hsu said it is important that the banking system is held to the highest standards and serves as a source of strength to the overall economy.
  • ESG: Toomey also expressed concern that the Biden administration is using financial regulation to advance “social goals that are unrelated to banking.” Toomey and fellow Republicans have questioned the financial relevance of regulators’ growing emphasis on climate risk.

Fed Releases Large-Bank Capital Requirements

The Federal Reserve this week announced capital requirements for large banks, effective Oct. 1. The requirements are based on the stress capital buffer (SCB) framework, which is determined by each bank’s stress test results. Each bank must meet a minimum capital requirement of 4.5 percent with an SCB of at least 2.5 percent, plus a surcharge of at least 1.0 percent for Global Systemically Important Banks (GSIBs). This year marks a new normal for the SCB framework after its rollout was delayed during the pandemic last year. In the announcement, the Board directed the staff to “conduct a closer examination of issues raised in the reconsideration process to inform continuing improvements in its stress testing methodology for next year’s stress tests.”

Estimating the Implicit Capital Charges in the Stress Tests

The implicit capital charges in the stress tests and the degree to which stress tests distort or impede bank lending have sparked an active debate over the years. A new BPI research note derives stress capital buffers for major loan categories among stress-tested banks. The analysis shows that portfolio-specific stress capital buffers (SCBs) for commercial and industrial, commercial real estate and credit card loans are well in excess of the 2.5-percent capital conservation buffer included in the Basel Framework. Banks wanting to reduce their SCB are incentivized to shrink loan exposures in these portfolios. There is also notable variation in portfolio-specific SCBs over time. To better understand those changes, it would be important for the Federal Reserve to report how much variability is explained by annual revisions to the supervisory stress scenarios, changes in bank portfolios and updates to supervisory models.

BIS Report Eyes Reg Solutions for Big Tech Financial Footprint

A new report from the Bank for International Settlements calls for an “entity-based” approach to regulating Big Tech firms offering financial services, doubling down on a series of recent, similar recommendations made by the group of global central bankers. Such firms’ market power, amassed through troves of consumer data, can threaten the financial system in new ways, such as by posing privacy and data governance risks, the report argues. Big Tech firms can use the network effects of their data-fueled business models to scale up rapidly and establish dominance. The current financial regulatory framework favors an “activities-based” approach, the BIS says, whereas entity-based rules may be a better fit to address Big Tech risks.

Fed’s Waller: CBDC May Be ‘Solution in Search of a Problem’

Federal Reserve Governor Christopher Waller this week cast doubt on the prospects of a U.S. central bank digital currency, saying he was “highly skeptical” of the need for a CBDC. It’s unclear what problem in the U.S. financial system a CBDC would actually solve, Waller said in a speech at the American Enterprise Institute. In general, the government should only compete with the private sector in the event of market failure, Waller said – and the division of labor between banks and the Fed indicates an efficient market. He also rebutted several potential reasons for launching a CBDC: physical dollars are not going to vanish; the existing U.S. payments system is globally connected and efficient; real-time payments already exist; and options like the Bank On program are better conduits than a CBDC to draw more unbanked people into the banking system. Additionally, Waller argued that the dollar’s reserve currency status and U.S. monetary policy are not being threatened, either by stablecoins or by a Chinese CBDC.

A Case Study in Holding Excess Liquidity

We unexpectedly unearthed a nugget of insight into current bank regulation and supervision in a 50-year-old report on the discount window, as seen in a new blog post. In 1965, the Federal Reserve launched a major review of the discount window. In 1971, the Federal Reserve Board published the result of the review: “Reappraisal of the Federal Reserve Discount Mechanisms.” The volume includes a chapter on “Discount Policy and Bank Supervision.” The entire chapter (really the entire book) is fascinating (for example, the chapter includes several numerical measures of liquidity adequacy used by examiners 50 years before the LCR purportedly became the first numerical measure of liquidity adequacy), but one small section especially caught our eye. Appendices to the chapter provide four examiner comments on big and small banks with too much or too little liquidity. The examiner comment about a community bank with excessive liquidity is enlightening.

In Case You Missed It

Senators Split Over Scope of Crypto Tax Proposal in Infrastructure Bill

Sens. Ron Wyden (D-OR), Cynthia Lummis (R-WY) and Pat Toomey (R-PA) proposed an amendment to narrow the language targeting cryptocurrency transactions as a revenue raiser in the $550 billion bipartisan infrastructure bill. The amendment would narrow tax reporting requirements to cryptocurrency brokers on exchanges where people buy and sell the digital coins, rather than casting a wider net on crypto entities like “miners” as in the original legislation. However, the White House this week backed a broader crypto tax reporting amendment by Sens. Rob Portman (R-OH), Kyrsten Sinema (D-AZ) and Mark Warner (D-VA).

The cryptocurrency industry has criticized the original measure as being too broad and imposing data requirements on players who may not have access to the data they’re meant to report. The original proposal has been projected to raise $28 billion, but the narrower version would likely decrease that total slightly. The Senate hopes to finalize the bipartisan infrastructure bill over the weekend.

New Cyber Director Office in Suspense on Staffing as House Departs Washington 

The new Office of the National Cyber Director, led by Chris Inglis, is still waiting to staff up after the House failed to vote on a bill authorizing it to detail employees from other federal agencies before leaving for the August recess, according to Inside Cybersecurity. The absence of rank-and-file personnel threatens to hinder the day-to-day operations of the new office at a critical juncture for national cybersecurity issues. Funding for the office is included in the bipartisan infrastructure package.

Cyber Upgrades Included in Infrastructure Package 

The bipartisan infrastructure package includes incentives for cyber upgrades to the electrical grid and provisions on cyber in the transportation sector, though some in the cyber industry called for mandatory cyber requirements for sectors like water and transportation that typically have lighter standards, according to Inside Cybersecurity this week. The bill also includes cybersecurity provisions related to a new grant program for expanding broadband access, which would partly take aim at telecom gear from China. The legislation would provide $21 million to stand up the Office of the National Cyber Director. It would also create a “significant incident” cyber category, establish a Cyber Response and Recovery Fund and provide cyber assistance to state and local governments.

BPI’s Nelson: I Don’t Know Why She Swallowed a Fly

Over the past 13 years, the Federal Reserve has consistently solved problems – whether they were partly or entirely of its own creation — by becoming larger and more involved in the financial system, BPI Chief Economist Bill Nelson wrote this week in a Morning Consult op-ed. That greater size and involvement has led in turn to still more problems, which the Fed has again sought to fix by expanding its reach into markets. This process has transformed the Fed from an efficiently scaled institution conducting policy with a small imprint on financial markets to a behemoth that is the largest borrower in both the unsecured and secured short-term funding markets. The Fed predicts that by 2023, its balance sheet will equal 39 percent of gross domestic product, up from 6 percent in mid-2007. How did we get here? Consider the problems the Fed faced and the solutions it adopted.

SEC’s Gensler Signals Tougher Rules Ahead for Crypto ‘Wild West’ 

SEC Chair Gary Gensler said the agency will police cryptocurrency as strongly as its authority allows, according to a Wall Street Journal article this week. “We just don’t have enough investor protection in crypto. Frankly, at this time, it’s more like the Wild West,” Gensler said in a recent speech to the Aspen Security Forum. “We have taken and will continue to take our authorities as far as they go.” Gensler, a former Democratic CFTC chief who once taught an MIT course on cryptocurrency, cited stablecoins and “DeFi,” or decentralized finance platforms, as areas that could warrant more SEC scrutiny. One challenge for financial regulators is uncertainty over what investment category different crypto assets fall into, such as commodities or securities, and thus how they should be regulated under various laws. Federal regulators are currently weighing how to regulate stablecoins. 

Bitcoin Isn’t Gold – and It Isn’t Green, Either

European lawmakers are scrutinizing the green ramifications of Bitcoin mining, which consumes more electricity per year than a country the size of Portugal or Austria, according to a recent POLITICO article. The carbon footprint of a single Bitcoin transaction massively outweighs that of baking in a gas oven or using a credit card. European Parliament members are weighing amendments to a large-scale consumer protection bill for crypto assets that would set limits on the digital assets’ energy consumption.

Jamie Dimon: If You Paid Your Debt to Society, You Should Be Allowed to Work

Nearly half of formerly incarcerated people are unemployed a year after leaving prison, the sign of a public policy gap that needs to be filled, JPMorgan Chase CEO Jamie Dimon wrote this week in a New York Times op-ed. Breaking employment barriers for people with criminal backgrounds could help fill job openings across the nation and build fulfilling, productive employment opportunities for those individuals, he wrote. JPMorgan Chase is a member of the Second Chance Business Coalition, which helps businesses share best practices and test new approaches to support advancement and hiring of formerly incarcerated people. In the op-ed, Dimon also expressed support for legislative reforms like the federal Clean Slate Act of 2021 that would help clear a path to employment for people with records by automating the record-sealing or -clearing process for certain criminal offenses. BPI last year urged the FDIC to clarify its policies in a way that would allow more rehabilitated people with criminal records the opportunity to pursue banking industry careers.

BofA Invests in NY Green Bank

Bank of America invested $314 million in NY Green Bank, a state-financed backer of sustainable infrastructure projects, according to American Banker. The investment is the largest-ever private fundraising deal by a green bank in the U.S.

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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.