BPInsights: December 16, 2023

Will Apple’s Wallet Stay Closed?

For years, Apple has faced scrutiny for tying use of the iPhone’s near-field communication system to use of Apple’s digital wallet, preventing other providers from accessing that function.  In the United States, Apple is facing an antitrust lawsuit and a reported Justice Department investigation.  In the European Union, it is facing the threat of legislative action and an enforcement action by the EU’s antitrust regulator.  This week, it was reported that Apple has offered to settle that action by granting access to its NFC, and thereby allowing EU companies access to its tap-and-go function.  If an agreement is reached, it raises the question of whether Apple will also take that step in the United States, or continue to battle against reform.

Five Key Things

1. ‘Near Final’ and a Sharp Contrast to US: UK Banks to Hold 3% More Capital Under Basel Plan

The Bank of England this week released the first part of its “near-final” Basel 3.1 standards plan. The glimpse at the UK version of global bank capital rules demonstrates a stark contrast with the U.S. Basel proposal.

  • Key quote from a Bloomberg article: “The measures, which are known as the Basel 3.1 standards, will mean UK banks would have to boost the amount of capital they hold to absorb unexpected losses by about 3%, according to a Tuesday statement from the BOE’s Prudential Regulation Authority. Twelve months ago, an official estimated the effective increase at 6%. The new expectation is a fraction of the hit that lenders in the US and Europe are bracing for. US banks could face an increase of around 16% while EU firms could see a jump of about 10%.”
  • Adjustments: The Bank of England modified the standards in some ways in response to comments. It removed a requirement for banks to use market risk internal modeling to assess the default risk of their exposure to sovereigns.
  • Holistic: “The focus of these rules is not on the aggregate amount of capital in the system but on making sure that risk is properly captured across a range of firms and activities,” Sam Woods, deputy governor of prudential regulation and chief executive officer of the PRA, said in a statement.

2. Basel Proposal Chokes Off Financing for Developing Countries

The Basel capital proposal would hurt investment in developing countries around the globe, according to a Bloomberg op-ed by Mihir Sharma. The proposal would raise costs for the large banks that often finance infrastructure and economic growth in emerging markets such as India, Sharma wrote. Such projects would become costlier for banks to support under the Basel rules, particularly longer-duration loans such as infrastructure lending. “New ways of weighting the risk attached to various assets — such as those the Basel III endgame proposes to implement for US banks — threaten to penalize the poorest countries the most,” Sharma wrote. The op-ed points out that less investment in higher-yielding emerging market projects could cost retirement savers good returns. Green investments could also suffer: “Policymakers should consider how endless restrictions aimed at preventing a future financial crisis are worsening a climate crisis that threatens devastating impacts now. Their zeal for a safer banking sector may be fueling risks that are far harder to contain.”

3. BPI Supports the ‘Close the Shadow Banking Loophole Act’

Bipartisan legislation introduced Friday aims to prevent Big Tech and other nonbanks from exploiting a loophole that could destabilize the financial system and threaten consumer privacy. The “Close the Shadow Banking Loophole Act,” introduced by Senate Banking Committee Chairman Sherrod Brown (D-OH) and Senator John Kennedy (R-LA), prohibits fintechs and other nonbank financial entities from operating like a bank and benefiting from federal deposit insurance without being subject to the comprehensive set of rules designed to keep the financial system safe.

BPI President and CEO Greg Baer issued the following statement in response: “BPI supports Chairman Brown and Senator Kennedy’s bipartisan efforts to close the ILC loophole and guarantee equal treatment for entities providing indistinguishable banking products and services under the law. Any entity seeking the benefits of bank ownership must be held to the same rules that apply to banks to prevent unacceptable risks to consumers, taxpayers and the existing financial framework.”

The legislation has garnered the support of a diverse coalition of stakeholders.
BPI joined with consumer organizations, credit unions and other financial services trades in submitting a letter Friday in support of legislation.

The coalition includes Americans for Financial Reform, Bank Policy Institute, Center for Responsible Lending, Consumer Federation of America, Credit Union National Association, Independent Community Bankers of America, Mid-Size Bank Coalition of America, National Association of Federally-Insured Credit Unions, National Community Reinvestment Coalition, National Consumer Law Center (on behalf of its low-income clients) and U.S. PIRG.

Why this legislation matters:
The ILC loophole currently allows commercial entities to subvert congressional intent and bypass the safeguards designed to uphold the separation between banking and commerce. The loophole…

  • Introduces greater risk to the financial system and undermines economic competitiveness;
  • Gives Big Tech companies access to sensitive balance and transaction data, thereby adding to their significant collection of personal and behavioral information; and
  • Exempts these nonbanks from many consumer data and privacy protections.

4. The Basel Proposal’s New Profit and Loss Attribution Tests: Not Ready for Prime Time

New statistical tests in the Basel proposal’s market risk capital framework are designed to compare banks’ risk management models with their trading desk models. Because bank risk models must compute more data faster and more efficiently than trading desk models, these models are sometimes different. The tests aim to measure the consistency between the two types of models and ensure they capture the same risks. But these tests suffer from a fatal flaw: The more effectively a bank hedges its market risk, the more the tests will tend to fail. These test failures often cannot be fixed even if a bank rectifies the problems that led to the test failures in the first place.

If the risk models fail either of the Basel proposal’s two tests, the bank must stop using its risk management models for capital calculations, resulting in much higher capital requirements. Banks may essentially be punished for hedging well.

Bottom line: In light of these fundamental issues, the PLA tests are not ready for prime time and should not be used to validate banks’ internal risk models or determine eligibility for models-based approaches. Instead, the agencies should repurpose the tests to be for reporting and monitoring purposes only. The agencies could also consider eliminating the Spearman correlation test entirely, as it is the more problematic of the two tests.

5. Senators Call for Venmo, Cash App to Protect Scammed Customers

Senate Banking Committee Chairman Sherrod Brown (D-OH), Sen. Elizabeth Warren (D-MA) and Sen. Jack Reed (D-RI) called on payment apps Venmo and Cash App in letters this week to reimburse customers who are victims of scams. “We are extremely concerned that instant payment platforms are not taking reasonable, commonsense, and proactive steps to protect their customers,” the senators wrote. “Venmo must provide a safe platform for American consumers – who deserve a payments system that provides them with speed and convenience, but above all, that keeps their money safe.” The outreach follows another letter in June urging Venmo to do more to address fraud on the app.

  • Stepping back: Survey data shows that the bank-owned Zelle platform offers a safer alternative to Venmo, PayPal and Cash App. The senators noted Zelle has taken recent steps to reimburse customers who are subject to impostor scams.
  • Regulatory lens: The CFPB has recently targeted large nonbank payment apps with extra scrutiny.

In Case You Missed It

FDIC’s McKernan Suggests Step-by-Step Basel Trading Book Approach

FDIC board member Jonathan McKernan suggested this week that policymakers consider rolling out the Basel Endgame overhaul in a more phased approach that “punts on the underdeveloped aspects of the Endgame reforms pending further data collection, analysis and debate, while proceeding with implementation of the less contested aspects.” A gradual approach could foster consensus, McKernan said in a speech at an ISDA conference.

  • ‘Appropriate objectives’: McKernan named several aspects of the proposed market risk changes that make sense, in his view, such as replacing the value-at-risk method of estimating tail risk with an expected shortfall measure and shifting the model approval process from the banking organization level to individual trading desks. “These strike me as appropriate objectives for our Endgame proposal,” McKernan said.
  • Fundamental issues: “Aspects of the Endgame market risk reforms have the potential to address weaknesses in the current framework,” McKernan said. “But at the same time, important aspects of the Endgame market risk reforms are underdeveloped and perhaps even fundamentally flawed,” he said, such as the Profit and Loss Attribution Test. He said delaying the rollout of  less developed aspects could allow a “trial run” for the rest of the framework and the chance to gather more data.
  • Calibration: McKernan also flagged for consideration the calibration of the 10 percent credit conversion factor for unconditionally cancellable lines of credit, and said “[i]t might also make sense to delay implementation of the minimum haircut floors for securities financing transactions pending a rulemaking by the markets regulators that can more directly address the risks associated with excessive leverage outside the banking system.”
  • Outside the trading book: McKernan’s phased-approach suggestion focused on market risk overhauls, but “I am skeptical that my concerns with the proposal’s approach to the banking book could be addressed through a phased approach,” he said. “There is also some doubt whether a phased approach would solve problems posed by the operational risk framework, which appears to have more fundamental problems.” The Basel Committee has failed to fix the overcapitalization of banks with high fee income, he said. Other operational risk complications involve client-cleared derivatives, he said.
  • Reverseengineering: “I oppose efforts to reverse engineer higher capital requirements without regard to the costs and benefits or the underlying calibration framework,” McKernan said. “That does, however, seem to leave open an approach that moves to finalize the less contested aspects of the Endgame market risk reforms and then finalizes the rest through future notice-and-comment rulemakings that can rationalize our own U.S. implementations.”

The Crypto Ledger

Here’s the latest in crypto.

  • Basel on stablecoins: Stablecoins’ “reserves” used to back the digital assets should meet certain criteria, such as short-term maturity and high credit quality, in order to be grouped in a lower-risk category, according to a recent Basel Committee consultation.
  • Worst witness: David Mills, the lead strategist in convicted crypto founder Sam Bankman-Fried’s defense, said Bankman-Fried was the “worst person I’ve ever seen” under cross-examination, according to Bloomberg.
  • Coinbase: Coinbase announced this week that it will offer spot crypto trading on its international exchange for non-U.S. institutional clients. The announcement comes as Coinbase faces recent regulatory scrutiny, particularly from the SEC.

Discover Names Rhodes as New CEO

Discover Financial Services this week announced it has appointed Michael Rhodes as its new CEO. Rhodes, who will succeed interim CEO John Owen, comes from TD Bank, where he was Group Head of Canadian Personal Banking.

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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.