BPInsights: December 19, 2020

Stories Driving the Week

Aggregate Stress Test Results Broadly in line with Expectations. The Economy will Benefit with the Lift of the Ban on Share Buybacks.

Yesterday the Federal Reserve Board (Board) released the results of the second stress tests. In aggregate, the results were broadly in line with expectations and the derived stress capital buffer requirement based on yesterday’s results was similar to the one calculated using June’s stress test results. More precisely, our preliminary analysis estimates an aggregate stress capital buffer of 3.3 percent in each of the two stress scenarios, which is about the same as one based on the June’s stress test results.

There are several important factors that explain this finding. First, although loan losses were higher relative to the first stress test, provisions for loan losses fell because banks built large allowances for credit losses over the first half of this year. That said, some banks with a large share of loan deferrals as of June 30 likely experienced higher provisions. As shown in a recent BPI survey, a substantial majority of those loans are now performing so those results likely understate bank performance if a severe drop in economic activity were to occur. Second, banks with substantial trading and investment banking operations had a strong performance and as a result saw lower peak-to-trough decline in their common equity tier 1 capital ratios under stress. Moreover, as shown in a recent BPI post, we believe that trading revenue’s diversification effect is understated in the stress tests. Third, projections for noninterest expense rose substantially relative to the June tests. We believe this could be explained by the sharp increase in banks’ balance sheets as a result of the pandemic. However, because the increase in bank size is mainly accounted for by the rise in deposits at Federal Reserve Banks, we also believe this result understates bank performance in the second stress tests. Other relevant factors included an expected decline in projected net interest income and moderate increases in losses associated with the global market shock and operational risk events.

Based on these results, the Board decided to modify the dividend and share buyback restrictions by extending the cap of the average four quarter net income on dividends plus share buybacks. This restriction will stay in place in the first quarter of 2021. In addition, the automatic distribution limitations would also apply if a firm were to move inside its buffer capital requirement (presumably using the October SCB). Finally, the Board is extending the time period to notify firms whether their stress capital buffer requirements will be recalculated until March 31, 2021.   

FDIC Codifies ILC Policy, Widening Banking Loophole for Big Tech

The Federal Deposit Insurance Corp. voted Dec. 15 to finalize its supervision framework for companies seeking to own Industrial Loan Companies, a charter that permits companies to engage in banking activities while avoiding consolidated supervision by the Federal Reserve. The final rule would increase a parent company’s permitted share of representation on the ILC board to less than 50 percent, as opposed to 25 percent in the initially proposed version of the rule.

BPI has argued that ILCs represent a dangerous muddling of banking and commerce and their parent companies should face the same multi-layered federal supervision that governs banks. The FDIC rule could open a back door to the banking system for Big Tech companies like Amazon or Google. General Motors applied for an ILC charter Dec. 11.

BPI, the Center for Responsible Lending and the Independent Community Bankers of America urged Congress to close the statutory loophole that enables commercial firms to own ILCs and avert Federal Reserve supervision in a statement Dec. 17.

Response to “Chartering the FinTech Future”

The OCC’s Chief Economist Charles Calomiris recently authored a working paper accusing state authorities, traditional banks, universal banks, the Federal Reserve and possibly even the members of the National Community Reinvestment Coalition as opposing the OCC’s plans to provide bank charters to FinTechs because such charters are against all of their self interests. He calls out BPI specifically and states that our notes on FinTech bank charters are “stoking fear.” Our notes have pointed that the bank charters granted in Wyoming allow a cryptocurrency custody bank to accept uninsured deposits and at least potentially invest the proceeds in munis, corporates and asset-backed securities. Calomiris dismisses our concerns that these banks could be subject to destabilizing runs on their deposits by hypothesizing an imaginary stablecoin-issuing bank that bears no resemblance to the very real banks we discuss.

We published a response and conclude the post encouraging Mr. Calomiris to respond to the substance of our notes rather than accuse us (and a lot of others) of bad faith, and give sufficiently serious considerations to the financial stability risks of granting bank charters to FinTechs, as the OCC and certain states are proposing to do.

Fed Keeps Interest Rates, Bond Buying on Same Course as Economy Recovers; Powell Calls for Fiscal Stimulus

The Federal Reserve kept its benchmark interest rate near zero and said it will continue to expand its bond-buying program at the same level to support the U.S. economy as it rebounds from the pandemic downturn, Fed Chair Jay Powell said Dec. 16 in a press conference after the central bank’s policy meeting.

The central bank will continue to increase its Treasury bond purchases by at least $80 billion per month and its agency mortgage-backed securities purchases by at least $40 billion per month, according to its policy statement after the meeting. The Fed will keep expanding its balance sheet until the economy notches “substantial progress” toward full employment and 2 percent average inflation, Powell said.

Powell emphasized the need for Congress to enact fiscal stimulus, saying households and businesses need immediate fiscal support more acutely than gradual interest-rate changes. He defended the Fed’s decision not to further expand its bond purchases or shift its focus to longer-maturity bonds, but left open the possibility to do so in the future.

Powell also said that the central bank’s role in evaluating climate change is in its early stages. The Fed announced it joined the Network of Central Banks and Supervisors for Greening the Financial System this week. “I think there’s work to be done to understand the connection between climate change and the strength and resilience of financial markets and financial institutions,” Powell said. “That work is in its early days.” Powell also emphasized that he would be “very reluctant” to see the Fed “picking one area as creditworthy and another not.

The central bank chief predicted that economic activity will pulse back to more normal levels around the second half of next year, when more widely available vaccines may revive the flow of in-person commerce, and said he does not see the Fed permanently backstopping Treasury markets as a foregone conclusion.

He also reflected that banks have “been a source of strength through this crisis.”

BPI Research Note: Banks Offering Small Dollar Loans Face Challenges in Relying on APR to Convey Borrowing Cost

Banks offering short-term, small dollar loans provide a safe alternative to payday loans for borrowers with low or unstable incomes and sudden cash shortfalls. But the per-dollar costs to develop and administer small dollar programs and the short loan (typically three- to six-month) terms can push the loans’ average percentage rates above those of other types of consumer credit that banks provide, according to a Dec. 15 BPI research note by Paul Calem. These factors can also make the APR a misleading measure of the cost to borrowers.

When pricing small dollar loans, banks seek to balance potentially elevated costs, including program administrative costs and potentially high repayment risk, with potential benefits of providing such credit. Small dollar loan programs can bring low-income borrowers into the banking system, where they may qualify for more products as their credit profile improves. Pricing for small dollar credit can vary among banks offering these programs, partly because of variation in the credit risk profiles of the populations they serve.

In Case You Missed It

Quote of the Week

“We have been quite brave to ask banks to refrain from paying dividends at this difficult juncture,” Andrea Enria, chair of the ECB’s supervisory board, said in a Dec. 15 Financial Times article. “But at the same time we have to be reasonable — we are now moving out of that uncertainty, a vaccine has been rolled out and the macroeconomic outlook is lifting slightly, so we cannot play god forever.”

BPI’s Pat Parkinson Publishes Working Paper Proposing Treasury Market Liquidity Boosters

BPI Senior Fellow Pat Parkinson and Nellie Liang, a senior fellow at the Brookings Institution, proposed four measures in a Dec. 16 Brookings working paper aimed at increasing the liquidity of the Treasury markets under stress. The recommendations would reduce the need for the Federal Reserve to intervene with ex post emergency measures to support Treasury market liquidity, like the measures it took in March to restore market functioning in the face of the pandemic. Specifically, the paper proposes that the Fed create a new standing repo facility; that policymakers consider measures to broaden the use of central clearing of Treasuries; that bank regulations be changed in a targeted way to allow bank-affiliated dealers to provide more liquidity without reducing safety and soundness; and that more data be collected and disseminated about bilateral uncleared repos and market intermediation by broker-dealers.

BPI’s Greg Baer Weighs in on FinTech Charter, Shell Companies on Banking With Interest Podcast

BPI President and CEO Greg Baer joined Rob Blackwell on the Banking with Interest podcast Dec. 15, where he discussed anti-money laundering reform legislation, why Figure Bank’s application for an uninsured national bank charter would pose risks to consumers, climate change stress testing and issues with the OCC’s Fair Access proposal.

“All the heat and noise has been around oil and gas, but what they have proposed is breathtaking in its scope and its divergence from history,” Baer said about the OCC proposal.

WSJ: European Bank Dividend Ban Lifted, But Restrictions Remain

The European Central Bank on Dec. 15 eased its ban on bank dividends and share repurchases, but left some restrictions in place as limited payouts resume, The Wall Street Journal reported Dec. 15. The ECB said banks can restart limited shareholder payouts in 2021, but dividends and buybacks must be below 15 percent of the combined profits for the past two years or no higher than 0.2 percentage points of the common equity tier 1 ratio, whichever is lower. Additionally, the ECB iterated its expectation that banks adopt “extreme moderation” with regards to employee pay until Sept. 30, 2021 to assist with preserving capital. The move follows a similar step by the Bank of England last week and came as the Federal Reserve prepared to release the results of its second round of stress tests, which are expected to determine whether it will lift restrictions on U.S. bank dividends and buybacks.

FDIC Narrows Restrictions on Deposit Brokers

The FDIC finalized a rule Dec. 15 that narrows the universe of companies that are considered deposit brokers. Under the final rule, only firms that partner with more than one insured depository institution are considered deposit brokers. The policy, which could allow more room for banks to partner with outside firms, hinges on whether a firm facilitates the placement of deposits, either by moving the funds or negotiating fees or other terms. The rule will focus on situations where the primary purpose of a partnership between a bank and outside firm is deposit placement.

Huntington to Merge With TCF

Huntington Bancshares Inc. and TCF Financial Corp. agreed to combine in a $22 billion all-stock merger, Huntington announced Dec. 13. The combined bank will maintain dual headquarters in Columbus, Ohio, and Detroit, Mich. TCF will merge into Huntington, and the combined bank will operate under the Huntington name. Huntington CEO Stephen Steinour will lead the combined company after the merger.

Fed Joins Climate-Focused Central Bank Group

The Federal Reserve officially joined the Network of Central Banks and Supervisors for Greening the Financial System, a group of central banks focused on addressing climate change, the central bank announced Dec. 15. The Fed had participated in NGFS activities and discussions more than a year prior, but had not formally joined the organization until this week. “As we develop our understanding of how best to assess the impact of climate change on the financial system, we look forward to continuing and deepening our discussions with our NGFS colleagues from around the world,” Fed Chair Jay Powell said in a statement.

BPI Urges Tailored Scope for CFPB Small Business Lending Data Collection Rule

BPI encouraged the Consumer Financial Protection Bureau in a Dec. 14 comment letter to continue taking a tailored approach to its small business lending data collection rule under Section 1071 of the Dodd-Frank banking law. Banks should be able to rely on information that borrowers provide when reporting such data and should be given flexibility on the time period for collecting that information, BPI said in its comment letter. The CFPB should also tailor and clearly define the scope of what loan products are covered and excluded under the policy, BPI wrote.

GAO: Leveraged Loans Pose No Significant Threat

Leveraged lending does not pose significant threats to financial stability, according to findings from a Government Accountability Office report released on Wednesday. The report determined that while leveraged loans grew from $0.5 trillion in 2010 to $1.2 trillion in 2019, the growth of these loans has not posed financial stability threats due to the strong capital positions held by large banks that “have allowed them to manage their leveraged lending exposures.” Additionally, CLO securities were found to be less risky today than similar securities were in 2007-2009.

FinCEN Encourages Information Sharing Among Financial Institutions in Newly Published 314(b) Fact Sheet

On Dec. 10, the Financial Crimes Enforcement Network released a new 314(b) Fact Sheet, intended to promote greater information sharing amongst financial institutions. The release was concurrent with remarks by FinCEN Director Blanco in which he emphasized the importance of information sharing in order to better identify and report potential money laundering or terrorist financing. The Fact Sheet importantly broadens circumstances in which institutions can share information, including even in circumstances where a specified unlawful activity has not yet been identified, going further than previous guidance. The Fact Sheet also allows for nonfinancial institutions, such as compliance service providers that form and operate an association of financial institutions, to participate in information sharing agreements.

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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.