BPInsights: February 13, 2021

Stories Driving the Week

The Fact That Big Banks’ Stock Prices Got Hammered This Spring Hardly Proves Banks Are TBTF

BPI Chief Economist Bill Nelson responded to a blog post on the Federal Reserve Bank of New York’s Liberty Street Economics blog asserting that a pandemic stock-price slump among the nation’s largest banks confirms that investors see them as less risky than regular banks because they would be bailed out in a crisis. A more plausible explanation for big bank stock underperformance during COVID-19 is that investors were concerned that those banks were more exposed to pandemic-induced losses, meaning that investors required a higher risk premium to compensate for that added risk. A higher risk premium would drive the stock price down. Nelson also pointed to BPI research from September that shows that in the COVID-19 shock, bond spreads of Global Systemically Important Banks widened by more than their non-GSIB counterparts, showing that investors required a higher return from GSIBs during the pandemic. Required returns on debt are more sensitive to bailout implications.

FT: Banks Want Tech Disrupters to Play Fair

Banks have made it clear: Tech firms, from small startups to Big Tech giants, that want to do banking business should play by banking rules. In a Financial Times article this week, banks set out fair regulation of tech players in banking as a policy priority under the new Administration. Policymakers should prevent tech companies from exploiting loopholes, such as lite-touch banking charters, to do what banks do without the safety measures that guard bank consumers’ deposits. “These new ersatz bank charters lack protections for U.S. consumers and are a risk to financial stability,” BPI President and CEO Greg Baer said in the article. “They would enable tech companies to operate without the consumer and safety and soundness protections designed for a full-fledged bank.”

The article also explored the idea of fairer regulation for nonbank financial firms, such as hedge funds and money market funds – some of which showed vulnerability in pandemic market turmoil last year, in contrast to well-capitalized banks. The Financial Stability Oversight Council could potentially examine that issue in the future.

Biden Considering Lisa Cook, William Spriggs For Open Fed Seat

President Joe Biden is considering nominating Michigan State University economist Lisa Cook or AFL-CIO economist William Spriggs to an open Federal Reserve Board seat, according to a Feb. 10 Bloomberg piece. Cook, an Obama-era member of the Council of Economic Advisers, would be the first Black woman to join the Fed’s Board of Governors. Cook’s writing suggests she is a monetary dove who focuses more on other priorities, such as supporting full employment, over limiting inflation. Spriggs, an Obama Administration Labor Department official, is the AFL-CIO’s chief economist and teaches at Howard University.

Yellen Considering Raskin for Treasury Climate Role

Treasury Secretary Janet Yellen is considering Sarah Bloom Raskin, a former Deputy Treasury Secretary, to lead a new department hub in charge of climate change issues, according to a Feb. 12 Wall Street Journal article. The Treasury climate czar would examine climate change risks to the financial system, such as higher flood risk that threatens real estate value as sea levels rise. The move comes as the Administration weighs how to assess the financial implications of climate change. BPI has cautioned against using stress tests to evaluate banks’ climate change exposures, as they rely on very long time horizons and variable data.

Venmo Debt Collection Practices Under CFPB Scrutiny

PayPal Inc.’s Venmo faces a Consumer Financial Protection Bureau probe over how it pursues customers who overdraw their accounts, according to The Wall Street Journal. The CFPB issued a Civil Investigative Demand to PayPal, which owns Venmo, “related to Venmo’s unauthorized funds transfers and collections processes, and related matters.” PayPal said it was cooperating with regulators. Venmo has threatened to direct debt collectors toward customers who overdraw accounts, even when they are victims of scams, the WSJ reported.

Fed Releases 2021 Stress-Test Scenarios

The Federal Reserve on Feb. 12 unveiled the hypothetical scenarios underpinning its stress test this year. Nineteen large banks will be subject to the test this year, which examines how banks’ balance sheets would weather a hypothetical crisis. Last year, banks showed resilience amid hypothetical shocks as well as the genuine stress of the pandemic’s economic fallout.

The scenario entails a hypothetical recession starting in the first quarter of this year, with a severe global downturn and stress in commercial real estate and corporate debt markets. The U.S. unemployment rate in the scenario would peak at 10.75 percent in the third quarter of next year, with a GDP drop of 4 percent from the fourth quarter of 2020 to the third quarter of 2022. The scenario also features a 55 percent decline in equity prices.

In Case You Missed It

BPI’s Heather Hogsett Joins Supply-Chain Risk Panel at Women in Payments Symposium

Heather Hogsett, Senior Vice President, Technology and Risk Strategy at BPI, participated in a panel on “Trends in Cybersecurity and Supply Chain Risk Management” on Feb. 11 at the Women in Payments 2021 Symposium. The discussion explored how banks and the broader financial industry are innovating to keep customer data secure amid highly sophisticated cyber attacks against government and businesses, such as the recent SolarWinds incident. The SolarWinds breach exemplifies the kinds of sophisticated cyber attacks that continue to expand and highlights the interdependencies across the industry and its third parties. It also underscored the importance of information sharing between the industry and government agencies given the need for financial firms to safely share information through government channels that may have been compromised. Hogsett noted that given the nature of the relationships with regulators and other government agencies, this dialogue can be a challenge, but finding ways to provide greater transparency will be important to help firms adjust their own defenses where necessary and help reduce risk across the entire financial sector.

OCC Conditionally Approves Second Crypto Custody Firm for Trust Charter

The Office of the Comptroller of the Currency granted a conditional approval to Protego Trust Co. to convert its state trust bank charter to a national one, according to an agency announcement on Feb. 5. Protego, based in Washington state, focuses on holding digital currencies in custody for its clients. It joins Anchorage, a South Dakota-based crypto firm, in receiving OCC approval to convert a state trust charter to a national one.

Wells Fargo Invests in 6 Black-Owned Banks

Wells Fargo & Co. has made equity investments in six Black-owned banks and will share financial, tech and product expertise with them, according to a Bloomberg piece on Feb. 8. “These institutions, many of which have been around for over 100 years, are really vital to these communities, and if we’re going to begin to address the inequity that’s in many of our communities these institutions need to be healthier and need to be able to grow, to be more competitive,” Bill Daley, Vice Chairman of Public Affairs at Wells Fargo, said.

The investments are part of a broader $50 million pledge to support minority-focused institutions. The banks are: Broadway Federal Bank in Los Angeles, Carver Federal Savings Bank in New York, Citizens Savings Bank & Trust in Nashville, Commonwealth National Bank in Mobile, Ala., M&F Bank in Durham, N.C. and Optus Bank in Columbia, S.C. Bank of America Corp. has also made equity investments in minority depository institutions, and Citigroup Inc. has also pledged to provide MDIs with growth capital. Truist has also made similar commitments.


Bank of America Pledges to be Net Zero Before 2050

Bank of America Corp. said it plans to achieve net zero greenhouse gas emissions in its financing activities, supply chain and operations before 2050, according to a Feb. 11 press release. BofA, a core member of the Partnership for Carbon Accounting Financials, also outlined steps toward reducing its environmental impact by 2030, such as cutting energy use by 55 percent. It achieved carbon-neutral operations in 2019. The bank joins JPMorgan Chase & Co. in setting a net-zero emissions target and several other banks in climate-related commitments.

BPI Blog: Turns Out Leveraged Loans Aren’t a Systemic Risk After All

The market stress of the COVID-19 pandemic wrenched the leveraged loan market, but those effects did not threaten systemwide financial stability, a December 2020 GAO report shows. Yet bank participation in that market has been curtailed in recent years – restrictions that now appear unfounded, BPI Chief Economist Bill Nelson writes in a new blog post.

The Federal Reserve, along with the OCC and FDIC, issued guidance in 2013 and FAQs in 2014 that restricted banks’ ability to originate, then sell, syndicated loans that would be too risky for the bank itself to hold. Usually, such restrictions from banking regulators reflect concerns about safety and soundness risks for a bank, but because the bank does not hold the loan, the bank’s safety is not at issue. Instead, the agencies justified both these actions by pointing to “risks for the financial system” or similar language. Recently released transcripts of 2015 FOMC meetings call into question whether any Board officials responsible for assessing financial stability actually judged leveraged presented risks to the financial system.

Leveraged loans just faced a pandemic reckoning, like the rest of the financial markets, that tested whether stress among these loans would undermine financial stability. Their performance demonstrates that it would not. So why were they on the Fed’s radar in 2014? The Fed was winding down its asset purchases and deciding on how strongly to indicate its intent to keep interest rates near zero after the purchases ended. At the same time, some FOMC participants were concerned about low interest rates driving investors to seek higher yields by choosing riskier products — in particular, leveraged loans. The leveraged lending guidance and FAQs enabled the Fed to allay these concerns and continue its easy monetary policy. After the Fed’s FAQs in November 2014, leveraged lending slowed considerably, preventing some businesses in the economy from receiving credit and pursuing economic opportunities. Now that new FOMC transcripts call into question whether Board officials actually judged the loans to pose systemic risk, and the GAO has concluded that the performance of the loans during 2020 demonstrates that they don’t pose systemic risk, those economic opportunities appear to have been needlessly lost.


JPMorgan’s Dimon Meets With Biden Administration

JPMorgan Chase & Co. CEO Jamie Dimon met with President Joe Biden, Vice President Kamala Harris and Treasury Secretary Janet Yellen at the White House on Feb. 9, according to the Financial Times. Other business leaders, including Walmart CEO Doug McMillon and outgoing U.S. Chamber of Commerce CEO Tom Donohue, also attended. The President is seeking support from business leaders on his $1.9 trillion stimulus package. Dimon described the meeting, which covered a range of topics from infrastructure to healthcare, as “constructive and detailed.”

Treasury Holds Innovation Summit

Treasury Secretary Janet Yellen hosted a Financial Sector Innovation Policy Roundtable this week, according to a Treasury Department press release. Yellen called for using tech innovations such as digital ID to expand financial services access in underserved communities. She also warned against the use of cryptocurrencies in financial crime and said innovative approaches can help root out money laundering and fraud.

BPI, Joint Trades File Amici Brief in Goldman Shareholder Class Action Case Before SCOTUS 

BPI, along with the Securities Industry and Financial Markets Association and other financial and business trades, filed an amici curiae brief in support of Goldman Sachs Group Inc. in a case before the Supreme Court relating to the ability of shareholders to bring securities fraud class-action lawsuits against public companies whose stock prices fall. The case is Goldman Sachs Group Inc. et al. v. Arkansas Teacher Retirement System et al.  
 
At issue is whether shareholders can file class-action lawsuits when a company makes a general, public statement, such as saying “clients’ interests come first” in an annual report, and then its share price falls. Pension funds argued that Goldman misled the markets and inflated its stock price by making that kind of generic statement ahead of government enforcement actions against the bank related to collateralized debt obligation trades. BPI and the other trades argue in the brief that upholding the Second U.S. Circuit Court of Appeals decision to allow a class action without an opportunity to show that the statements did not actually affect the stock price when made could expose companies to baseless lawsuits premised on generic company statements that didn’t actually affect the market. 
 
The SEC and Department of Justice also filed an amici brief  supporting the argument that the generic nature of the bank’s allegedly misleading statements be taken into account when considering whether the statements affected its stock price and whether the court presumes the shareholders all relied on the same alleged misrepresentations when they bought shares.  
 
The case is scheduled for oral argument at the Supreme Court on March 29. 

BPI/Columbia Conference Continues With Liquidity Insurance Panel

On Feb. 12, 2021, BPI and Columbia University hosted the second panel of the 2021 Annual Columbia SIPA/BPI Bank Regulation Research Conference.  The panel featured two papers related to liquidity insurance under the COVID-19 pandemic and its impact on credit provision and bank stock prices.

The first paper discussed was “Liquidity Insurance vs. Credit Provision: Evidence from the COVID-19 Crisis.” The motivation for this paper was the large volume of drawdowns from bank credit lines that took place in March-May 2020 as COVID-related lockdowns spread across the country. In total, banks provided over $500 billion of financing through credit lines, exceeding the Global Financial Crisis in terms of size and velocity. The paper uses data on the syndicated loan market, Senior Loan Officer Opinion Survey and government programs (Paycheck Protection Program and Main Street Lending Program) to analyze lending standards and volumes of credit provision in the aftermath of the COVID-19 shock.

The authors show that there was a relevant decline in new syndicated loans while loan standards tightened. Three potential mechanisms were discussed: i) Liquidity drain as new loans need to be funded; ii) Reduction in capital ratios led by moving credit draws on-balance sheet and the subsequent increase in risk-weighted assets; iii) Increased risk aversion as the uncertainty around the economic outlook changed bank assessment of potential future losses. The paper finds that banks with greater exposure to credit line drawdowns saw lower rates of lending in the second quarter of 2020, and also tended to report tighter loan standards. Banks with credit line portfolios more exposed to COVID-affected industries also saw larger declines. Interestingly, evidence from government-sponsored programs like PPP and MSLP show similar trends despite the secured nature of these loans. The authors conclude with a call to better understand the variations of risk tolerance during times of stress as a determinant of credit provision.

The second paper discussed was “What explains the crash of bank stock prices during COVID-19?  The role of health, financial and oil price risks.” The paper observes that bank stocks have significantly underperformed non-financial corporates since the onset of the pandemic and aims to provide an explanation through measures of balance sheet liquidity in times of stress. The authors believe that aggregate drawdown risk is not well-captured in traditional measures of bank performance and generate an ex-ante measure of liquidity risk by combining unused commitments and wholesale funding (net of current liquidity and scaled by total assets). The paper then applies this metric to explain stock market returns between Jan. 1 and March 23, 2021, thus avoiding confounding factors from Fed intervention in late March. The authors find evidence to suggest that higher ex-ante liquidity risk significantly impacts stock market returns. The authors also derive implications for stress testing from their results and argue for a measure of contingent capital shortfall that accounts for off-balance sheet commitments.


N.Y. State Regulator Offers CRA Credit for Climate-Focused Investments

Banks subject to New York state regulation can earn state Community Reinvestment Act credit for investments that help reduce climate change impacts on low-income communities, according to a Feb. 9 American Banker article. The article cites a Feb. 9 letter from the New York State Department of Financial Services, the state’s banking regulator. Investment efforts could include solar panel projects or flood safeguards for housing developments. The guidance is voluntary and pertains only to the New York version of the CRA, not the federal one; New York is one of a few states with CRA laws on their books. Banks affected by the guidance include Bank of New York Mellon, Goldman Sachs Bank USA, M&T Bank and New York Community Bank.

Sen. Richard Shelby to Retire

Former Senate Banking Committee Chair Richard Shelby (R-AL) announced on Feb. 8 he would retire when his term ends next year, according to The New York Times. Shelby joins Sen. Pat Toomey (R-PA), the banking panel’s ranking member, in deciding not to run for re-election. Shelby is Alabama’s longest-serving senator.

MUFG Promotes Kevin Cronin to Most Senior Americas Post

MUFG promoted executive Kevin Cronin to its top banking job in the Americas, the Japanese financial conglomerate announced Feb. 9. Cronin, who previously led MUFG’s Global Corporate and Investment Bank in the Americas, will serve as Regional Executive for the Americas for MUFG and its primary banking subsidiary, as well as President and CEO of MUFG Union Bank and its holding company, MUFG Americas Holding Corp. Cronin will succeed Stephen Cummings, who is retiring in March.

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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.