BPInsights: February 18, 2023

The Problem with “Too Big to Manage”

A new regulatory regime has quieted talk of “Too Big to Fail,” but now some have suggested “Too Big to Manage” is a problem. Not only is Too Big to Manage a faulty concept – it’s also not the law. Here’s how it’s wrong:

  • Complexity has benefits. Too Big to Manage assumes complexity comes with only costs and no benefits. But complexity means diversification. Diversified firms outperform undiversified ones, earning higher returns with lower risk.  And the largest globally active banks’ GSIB capital surcharge is expressly designed to reduce the chance of default at a systemically important bank – so the default risk is lower at a large, diversified bank than at a small one.
  • Large, diversified banks provide essential services to American businesses. Major American companies operating throughout the global economy need services, and only large, diversified banks can provide them. The complexity of large U.S. banks enables these companies to succeed and fuels U.S. economic growth, from capital markets to lending and custody services.
  • What does “Too Big to Manage” really mean?   How are banking agency examiners to determine the difference between a poorly managed bank and a bank that is too big to manage any way but poorly? For the former, Congress has established many tools to resolve the problem. For the latter, there are many reasons to be skeptical. Federal banking examiners may deem a bank well-managed based on whether it complies with examination mandates, many of which are non-public, rather than by historical evidence, market performance, financial strength and the oversight and judgment of its board.  TBTM will become UTC – unwilling to comply.
  • Large banks are not more complex than ever. Much of the growth in their assets reflects inflation and larger holdings of low-risk assets in response to regulatory liquidity requirements. This does not mean banks are more complex. It means they are less vulnerable to liquidity pressures – safer and easier to manage. In the one year that risk assets of the large banks increased substantially (2009) it was because large banks purchased failed or failing securities firms and two large securities firms became bank holding companies. In other words: diversification. 

To learn more, click here.

Five Key Things

1. How the Beneficial Ownership Database Could Help Target Financial Crime

BPI this week responded to FinCEN’s proposed rule on access and safeguards for beneficial ownership information that will be reported to the bureau under the recently enacted Corporate Transparency Act. When crafting limits around access to this information, FinCEN should carry out Congress’ goals to ensure the information’s usefulness in mitigating illicit finance risks and eliminate unnecessary burdens on small businesses.

  • What’s happening: FinCEN is seeking input on a proposed rule for how banks and other users can access the corporate beneficial ownership directory established by the Anti-Money Laundering Act, a comprehensive AML reform law that included the CTA.  The directory will contain information about businesses’ beneficial owners to aid law enforcement and financial institutions in their efforts to combat the use of anonymous shell companies to launder money. The proposed rule specifies who will have access to information in the directory, how they may use that information, and how they must secure it.  The directory is meant to enhance banks’ and law enforcement’s ability to root out illicit financing and criminal activity, and so overly stringent limits on the ability of banks to access and use information would undermine that key policy goal.
  • What BPI is saying: “We strongly supported the legislation creating a beneficial ownership registry because it would make it easier to stop flows of illicit finance, but the proposed rule imposes so many restrictions that it would not achieve that goal.” – Greg Baer, BPI president and CEO.
  • Why it matters: As drafted, the rule narrowly limits banks’ database access and would restrict the ways banks could use beneficial ownership information to comply with the Bank Secrecy Act.  The result is contrary to Congressional intent and contradicts the Anti-Money Laundering Act’s important goals: modernizing the KYC process for both banks and the businesses they serve, and maximizing the usefulness of information for law enforcement.
  • Bottom line: “The way they’ve interpreted it is so limiting, it’s unclear if banks will even use this,” BPI Senior Vice President of Government Affairs Cara Camacho told Morning Money.

Learn more, including BPI’s recommendations, here.

2. Brainard Tapped to Lead National Economic Council

The White House this week announced the appointment of Federal Reserve Vice Chair Lael Brainard as director of the National Economic Council. Brainard’s move to the influential Administration post will leave a prominent vacancy on the Fed’s Board of Governors. Brainard, a monetary policy “dove”, led the central bank’s work on the interagency Community Reinvestment Act revamp and the FedNow payments network, as noted in a Fed press release. The rumor mill has proffered several possible replacements, but it’s unclear at this time who will be nominated to take her place.

3. Tailoring, M&A and Transparent Supervision: Michelle Bowman’s Remarks

Federal Reserve Governor Michelle (Miki) Bowman covered several relevant regulatory topics in a speech this week. Here are some takeaways:

  • Tailoring: Bowman expressed support for the regulatory tailoring regime that differentiates regulatory requirements for banks based on size and risk profile. She said tailoring should “continue to feature prominently in upcoming proposed revisions to the capital framework.” While the Fed will likely propose new capital requirements for the largest banks, including as part of its Basel Finalization proposal, “my understanding is that there are no plans to propose changes to the community bank capital framework as part of this capital review,” Bowman said. She didn’t speak specifically to whether the proposal would apply to category 2 or 3 banks.
  • M&A: Bowman expressed concern that bank merger reviews are taking too long. Overly lengthy merger reviews can increase operational risk, raise expenses and jeopardize employee retention, she noted. “I am concerned about delays in the applications process and am concerned that the increase in average processing times will become the new normal,” Bowman said. Greater transparency can help ensure clear expectations about merger review timelines, she said.
  • Clear expectations: The Fed should maintain clear supervisory expectations for the banks it oversees, Bowman said, pointing to the publication of the Large Institution Supervision Coordinating Committee manual as an example of improved transparency. She also said that the Fed’s “role as a banking supervisor is not to replace a bank’s management and board of directors in adopting a banking strategy and risk appetite.”

4. Reuters: Binance Moved Millions from U.S. Partner’s Bank Account to CEO Zhao’s Trading Firm

Crypto exchange Binance transferred hundreds of millions of dollars from a Silvergate Bank account belonging to Binance.US, its purportedly independent U.S. partner, to Merit Peak Ltd., a trading firm managed by Binance CEO Changpeng Zhao, Reuters reported this week. Over the first three months of 2021, more than $400 million flowed from the Binance.US account to the trading firm, according to the article. “The money transfers suggest that the global Binance exchange, which is not licensed to operate in the United States, controlled the finances of Binance.US, despite maintaining that the American entity is entirely independent and operates as its ‘US partner,'” the piece says. U.S. officials have sought information about the relationship between Binance and Binance.US as part of ongoing probes. 

5. Within the Ring-Fence, Global Financing is Trapped Behind Borders

A recent article in The Economist told the story of de-globalization. One important, overlooked factor in that phenomenon: geographical ring-fencing of banks in the U.S. and Europe, which traps trade and other forms of finance within sovereign borders, according to an Economist letter to the editor by BPI’s Greg Baer. That effort takes two forms: ring-fencing of capital and liquidity in the wake of Lehman Brothers, and the anti-money laundering mandates to “de-risk” clients in developing countries. “Some ring-fencing of capital was needed, but the high levels now required to be held hostage in local jurisdictions appear to assume that all those reforms were fruitless,” Baer wrote in the letter. “The effects of these regulatory mandates may be larger than any tariff or export or import restriction, but receive far less attention, perhaps because they are less transparent and more complex.”

In Case You Missed It

The Crypto Ledger

Both banking regulators and the SEC have trained their eyes on crypto in the regulated financial system. The scrutiny is causing some crypto-oriented banks as well as firms like PayPal to step back from the sector. The SEC recently proposed new restrictions expanding the range of client assets that investment advisers must secure with “qualified custodians” such as banks or broker-dealers to include crypto assets. New York’s state financial regulator ordered Paxos to stop minting Binance’s BUSD stablecoin. Here’s what else is new in crypto.

  • Terra: The SEC this week charged Terraform Labs, the company behind collapsed stablecoin TerraUSD, and founder Do Kwon with engineering a multibillion-dollar crypto fraud.
  • Binance fines: Crypto exchange Binance expects to pay penalties to U.S. authorities to settle probes of its business, according to The Wall Street Journal. The firm has faced DOJ and CFTC investigations, including over possible anti-money laundering violations.
  • FDIC: The FDIC this week demanded that several crypto and fintech firms stop misrepresenting their deposit insurance protection, the agency’s latest move against such firms. Crypto exchange CEX.IO Corp., Zera Financial, Captainaltcoin.com and Banklesstimes.com received cease-and-desist letters from the regulator.
  • Frozen and taxed: Some crypto customers without access to frozen funds at bankrupt platforms like Celsius Network still face tax bills on their investments, according to Bloomberg.

Who Will Be Europe’s Next Bank Overseer?

Three high-profile female central bankers are potential candidates to succeed Andrea Enria as Europe’s top bank supervisor. The Bundesbank’s Claudia Buch, the Bank of Spain’s Margarita Delgado and the Central Bank of Ireland’s Sharon Donnery are emerging as strong contenders, although the formal process has not yet begun, Bloomberg reported this week.

  • Next steps: Enria is scheduled to step down in December when his five-year term as the chair of the European Central Bank Supervisory Board ends.
  • The three: Donnery is known for her stint leading the ECB’s task-force on non-performing loans. Buch is an economist who has “taken hawkish positions when it comes to forcing banks to build up capital to prepare for economic downturns,” the Bloomberg article said. Delgado, who has served as a deputy director general in the ECB’s supervisory arm, has acknowledged the limits of banking supervision, saying in a previous Bloomberg interview that regulators shouldn’t use banks as a tool for climate policy.
  • The stakes: The position plays a critical role in overseeing banks across the EU. During the pandemic, European bank supervisors faced particular scrutiny for restricting banks’ capital distributions.

Pitching the Digital Euro to the Public

Eurozone central bankers will gather in Finland next week to discuss how to pitch the idea of a digital euro to the public, according to POLITICO. The officials will discuss, among other topics, how to persuade the public that a digital version of the euro is worthwhile and does not threaten democracy or liberties, according to the article. The gathering comes amid anxiety about China’s digital yuan and fears of stablecoins backed by Big Tech that could challenge sovereign currency.

Quantifying the Costs and Benefits of Quantitative Easing

This Mercatus Center policy brief summarizes a paper co-authored by BPI chief economist Bill Nelson, which conducts a systematic analysis of the costs and benefits of large-scale securities purchases, as exemplified by the Federal Reserve’s QE4 program as a concrete example. This program was initiated at the onset of the pandemic in March 2020 and continued for two years, leading to a doubling of the Fed’s securities holdings to about $8.5 trillion as of March 2022. While QE4 was initially aimed at mitigating strains in markets for Treasuries and agency mortgage-backed securities, it was subsequently broadened with the aim of supporting market functioning and providing monetary stimulus. However, QE4 did not have any notable benefits in reducing term premiums, and since the securities purchases were financed by expanding the Fed’s short-term liabilities, the program amplified the interest rate risk associated with the publicly held debt of the consolidated federal government. Simulation analysis presented in this paper indicates that QE4 is likely to reduce the Federal Reserve’s remittances to the U.S. Treasury by about $760 billion over the next 10 years. To learn more, read the full National Bureau of Economic Research Working Paper.

TD Bank Launches Black Entrepreneur Credit Access Program

TD Bank this week announced the launch of a lending program focused on boosting credit access for black entrepreneurs. The program offers an enhanced credit review process, including a holistic view of the application, and enables applicants to work directly with a specialized customer experience team.

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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.