BPInsights: February 19, 2022

Stories Driving the Week

Does the World Need a Dollar CBDC?

The Federal Reserve is asking the public whether it should issue a central bank digital currency. The case for a U.S. CBDC seems to be waning. Fed governors, former and current, have expressed concerns about the prospect of a digital dollar, and Fed Chair Jerome Powell has noted that Congressional authorization would be required to make it happen.

Central bankers backing off: The Fed isn’t the only central bank hesitating. The U.K., Australia and Canada, key U.S. allies, have also slowed down their CBDC plans, seeing no compelling case for a digital currency. This hesitancy is notable because interest in CBDC worldwide appeared to grow based on what other central banks were doing.

What happened? Central bankers are noticing significant, unavoidable costs of a CBDC. Benefits are hard to identify, and measures to prevent harmful side effects would diminish those benefits. Like private-sector stablecoins, CBDC lacks practical use cases – in fact, its most attractive use case would be its most dangerous: as a safe haven in crisis that would strip funding from the economy.

A new BPI blog post gives an updated breakdown of the costs and benefits of a U.S. CBDC and explains why it’s looking increasingly unappealing.

Deep Dive: DFAST 2022 Stress Test Scenarios

The Federal Reserve on Feb. 10, 2022, released the scenarios it will use to perform its stress tests for this year, with added components for banks with large trading operations. The severely adverse scenario is designed to test banks’ resilience in a severe economic downturn. A new analysis from BPI’s economists delves into what’s different in this year’s scenarios.

Bank Climate Risk Guidance Needs Flexibility

Banks and financial regulators are considering different ways to manage climate-related financial risk. In two separate comment letters filed this week with the OCC and the Basel Committee, BPI offers principles to guide regulators’ approaches.

What BPI is saying: “Banks are essential to a smooth transition to a greener economy by helping their customers across all industries meet their financing needs. To support that transition banks need a flexible, risk-based approach from banking supervisors, as opposed to granular, prescriptive rules,” BPI Senior Vice President and Associate General Counsel Lauren Anderson said.

“It’s essential that regulators take thoughtful, steady steps forward, not over-committing with false precision-based rules at this point. We look forward to working with the Basel Committee and the OCC on these important policy issues.”

What’s New on Russia Sanctions

The Senate released a symbolic bipartisan statement on Russia sanctions after disagreements held up the legislative sanctions process as the threat of a Ukraine invasion loomed.

A deeper look: For a deep dive on potential sanctions ramifications – and the complexity of sanctions discussions between the U.S. and Europe – see this POLITICO piece.

Biden warning: President Joe Biden warned in a speech this week that the U.S. was ready to hit Russia hard with financial sanctions.

International perspective: Financial Stability Board Chair Klaas Knot, also the Dutch central bank chief, cautioned in a Financial Times interview that “severe measures” in Russia sanctions could disrupt global payment flows. However, he noted that global banks are well prepared to weather a shock. “A well-capitalised banking sector has proven its value over the last few years. I think if you look at the main difference between the pandemic shock and the global financial crisis, it was that this time around, the banks were absorbing rather than amplifying the shock.”

Hsu Previews Joint CRA Revamp

Acting Comptroller Michael Hsu in a speech this week previewed key aspects of new Community Reinvestment Act rules that the OCC is working with the Fed and the FDIC to revise. The new rules will give banks clear, consistent expectations on their CRA responsibilities and reflect a new era of banking that goes beyond brick-and-mortar branches, he said.

Fed’s Brainard Urges U.S. to Continue Consideration of CBDC 

Federal Reserve Gov. Lael Brainard, who is awaiting confirmation to be vice chair of the central bank, gave a speech Friday on central bank digital currency. She said the U.S. should look to the financial future and consider international implications as policymakers consider a central bank digital currency. Brainard outlined the Fed’s ongoing exploration of CBDC and the potential costs and benefits.

  • Rise of stablecoins: Brainard highlighted the emergence of stablecoins and the rising interest in crypto products among retail investors and established financial institutions. She called for strong regulatory framework to oversee stablecoins, including the quality of their reserves, to guard against run risk and fund settlement risk.
  • Payment system: Brainard said there may be improvements, such as faster payments or greater financial inclusion, resulting from payment system innovations. “It is prudent to explore whether there is a role for a CBDC to preserve some of the safe and effective elements of the financial system of the present in a way that is complementary to the private sector innovations transforming the financial landscape of the future.”
  • Stress safeguards: She noted the potential risk of depositors’ “flight to safety” into CBDC. “[I]t is important to undertake research regarding the tools and design features that could be introduced to limit such risks, such as offering a non-interest bearing CBDC and limiting the amount of CBDC an end user could hold or transfer.”
  • China: Brainard put a potential U.S. CBDC in an international context, alluding to China’s recent launch of its e-CNY. She said it is “essential that the United States be on the frontier of research and policy development regarding CBDC, as international developments related to CBDC can have implications for the global financial system.”

More Taxis Sitting Idle

An economist’s train pulls into the station in a remote college town late in the evening and she is glad to see that there is a taxi at the station.  She jumps out of the train, goes to the taxi, jumps in and asks to be taken to her hotel.  The taxi driver says, “I’m sorry, I can’t take you.  Recognizing the importance of a taxi always being available for arriving train passengers, there is a town ordinance requiring that there always be at least one taxi waiting at the station.”

This “last taxi” parable has often been used to describe bank liquidity requirements – banks can’t use the liquidity they are required to hold or they would violate the requirements.  In a new blog post, BPI’s chief economist explains that the situation is even worse than captured by the parable.  Banks report that during the COVID financial turmoil they raised additional unneeded liquidity simply to be sure they remained in compliance – there were two taxis at the station.  Moreover, banks pledge over a trillion dollars of collateral to the discount window but are reluctant to borrow because of the severe stigma associated with doing so, a reluctance that could extend to the Fed’s new standing repo facility as well – even more taxis held in reserve.  The reluctance to use these tools increases banks’ demand for reserve balances – deposits at the Fed.

In Case You Missed It

What’s New in Stablecoins, Crypto

Here’s what’s happening in the crypto and stablecoin space this week.

  • Senate hearing: Treasury official Nellie Liang testified before Congress on stablecoins for the second time this month, this time before the Senate Banking Committee. Liang has called for Congress to pass stablecoin legislation. BPI released a statement on the hearing calling on Congress to act promptly to address stablecoin risks such as consumer harm and unstable reserves. “Congress has acknowledged these risks through numerous hearings and should act promptly, in coordination with financial regulators, to establish clear rules that will help to promote competition and responsible innovation in a way that protects consumers,” BPI’s Paige Pidano Paridon said.
  • FSB report: The Financial Stability Board released a report this week on cryptoassets that said they could reach a point where they threaten financial stability. Financial stability risks from cryptoassets stem from their scale, structural weaknesses and interconnectedness with the traditional financial system, the report said. Crypto market vulnerabilities flagged in the report include liquidity mismatch, credit and operational risks, leverage, concentration risks among trading platforms and lack of regulatory oversight.
  • Fed minutes: Stablecoins appeared in the FOMC minutes released this week as a potential risk in funding markets. The major growth of stablecoins presents risks, including the risk of a run.
  • DOJ crypto team: The Department of Justice named Eun Young Choi to lead its new National Cryptocurrency Enforcement Team. The group will investigate and prosecute illicit crypto schemes. Choi is a veteran cybersecurity prosecutor.
  • Executive order delayed: The White House has been preparing to release an executive order on crypto strategy. Bloomberg reported this week that disagreements between Treasury Secretary Janet Yellen and the National Economic Council have stalled its release. The debate hinged on the scope of the order, including whether it mentioned a central bank digital currency.

BlockFi Hit with $100M in Penalties From SEC, States

The crypto lending arm of cryptocurrency firm BlockFi agreed to pay $100 million in penalties to the SEC and several states, the regulator announced this week. The firm failed to register its crypto lending product with the SEC, the SEC said. The SEC appears to be using a “regulation by enforcement” approach to take swift action against so-called “DeFi” firms. The action suggests that crypto platforms compensating customers who deposit their tokens will need to register as an investment company and its products as securities, echoing the treatment of money market mutual funds.

BPI Highlights Diversity Best Practices as House Panel Holds CDFI, MDI Hearing

BPI filed a statement for the record with the House Financial Services Committee for its hearing this week on CDFIs and MDIs. The statement outlined several banking industry best practices on diversity and inclusion that were featured in BPI’s “The Time is Now” report on the topic last year. CDFIs and MDIs play a crucial role in supporting minority communities and other banks should partner with them to amplify their efforts, the statement said.

Should the Fed Be a ‘Liquidity Provider of Last Resort’?

As COVID turmoil swept the U.S. Treasury markets in March 2020, the Federal Reserve intervened in a massive way by buying Treasuries. The action was appropriate, given the magnitude of the crisis and the importance of that market to the global financial system. But the Fed should give careful consideration to its future role as “liquidity provider of last resort” – and it should seek guidance from Congress and the public on what that role should be, a new BPI blog post says.

BMO Pledges C$100 Million to Black-Owned Businesses

Bank of Montreal pledged C$100 million (about $78 million U.S.) to support Black-owned businesses. The program, “Business Within Reach: BMO for Black Entrepreneurs,” offers loans of up to C$250,000 and education on financial planning, management and marketing.

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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.