BPInsights: January 20, 2024

This Week in Basel

This week, BPI and ABA filed a joint comment letter on the Basel capital proposal. The trades unveiled the letter in a joint press conference, where they highlighted key takeaways such as the excessive operational risk charge, the overlap with the stress tests and the disjointed contrast with the original international Basel agreement. BPI, this time joined by the Financial Services Forum, SIFMA and the U.S. Chamber of Commerce, filed a separate joint comment letter on the legal deficiencies of the proposal on Friday, Jan. 12.

Media highlights

Congressional pushback
Concerns from Congress span both parties and both chambers. In addition to the recent letters noted below, all Republican members of the Senate Banking and House Financial Services Committee wrote to express concerns and demand re-proposal. 

  • Harmful effects: A group of Democratic lawmakers led by Reps. Steven Horsford (D-NV), Joyce Beatty (D-OH), Gregory Meeks (D-NY) and Juan Vargas (D-CA) urged banking regulators to consider the proposal’s consequences for minority communities. The proposal could also harm retirees and college savers, small businesses, towns issuing municipal bonds and businesses hedging risk, the members of Congress wrote. The lawmakers raised concerns about not only the credit risk weights for mortgage lending, but also the impact of the operational risk charge. Many of the co-signers are members of the Congressional Black Caucus, Congressional Hispanic Caucus or Congressional Asian Pacific American Caucus.
  • House Democrats: A group of 23 House Democrats led by Rep. Bill Foster (D-IL) expressed concern about the proposal’s effects on credit availability for consumers and businesses and unequal Basel implementation across different jurisdictions. The proposal could push financing out of the regulated banking system, they observed. The letter also emphasized the need for banks of all sizes to be able to grow and compete. While the overwhelming majority of letters from Democrats questioned the proposal, there wasn’t unanimity in opposition by Democrats. Senate Banking Committee Chair Brown sent a letter with several Committee Democrats expressing support. 
  • Bipartisan House letter: A bipartisan group of House lawmakers led by Reps. Brad Sherman (D-CA) and Ann Wagner (R-MO) underlined the proposal’s constraints on capital markets. Higher charges on securitization, derivative hedging, securities underwriting and other services translate to less funding for businesses, lower liquidity and higher prices for consumers.
  • Bipartisan Senate letter: A bipartisan letter from Sens. Kyrsten Sinema (D-AZ) and Mike Crapo (R-ID) highlighted harmful effects on “corner gas stations, local grocery stores, and construction companies” through derivative hedging costs that would amplify inflation for everyday consumers. The two senators also stressed the impact on small businesses, energy projects and affordable housing.
  • SBC Republicans: Senate Republicans led by Banking Committee Ranking Member Tim Scott (R-SC) urged the agencies to withdraw and repropose the rule. The senators emphasized the process failures in the rulemaking such as a lack of economic analysis and unfounded premise that the banking system is undercapitalized.
  • Energy sector: Two separate letters, one from Sen. Joe Manchin (D-WV) and another from a group of senators led by Sen. Chris Van Hollen (D-MD), warned regulators of consequences for the energy sector stemming from high charges on energy equity investments.

Beyond banks
This proposal is remarkable in the opposition it has garnered from not just banks but their customers. The pushback from businesses includes more than 100 major U.S. companies from AT&T to Zaxby’s, with Dow, Hilton, Honeywell, Marriott, Siemens and U.S. Steel in between. In a letter, these businesses urged the banking agencies to repropose the rule.

  • Broad concerns: Housing groups such as the National Housing Conference and racial justice groups such as Black Leaders Organizing for Communities and a branch of the NAACP  expressed concern about the proposal, particularly its higher costs for mortgage lending to underserved communities. The proposal has also raised concerns among farmers and pension funds for its effects on hedging risk.

Within the Fed
This week, Governor Christopher Waller suggested it “might even be best to just pull it back and then work on this and then put it back on [a] later date.” Waller laid out why he has been opposed to the proposal: contradiction of its goal of harmonizing regulations across borders; interference with capital market functioning; the fundamentally flawed operational risk charge. His remarks signaled the tough road ahead to reach the “broad support” that Chairman Jerome Powell is seeking.

In addition, Governor Michelle Bowman this week said the proposal needs “substantive changes.” She called for the Fed to seek comment on any revised proposal. “That path should ensure that sufficient consideration is given to the wide-reaching consequences of capital reform to the U.S. banking industry, the U.S. economy, and, importantly, U.S. businesses,” Bowman said. “We should consider tradeoffs in addressing scope, calibration, and tailoring. And we should appropriately adjust the excessive calibrations and eliminate regulatory overreach in the proposed rule.” The agencies should address overlap in the stress tests and the market risk part of the proposal; avoid an operational risk framework that penalizes diversified banks; and align credit risk weights with underlying risk levels, Bowman said.

Five Key Things

1. BPI’s Baer on Banking With Interest Podcast: Regulators Should Show Their Work

BPI President and CEO Greg Baer joined the Banking With Interest podcast recently with host Rob Blackwell to discuss problems with the Basel proposal. Baer laid out issues such as the proposal’s overlap with the stress test’s capital charges, the flawed operational risk framework and the treatment of banks’ internal models. Baer delved into the legal deficiencies of the proposal. One key theme of the interview: The banking agencies needed to show their work and have provided insufficient analysis to justify their changes. “Traditionally, the agencies and, particularly, the Fed have been driven by data and analysis,” Baer said. “We don’t think that really happened here. If you’re thinking about how to calibrate risk weights across basically all bank assets and exposures, you’d think you would look at the data and what the loss experience has been on that probability of default, loss given default. We haven’t really seen that in this proposal.” Listen to the interview here.

2. Proposed Long-Term Debt Requirement Is Far Costlier than Agencies Say

The federal banking agencies’ proposal for regional banks to issue long-term debt would result in significant costs to the banks and the economy as a whole, BPI said in a comment letter submitted Tuesday. The cost of the requirement significantly surpasses the agencies’ estimate, and they should therefore reconsider the structure of the proposed requirements to control these heightened costs.

“The proposed long-term debt requirement is a symptom of a growing mismatch in the U.S. bank regulatory framework between the risk profiles of regional banks and their expanding regulatory requirements. This sector of the banking system provides crucial financing to American businesses and consumers and has a distinct business model from a globally active institution. The long-term debt proposal would impose sizable costs on these banks and the customers they serve without commensurate benefits. It’s also a repudiation of the bipartisan tailoring framework enshrined in law. The agencies should revise this proposal to align with the risk profiles of the banks to which it applies and to remedy underestimates in the cost of the requirements.” – Greg Baer, BPI President and CEO

Outsize costs: The costs of the LTD proposal are significantly underestimated. BPI estimates that the costs of the proposed LTD requirements are projected to increase pre-tax annual funding costs by nearly $5 billion. This estimate is approximately 3x higher than the estimates provided in the proposal.

  • BPI recommends that the agencies recalibrate the requirement, differentiate the proposed requirements based on the statutory tailoring framework, and eliminate or significantly revise the prescriptive internal LTD requirement. These recommended changes would help to correct for the higher cost estimates.
  • The minimum denomination requirement for LTD is unsupported, would harm market depth and liquidity, and would be inconsistent with the disclosure-based framework of the federal securities laws and longstanding aspects of the bank capital framework.

The big picture: The banks subject to the proposed long-term debt requirement also face proposed capital increases and other complex regulatory changes under the Basel capital proposal. It is impossible to evaluate the true costs and benefits of this proposal until after any changes to capital requirements are known. The agencies should not finalize any new long-term debt requirement until after a Basel III Endgame rule is implemented.

Why it matters: Regional banks serve as a financing engine for small and mid-size businesses in the U.S. and played a crucial role in the country’s economic recovery from the COVID pandemic. Significant cost pressures on their business models would hurt the broader economy, particularly Main Street companies.

3. What’s Next for Bank Liquidity Rules? OCC’s Hsu Gives a Glimpse

Bank liquidity rules will likely undergo changes in the wake of the spring 2023 bank failures. Acting Comptroller Michael Hsu gave a preview of what may come next in a speech and Q&A with Columbia Law School this week. Here are some highlights.

  • Deposit outflows: The liquidity coverage ratio’s outflow classifications may need to differentiate higher-risk deposits from retail demand deposits, Hsu suggested.
  • LCR success: Hsu said the LCR is an underappreciated success story but “parts of LCR in pretty targeted areas are undercalibrated.”
  • New liquidity requirement? Hsu previewed a potential new liquidity requirement, identifying a numerator and denominator but not a required ratio. Hsu said the ratio should be calibrated to meet five days of outflows under stress. This new requirement must address banks’ operational readiness to use the Fed’s discount window, he said. A Bloomberg article this week said that new liquidity measures would aim to remove stigma from discount window borrowing, and that banks would have to borrow from the discount window at least once a year.
  • Discount window: Hsu appears to oppose counting banks’ access to the discount window for the liquidity coverage ratio. It is not clear if he shares a similar view on counting discount window access in banks’ internal liquidity stress tests.
  • Payments: Innovations around faster payments require banks and regulators to develop new “braking” systems to mitigate new risks, Hsu said.

4. BPI Calls for Targeted Adjustments to FDIC Rules Around Second-Chance Hiring Law

BPI supports the FDIC’s proposed changes to Section 19 regulations, which govern banks’ ability to hire job candidates with minor criminal records. The proposed changes would implement the Fair Hiring in Banking Act, a piece of bipartisan legislation that amended Section 19 of the Federal Deposit Insurance Act. This regulatory change will provide welcome clarity to banks seeking to expand job opportunities to a broader range of individuals, including rehabilitated candidates with minor prior offenses. A few technical adjustments – such as clarifying language that could prompt banks to undertake lengthy record checks to determine eligibility – would enhance this clarity, BPI said in a comment letter this week. BPI has long supported efforts to amend Section 19 to support second-chance hiring opportunities in the banking sector.

5. The Future of Judicial Deference to Agency Rules Could Hinge on Fishing Boat Fees Cases

The Supreme Court this week heard a pair of cases – involving a federal rule requiring fishing boats to pay for at-sea government monitors – focused on whether the Court should end Chevron deference, under which courts defer to an agency’s interpretation of a statute when that statute is ambiguous.  Where there is ambiguity, a court is to defer to an agency’s reading so long as it is reasonable, even if the court believes a different reading is better and even if an agency has flip-flopped in its interpretation.  A majority of the court seemed inclined to either discard or significantly restrict the use of Chevron.  In effect, under another line of cases, this could require the agency to provide persuasive reasoning for its interpretation.  The future ramifications are unclear: under Chevron’s so-called Step 1, a court is not to defer to an agency if the court, using all the interpretive tools at its disposal, can reach a clear interpretation.  As noted at the argument, practice among federal courts has varied considerably, with some rarely reaching Step 2 and others doing so frequently (and therefore deferring to the agency reading).   But an elimination or restriction of Chevron would certainly put those litigating against the government on more equal footing in cases where interpretation of the statute is at issue.  There is also debate about whether cases previously decided on a Chevron Step 2 deference could be relitigated.  Notably, Chevron deference does not implicate the power of agencies to write or interpret regulations – the latter being a separate thread of cases known as Auer deference which itself was narrowed by the Supreme Court in a 2019 decision (SCOTUS Ruling on the Dept. of Veterans Affairs Regulation Has Implications for the Banking Industry and Supervisors – Bank Policy Institute (bpi.com) 

In Case You Missed It

The Crypto Ledger

Here’s what’s new in crypto.

  • Coinbase in court: This week Coinbase faced the SEC in court in a case with significant implications for the overall crypto industry. The SEC contends that most digital assets are securities and therefore fall under its jurisdiction.
  • Legislative look: Senate Banking Committee Chairman Sherrod Brown (D-OH) said he plans to take a closer look at crypto and money laundering soon.
  • EU money laundering rules: The European Union agreed on tougher anti-money laundering rules and broadened such rules to crypto assets, according to a Reuters piece this week.

Bank CEOs Call for Basel Changes

Several bank CEOs in recent days called for revisions to the Basel capital proposal. “I very much hope that it is…completely revised,” Citigroup CEO Jane Fraser said recently on the bank’s earnings call. Goldman Sachs CEO David Solomon said the proposal “should be withdrawn and re-proposed.” He added that the Fed is “listening carefully” to feedback and that this is “the end of the beginning of the process.” Bank of America CEO Brian Moynihan said regulators must change the proposed rule “because I do not think it is the right balance.”

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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.