BPInsights: January 28, 2023

Basel Will Soon Be Finalized. Here’s How It Began

U.S. bank regulators will soon propose rules implementing the 2017 revisions to the international Basel capital accord. The implications will be significant — for U.S. banks, their customers and the U.S. economy.

This week, BPI launched a new analysis series exploring the key questions ahead as regulators finalize changes to the Basel framework and as the Fed conducts a “holistic review” of U.S. capital requirements. Those crucial questions include:

  • What will the structure and scope of bank capital requirements be? For example, will the largest U.S. banks need to continue to comply with two sets, or “stacks”, of capital requirements — and, if that changes, how will it affect stress testing? And will only the largest banks be subject to certain requirements, or other banks, too?
  • What will the level of capital requirements be?
  • What trade-offs will regulators make when putting requirements in place?
  • How will U.S.-specific rules intersect with international Basel standards?

U.S. economic growth depends on getting these decisions right. As currently proposed, the changes will likely result in significantly higher capital requirements for the largest banks, despite the fact that U.S. capital requirements are already among the highest in the world and well in excess of minimum international standards.

The first post describes the background of the Basel standards and how they have evolved over time.

Five Key Things

1. Custodia Bank Denied Federal Reserve System Membership and Master Account Access

Two significant developments transpired on Friday concerning Custodia Bank’s effort to gain access to the Federal Reserve system. First, the Federal Reserve Board denied Custodia Bank’s application to become a member, stating that the justification for the decision was that: “The firm’s novel business model and proposed focus on crypto-assets presented significant safety and soundness risks.” Later in the day, the Federal Reserve Bank of Kansas City revealed in a filing to the U.S. District Court of Wyoming that Custodia’s application for a master account had been denied. The filing was in response to a suit filed by Custodia against the Federal Reserve Board and the Federal Reserve Bank of Kansas City in June 2022.
Custodia’s suit accused the central bank of unlawfully delaying a decision on Custodia’s application for a Fed master account and violating due process by lacking “discernable standards” or “intelligible principles” for making account opening determinations. According to the American Banker, the Federal Reserve Bank of Kansas City and the Federal Reserve Board argued in its filing that “the ruling should render Custodia’s lawsuit moot.”
Custodia Bank, a stated-charted special purpose depository institution, initially applied for a Federal Reserve master account in August 2021. The application’s approval would have enabled Custodia to connect directly to the U.S. payment system and to clear and settle private transactions without concern about liquidity or credit risk. As BPI has previously cautioned, creating a new interlinkage between novel charters and regulated institutions via a master account, without adequate safeguards, could create a mechanism for transferring risk posed by those novel charters to Reserve Banks, the payments system and its participants.
Custodia issued a statement in response to the Federal Reserve Board’s initial decision regarding membership stating that it will continue to litigate that decision.

2. BPI Supports Innovation, Competition and Protection of Consumer Data in Letter to CFPB on Section 1033 Rulemaking

BPI responded this week to the Consumer Financial Protection Bureau’s Outline of Proposals addressing consumer data portability — an effort required under Section 1033 of the Dodd-Frank Act. The current proposal being considered seeks to provide consumers the right to collect their personal financial information from companies offering a financial product or service, subject to clear terms, requirements and limitations.

Around 80% of consumer respondents were unaware that third-party app providers gather users’ financial data and 78% were unaware that aggregators have access to personal data even when the app is closed or deleted, according to a recent survey. To empower and better protect consumers, BPI requests that the final rule establish a principles-based final rule and codify the following:

  • Consumers must have transparency into — and control over — where, how and the extent to which their data is shared.
  • Data must be secure and protected with bank-like safeguards no matter where it resides.
  • Any entity that causes harm to a consumer is responsible for remedying the harm.
  • Establish a date certain to ban screen scraping to encourage the transition to safer alternatives, like application programming interfaces.

3. CFPB Seeks Input on Credit Card Market

The CFPB this week sought public comment on the credit card market. The request for information will inform the Bureau’s biennial report on the topic. The CFPB is requesting information on:

  • Terms of credit card agreements and the practices of credit card issuers;
  • Effectiveness of disclosure of terms, fees and other expenses of credit card plans;
  • Adequacy of protections against unfair or deceptive acts or practices relating to credit card plans;
  • Cost and availability of consumer credit cards;
  • Safety and soundness of credit card issuers;
  • Use of risk-based pricing for consumer credit cards; and
  • Consumer credit card product innovation.

Since 2020 — when the CFPB last solicited input on the credit card market — the CFPB has added a few items, including an item in the section on safety and soundness seeking input on how capital requirements for different types of financial institutions affect credit card market competition and credit cost and access. An emphasis on competition has also been added as a new topic to the category of “innovation.”

4. White House Announces Playbook to Address Crypto Risk

The White House announced on Friday a new framework to address potential risks posed by digital assets. The framework outlines ongoing efforts by law enforcement and regulatory agencies to target enforcement actions against illicit actors, launch public awareness campaigns and issue guidance outlining permissible activities to minimize the risk to the broader financial system.

The framework also calls on more action from Congress to help strengthen transparency and disclosure requirements for cryptocurrency companies, to enact safeguards and to aid law enforcement through stronger penalties and additional resources.

5. Banks to Launch Digital Wallet

The group of large banks behind Zelle operator Early Warning Services plans to launch a digital wallet for online shopping. The wallet would be separate from Zelle and managed by EWS, which is owned by Wells Fargo, JPMorgan Chase, Bank of America, Truist, U.S. Bancorp, Capital One and PNC. The product will allow online shoppers to pay with a wallet linked to their debit and credit cards. Customers would not have to type in card numbers when using the wallet, preventing fraud and rejected payments, according to the Wall Street Journal.

In Case You Missed It

Biden Eyes CFPB Alum Borzekowski to Lead Financial Research Office

President Biden plans to nominate Ron Borzekowski to direct the Office of Financial Research, the White House announced this week. Borzekowski currently serves as executive director of Yale University’s Data-Intensive Social Science Center and as a senior economics researcher. Yale formerly served as an economics director at Amazon Web Services and helped stand up the CFPB’s Office of Research. Borzekowski also served as a senior economist at the Fed.

Some of the Many Ways Banks Keep Zelle Customers Safe

BPI published a new infographic this week outlining examples of just some of the many safeguards banks employ to protect Zelle users. These measures include secure access and encryption, customer authentication, account health monitoring and transaction alerts and verification. To learn more about Zelle and how to avoid common scams, please click here.

Federal Reserve Seeks to Address Regulatory Arbitrage in Latest Statement

The Federal Reserve issued a statement on Friday affirming equal regulatory treatment and restrictions on permissible activities for both Board-regulated insured and uninsured institutions. The statement emphasizes that all activities, including crypto-asset-related activities, must be lawful and performed in a safe and sound manner under adequate risk and safety controls and in compliance with all laws and regulations.

The Crypto Ledger

Binance processed nearly $346 million in bitcoin for crypto platform Bitzlato, which now faces major U.S. money laundering charges, Reuters reported this week. Binance was among Bitzlato’s top three counterparties between May 2018 and September 2022, according to Reuters. Other Bitzlato trading partners included Russian dark-web drug marketplace Hydra and an accused Russian Ponzi scheme site called Finiko. While the Reuters piece said there is no evidence that Binance broke the law in its Bitzlato transactions, Binance’s status as one of Bitzlato’s top counterparties may garner scrutiny from U.S. authorities. Reuters also previously reported that Binance has been under Department of Justice investigation for potential money laundering and sanctions violations.

Here’s what else is new in crypto:

  • Cold wallet: Binance has been holding collateral for some of its tokens in the same wallet as customer funds, a practice the company acknowledged as a “mistake” and said it is correcting. The mixing of client funds with collateral raises concerns in the wake of the FTX downfall, which involved the crypto exchange using customer assets for risky bets.
  • Crypto and capital: A draft EU law implementing finalized Basel III standards included significant capital requirements for crypto assets held by banks. The draft law received recent approval from the European Parliament’s economic affairs committee. The crypto provision aims to prevent crypto instability from spreading to the banking system.
  • Keep it separate: In recent guidance, New York’s state financial services regulator warned firms providing crypto custody services not to commingle customer assets with their own.

Waller Offers View of Fed Balance Sheet Path

Federal Reserve Governor Christopher Waller suggested recently that the Fed has plenty of room to shrink its balance sheet without disrupting the banking system. He pointed to the influx of extra liquidity to the ON RRP facility. “It sounds like you should be able to take $2 trillion out and nobody will miss it, because they’re already trying to give it back and get rid of it,” Waller said, according to the American Banker. He also offered a prediction of the pace of balance sheet shrinking: “Most likely, what we do is we continue to shrink the balance sheet, reserves come down and we’ll start slowing down as we approach maybe reserves being 10%, 11% of GDP and then we’ll kind of feel our way around to see where we should stop.”

Goldman Sachs, NYC Partnership to Boost Small Business

New York City Mayor Eric Adams and the city’s Department of Small Business Services this week announced a new NYC Small Business Opportunity Fund. The small business fund was launched in partnership with Goldman Sachs, as well as the Mastercard Center for Inclusive Growth, Community Reinvestment Fund and local community development financial institutions. The $75 million fund will serve local businesses with loans of up to $250,000 at a competitive 4 percent rate.

Six Large Banks Now Offer Small-Dollar Loans

Six of the eight largest banks — Regions, Truist, Wells Fargo, Bank of America, Huntington and U.S. Bank — now offer affordable small-dollar loans, according to the Pew Charitable Trusts. The loans offer consumers quick access to a safe, affordable way to meet short-term credit needs. Bank small-dollar loans represent a safer alternative to expensive payday loans and other nonbank financing options, although banks have historically struggled to roll out small-dollar lending programs in light of regulatory ambiguity.

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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.