BPInsights: July 17, 2021

Stories Driving the Week

Fed Accounts for FinTechs: Guidelines Should be Clear, Consistent and Strong

BPI and the Independent Community Bankers of America (ICBA) this week called on the Federal Reserve to strengthen proposed guidelines for evaluating account and services requests.

Due to the lack of oversight by federal banking regulators, FinTech firms that hold novel charters pose greater risks to the banking system. The joint letter encourages the Federal Reserve to establish a uniform set of standards that each of the 12 Federal Reserve Banks will apply as they evaluate requests for access to the payment system and to rigorously apply those standards — particularly for these novel charters.

“The question of which institutions should be permitted to open master accounts with a Federal Reserve Bank and obtain related services is a critical one, particularly in light of the increase in the availability of novel charters,” BPI SVP and Associate General Counsel Dafina Stewart and ICBA SVP of Payments and Technology Policy Deborah Matthews Phillips wrote in the joint comment letter. “Reserve Bank accounts and services stand at the center of our payments and monetary ecosystem, and both the resilience and the risk management of institutions that hold such accounts is a linchpin to the safety and effectiveness of the U.S. payments system.”

In their joint comment letter, BPI and ICBA said:

  • The final guidelines should ensure the safety and soundness of the nation’s payment system and appropriately mitigate the risks posed by firms with novel charters that may obtain Reserve Bank accounts and services.
  • The Federal Reserve should clearly identify which institutions are legally eligible to apply for Reserve Bank accounts and services, explain how it will monitor whether novel charter holders meet the application standards, and ensure all decisions regarding novel charters involve the Federal Reserve’s Board of Governors.
  • The guidelines should account for relationships between an applicant with a novel charter and its affiliates and not delegate to the Reserve Banks decisions on the interest rate they pay on reserve balances.

On Dividend Bans, Banks’ Cost of Equity, and Lending  

Last week, the European Central Bank (ECB) published a note analyzing how temporary capital distribution restrictions announced in March 2020 affected bank equity valuations. The note shows that equity valuations for the affected banks fell 7 percent. The ECB also estimates that the cost of equity for the entire banking sector likely increased. The note states that the main driver of the increase in banks’ cost of equity is most likely greater uncertainty over future capital distributions, rather than simply the temporary suspension of capital distributions.

As assumed and shown in the entire economic literature on optimal capital regulation, facing a higher cost of capital, banks would reduce lending or raise its cost. The result of the temporary restrictions has thus been a permanent increase in borrowing costs in the EU, and a corresponding permanent reduction in GDP.

The results of the ECB analysis were predictable—and predicted, as noted in a BPI blog post this week. 

Ways To Expand the Availability of Mortgage Loans to Low- and Moderate-Income Borrowers

The uneven economic impact of the pandemic in the U.S. economy has led policymakers and banks to focus on ways to expand credit availability to low- and moderate-income (LMI) households and help them to recover from the current crisis. Access to mortgage credit is crucial because homeownership is a catalyst to wealth-building. This BPI post describes three modest regulatory capital changes that would expand the availability of mortgage loans to LMI borrowers: (1) Incorporate some of the post-crisis changes to mortgage markets (e.g., income verification) in the assessment of the performance of loans to borrowers with less-than-pristine credit scores in the Federal Reserve’s stress tests; (2) close alignment in the assumptions used in the Federal Reserve and the FHFA stress tests; and (3) adjust capital requirements for mortgage servicing assets. These policy recommendations come at a time when nonbanks have dramatically increased their market share in the origination of mortgage loans. Reversing those trends would help more vulnerable borrowers because banks are much less dependent on the government agencies to extend credit to LMI borrowers and are better equipped to support their customers during a period of stress also without the help of the government.

No, Banks Were Not Bailed Out in 2020

Banks were a source of strength to the overall economy during the pandemic, maintaining resilience even as they significantly expanded their balance sheets to lend to the real economy. Yet a few observers claim that banks were actually bailed out last year, pointing to fiscal stimulus for businesses and families. These observers appear to think banks should hold capital and liquidity on the extraordinary assumption that the government will not act to defend the economy in a crisis. Now is not the time for complacency – but there is a tremendous amount to learn from what actually happened in 2020, and much to be done to ensure that the Federal Reserve does not have to continue to play as large a role in markets next time.  We shouldn’t be distracted and misguided by contemplating what could have happened if the government hadn’t done what any well-functioning government should have done, a recent BPI blog says.

Five Big Takeaways from Powell’s Capitol Hill Testimony

Federal Reserve Chair Jerome Powell discussed several key policy issues in his testimony before Congress his week, including cryptocurrency and stablecoins, President Joe Biden’s recent executive order on competition and LIBOR replacement rates. Here are BPI’s most noteworthy takeaways from his testimony.

  • Capital framework is strong: In response to questions about bank capital, Powell emphasized that the stress capital buffer effectively raised capital requirements for the largest banks. “I have felt and I have said on a number of occasions that the level of loss-absorbing capital in the system is about right,” Powell told Senate Banking Committee Chair Sherrod Brown (D-OH). “I think the experience of the pandemic bears that out.” He also said he would be prepared to deploy the CCyB if he thought the conditions the Fed laid out were triggered, but he hadn’t felt that was the case so far.
  • U.S. likely to move toward climate scenarios, but ‘not ready yet’: In response to a question from Sen. Tina Smith (D-MN) about European central banks and climate stress tests, Powell clarified that many central banks in Europe are running climate stress scenarios distinct from stress tests. He said the Fed hasn’t decided to do such exercises yet and is in the process of “looking very carefully” at the option. “My guess is that’s a direction we will go in that we are not ready to do yet,” he said.
  • SOFR is ‘voluntary’ as LIBOR replacement: In response to Rep. Bill Huizenga (R-MI), Powell said the Fed has been clear that market participants can use LIBOR replacement rates other than the Secured Overnight Financing Rate (SOFR) if they prefer, and that the use of SOFR is “voluntary.” Some banks and market participants prefer to use credit-sensitive rates rather than SOFR for certain transactions. He also reiterated his support for legislation addressing “hard tail” contracts that use LIBOR after the rate ends but lack adequate fallback language to transition to another rate. “I think it would be appropriate to have SOFR in the legislation, but not as an exclusive thing,” he said.
  • Stablecoins need a regulatory framework if they’re here to stay: In response to Rep. Patrick McHenry (R-NC), the top Republican on the House Financial Services Committee, Powell compared stablecoins to money market funds, “narrow banks” or even bank deposits, depending on their terms, “but without the regulation.” Bank deposits and money market funds have a “pretty strong regulatory framework,” Powell said. “That doesn’t exist really for stablecoins, and if they’re going to be a significant part of the payments universe, which we don’t think crypto assets will be but we think stablecoins might be, then we need an appropriate regulatory framework, which, frankly, we don’t have.” 
  • No rush on CBDC: Powell reiterated, in response to Rep. Stephen Lynch (D-MA), his position that the U.S. doesn’t need to be first in the global race to issue central bank digital currency, even as China pilots a digital yuan. He also repeated that the U.S. dollar is in no danger of losing its reserve-currency status. “We are the reserve currency, you know, we have first-mover advantage by virtue of that, so I think it’s way more important to get it right than it is to do it fast,” he said. He said the central bank’s upcoming white paper on digital currency will span a broad range of policy areas in digital payments: “that means stablecoins, it means crypto assets, it means a CBDC.” He framed the research release, which will be around September, as the beginning of a “major public consultation” with many groups, including Congress, on these topics.

BPI Blog: Green Investments and Risk 

U.S. financial regulators increasingly want banks to hedge against the risks of climate change. An assumption underpinning this effort is that regulators fully appreciate the severity of the climate change outlook, while banks and other market participants do not – therefore, requiring banks to invest more in green assets and divest from carbon-intensive “brown” assets should produce high returns as the underlying asset values adjust to reflect reality. However, a new BPI blog illustrates that green firms can actually pose a high risk to investors – in a broad portfolio designed to minimize risk for any given level of reward, the weight on an ETF of green firms generally rises with the risk of the portfolio. These results suggest that regulators should proceed with caution as they build scenario analyses that assume green firms are lower-risk options. In particular, if these results persist in further research, regulators may wish to avoid using the examination process to press banks to shift more money into greener assets.

In Case You Missed It

Regulatory Inaction on Digital Asset Rules Could Leave Consumers with Few Options in Regulated Banking Sector

BPI and the Consumer Bankers Association this week provided a response to the FDIC’s Request for Information on the digital activities of banks. Given that FinTechs are generally subject to little to no regulation or examination, it is clearly easier for them to innovate in the digital assets space – for example, by issuing or offering trading in cryptocurrencies and stablecoins.  Still, banks remain at the forefront of technological innovation and will seek to maintain that role as the digital assets market evolves.

Digital assets activities present all kinds of risks – consumer, operational and money laundering, to name just a few. Therefore, it is generally safer for consumers and the financial system for these activities to be conducted by well-regulated and well-supervised banks. Unlike FinTech or Big Tech companies, banks hold themselves to high risk-management and compliance standards and have the added benefit of being examined by the federal banking agencies.

“Banks are already subject to comprehensive and robust risk management, supervision and examination processes, are subject to consumer protection laws and regulations, maintain strong capital buffers, carry deposit insurance, undertake well-developed anti-money laundering practices and know-your-customer programs and have substantial experience with incorporating new technologies into the financial system,” BPI and CBA state in their comment letter. “Banks have the resources, talent and expertise to implement robust compliance programs, which is especially important with respect to digital assets.”

Quarles Urges Global Cooperation on Climate Risk

FSB Chair Randal Quarles, also Vice Chair for Supervision at the Federal Reserve, encouraged global finance officials to take a coordinated approach on climate risk and disclosure in a speech at the Venice International Conference on Climate Change this week. “Globally consistent, comparable, and reliable disclosures, as well as a broader set of high-quality, relevant data, together, can provide the basis to assess climate-related financial risks and the impact on financial stability,” Quarles said.  

White House Takes Aim at Ransomware with New Task Force

The White House is launching a cross-government task force on ransomware, POLITICO reported this week. The task force will coordinate a range of options to address the hacking scourge after a series of high-profile ransomware attacks disrupted meat and gasoline supply chains. The options notably include offensive measures such as disruptive cyberattacks on hacker gangs and work to stop ransomware payments made through cryptocurrency platforms. Other aspects of the approach include developing partnerships with businesses to speed up information-sharing on attacks and State Department rewards for tips that help identify cyber criminals. During a briefing on the task force for Congress, White House officials also asked for new authority to create cybersecurity standards for critical infrastructure.

BIS Working Paper Reviews Climate Change Stress Testing Pilot Programs

A recent Bank for International Settlements paper examines the technical challenges of early climate risk assessment exercises that have been undertaken by the Banque de France/ACPR, the DNB in the Netherlands and the Bank of England, which have been characterized as exploratory efforts to gather information and identify pockets of risk. The paper provides a useful summary of the exercises as well as the challenges inherent in climate stress testing.  The paper cites BPI Head of Research Francisco Covas’ research note on the challenges of stress testing and climate change, which include unreliable data and the multi-decade time horizon. BPI has argued that policymakers should not use the capital framework to manage climate risk in the financial system. 

ECB Launches Digital Euro Project

The European Central Bank announced this week it has launched the “investigation phase” of its digital euro project. The phase will last two years and examine design and distribution issues such as privacy and market impact. “A digital euro must be able to meet the needs of Europeans while at the same time helping to prevent illicit activities and avoiding any undesirable impact on financial stability and monetary policy,” the ECB said in a press release, adding that the investigative process will not predetermine any future decision on issuing a CBDC. The central bank also noted that a digital euro would complement cash, not replace it.

BPI Commends the CFE Fund for Achieving Significant Milestone, 100+ Bank On Certified Accounts

BPI in a press release this week commended the Cities for Financial Empowerment Fund (CFE Fund) on surpassing an important milestone of more than 100 Bank On nationally certified accounts offered by banks and credit unions, representing more than 50 percent of the market share of U.S. deposits.
“The CFE Fund is working successfully with America’s banks to make it easy and affordable for anyone to open a low-cost bank account,” said BPI President and CEO Greg Baer. “While the work is ongoing, the Bank On program has proven instrumental in helping to produce better outcomes in LMI communities across the nation. We are hopeful that regulators will create the right regulatory incentives—like offering CRA credit—to further encourage use of these products.”

Jen Easterly Confirmed as CISA Head

The Senate this week confirmed former NSA official and Morgan Stanley veteran Jen Easterly to lead the Cybersecurity and Infrastructure Security Agency (CISA). The position plays a crucial role in safeguarding cybersecurity across all critical infrastructure sectors, including the financial industry, and is responsible for protecting federal civilian agencies against cyberattacks. Easterly, along with the new National Cybersecurity Director Chris Inglis and Deputy National Security Advisor Anne Neuberger at the White House, will play key roles strengthening national cybersecurity policy including new requirements for federal agencies and their vendors, and will help shape new approaches to protecting critical infrastructure.

Bank of England Removes Bank Capital Distribution Restrictions

The U.K.’s Prudential Regulatory Authority on July 13 announced it had lifted pandemic-induced restrictions on bank dividends and share buybacks. The PRA said the “extraordinary guardrails” were no longer necessary in light of resilient banks and decreased uncertainty amid COVID-19 vaccination progress. The announcement came shortly after the Federal Reserve removed capital distribution restrictions on stress-tested U.S. banks following the June stress tests.

Bank Regulators Propose Interagency Guidance on Managing “Third-Party” Risk Presented by Business Relationships

This week, the U.S. federal banking agencies jointly issued anticipated proposed risk management guidance for third-party relationships.  For the first time, the agencies propose to harmonize their third-party risk management guidance for OCC/Fed/FDIC-supervised financial institutions and solicit public comment.
Third-party risk management has become a supervisory focus area in recent years.  The proposed guidance, which is principally based on the OCC’s existing guidance for federally-chartered banking organizations issued in 2013, would apply broadly to risks arising from “business arrangements between a banking organization and another entity, by contract or otherwise”.  This definition would pick up a wide universe of relationships including those with affiliates, FinTech companies, software providers and many other types of business partners and service providers.  The agencies emphasize that the proposed guidance is intended to be risk-based and that supervised financial institutions could scale their use of the framework as appropriate based on the level of risk, complexity and size of the institution and nature of the relationship.  Importantly, the proposed guidance identifies factors that institutions typically consider – i.e., rather than mandating certain actions.  The proposed guidance also would permit supervised institutions to rely on external service providers or organizations to facilitate vendor due diligence.
BPI has long advocated for the federal banking agencies to consider an interagency approach as inconsistencies in how regulators interpret and enforce existing guidance creates supervisory complexity that could distract financial institutions from risk management activities.  By harmonizing for the first time the agencies’ supervisory expectations, the proposed guidance would promote consistency.  The proposed guidance solicits public comment on a number of issues including whether the OCC’s 2020 FAQs on Third Party Relationships should be incorporated into the final version of the guidance.  Comments will be due 60 days following the proposal’s publication in the Federal Register.

Synchrony Raises U.S. Minimum Wage to $20 per Hour

Synchrony Financial announced this week it will raise its U.S. minimum hourly wage to $20. The change will take effect next month. Full-time hourly employees will also be eligible for a $1,000 bonus.  

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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.