BPInsights: July 20, 2018


Top of the Agenda

Leading Banks Launch Bank Policy Institute

The Bank Policy Institute (BPI), a new nonpartisan research and advocacy group representing the nation’s leading banks, opened its doors (press release). The new organization, BPI, is the result of a merger between the Clearing House Association and the Financial Services Roundtable. BPI members include universal banks, regional banks, and the major foreign banks doing business in the United States. Greg Baer, the CEO of BPI, describes the new research and advocacy organization’s focus and mission in his welcoming blog. BPI’s focus will be prudential regulation of banking, and how it affects not only safety and soundness and financial stability but also innovation and credit availability for banks.

An important component of BPI will be its technology policy division, BITS, which stands for Business, Innovation, Technology, and Security. Its mission is to strengthen the financial industry through information sharing and a coordinated approach to today’s dynamic technology and security environment.

Of course, you can always find the latest news and information on our website, www.bpi.com, or through Twitter @bankpolicy and@bankperspective. Also worth a follow: BPI CEO Greg Baer (@baerheel), and EVP, General Counsel & COO Jeremy Newell (@JeremyRNewell).

Of Note

Contrary to a Recent Op-Ed Banks and their Supervisors Take Risk-Data Management Very Seriously

BPI’s Bill Nelson and Francisco Covas published a blog in response to a Financial Times Op-Ed, which stated “the world’s biggest banks are doing an awful job of managing their data on risk.” The BPI authors note, the Federal Reserve, IMF, and Basel Committee take a different view than the opinion outlined in the Financial Times piece.

Senate Confirms Randal Quarles to 14-Year Term on Fed Board

On Tuesday, Federal Reserve Vice Chairman for Supervision Randal Quarles was confirmed to a 14-year term as a Board Governor, expiring January 31, 2032, by a vote of 66-33.

How Regulators Averted a Debacle in Credit-Default Swaps

When Blackstone Group made a bet that shook confidence in the credit derivatives market, the CFTC waged an unusual campaign to pressure the investment firm to back down. The CFTC had been warning Blackstone through private meetings before issuing an unorthodox public bulletin a week before the default deadline that said manufactured defaults could be considered market manipulation, according to a WSJ article.

Judge Says California Misused Mortgage Settlement Cash to Fill a Budget Hole

Last week a California Court of Appeal judge rebuked state lawmakers for misappropriating funds from the National Mortgage Settlement Deposit Fund for budget triage. California’s Department of Finance, with the Legislature’s tacit consent, diverted nearly $300 million toward servicing debt for housing bonds. This overtly political use was in violation of the settlement that required the funds be used to help homeowners.

Three Fintechs Try Out Faster Multistate Licensing Project

Two fintech companies have completed the first phase of a multistate pilot program to test more -efficient money service business licensing practices, Bloomberg reports. The pilot, which offers reciprocity to fintech firms seeking business licenses in any one of the sixteen participant states, comes amidst increasing calls for an examination of the burden that the lengthy and expensive state-by-state licensing process may place on fintech firms.

BPI News

Comment Letters

BPI Urges Banking Agencies to Revise Regulatory Capital Framework so that CECL Implementation Will Be Capital Neutral (Comment Letter)

Last Friday, BPI filed a comment letter on the Banking Agencies’ proposal to implement the current expected credit loss methodology (CECL) into their capital and Dodd-Frank Act Stress Testing (DFAST) rules. BPI’s comment letter (i) urges the Agencies to implement a capital neutral approach for CECL for purposes of all capital requirements (including stress capital requirements), (ii) strongly supports the Agencies’ proposal of a transitional arrangement by which the “day one” impact of the adoption of CECL would be phased in over a period of years, (iii) suggests that the FRB consider the collective effects of CECL into CCAR and the proposed stress buffer requirements and delay initial incorporation of CECL into CCAR until at least the 2021 stress testing cycle, and (iv) offers a range of suggestions regarding the proposed transitional arrangement and a quantitative impact study on the anticipated effects of CECL that we urge the agencies to conduct.

BPI Comments on FSB Recommendations for Consistent National Reporting of Data on Compensation Tools to Address Misconduct Risk

On July 6, BPI filed a comment letter with the FSB on its proposed “Recommendations for consistent national reporting of data on the use of compensation tools to address misconduct risk.” BPI’s letter stated that (i) the FSB’s Recommendations and compensation and misconduct efforts generally are not based on any clear FSB analysis or evidence that compensation practices have had or could have a material effect on financial stability, which is the group’s remit and (ii) the FSB has provided no additional analysis or explanation why a single global reporting standard on the use of certain compensation practices is a useful and effective tool for addressing financial stability risks, given the substantial variance among member jurisdictions’ labor and employment laws, compensation practices, and other relevant factors, among other recommendations.

Blog Posts

Stress Test Dummies: A Fundamental Problem with CCAR (and how to fix it)

After observing market analysis of the 2018 CCAR stress test results, BPI CEO Greg Baer was struck by how analysts and investors clearly understand something that many policymakers do not: how extreme, and thus how extraordinarily improbable, this year’s stress scenario was. To improve the CCAR stress tests, Baer suggests in this blog to look to an unlikely source for a solution – the National Highway Transportation Safety Agency (NHTSA).

The Current Expected Loss (CECL) Accounting Standard Will Make the Next Recession Worse

According to a blog from the BPI Research team, analysis demonstrates that the Current Expected Credit Loss (CECL) accounting standard would be procyclical if used for regulatory capital purposes. The blogpost summarizes some key results of a working paper just published by BPI that analyzes the performance of CECL had it been in place during the 2007-2009 financial crisis.

BPI Research Tackles LCR, Stress Tests and GSIB Requirements in a Series of Blogs

The BPI Research Department has had a busy few weeks. First, in a blog, Bill Nelson, Francisco Covas, and John Court describe two common misconceptions about GSIB surcharges: GSIB surcharges are calibrated, and surcharges account for subsequent regulatory changes. Next, Bill Nelson and Francisco Covas respond to President of the Federal Reserve Bank of Boston Eric Rosengren’s call for consideration of raising the countercyclical capital buffer (CCyB). The authors point out that raising capital requirements now just so you can lower them in a recession resembles the discredited “keep your powder dry” argument that monetary policy should be kept tight as the economy weakens so that it can be eased by more later. Lastly, Bill Nelson and Robert Lindgren published a blog on tailoring the LCR to fit large non-GSIBs. The author’s write, “Our results show that the complexity of the large non-GSIBs is similar to that of the medium-sized banks, not the GSIBs, indicating that they should be subject to the modified LCR, not the full LCR.”


Closing the Pandora’s Box of International Cyber Regulatory Fragmentation

With systems being digitized across almost every industry, the amount of new regulations aimed at protecting data and cybersecurity continue to proliferate. However, cyber regulation fragmentation is a genuine threat. There is a solution, however, writes BITS Josh Magri in a blog that is based partially on the Financial Services Sector Cybersecurity Profile, a meta framework based on the organizational structures of the National Institute of Standards and Technology “Framework for Improving Critical Infrastructure Cybersecurity” (NIST Framework).

Can Financial Institutions Save Privacy?

BITS’s Heather Hogsett writes that banks, which have long prioritized protecting customer data and securing banking information, have a unique position to be able to provide “greater transparency, clarity and control for customers” when it comes to their data. In a blog, Hogsett writes, “Critical aspects of protecting private information such as data governance, segmentation, encryption, access controls and retention policies are all familiar territory for financial firms. Now is the time to leverage this expertise to reimagine customer experiences through a privacy lens.”


BPI’s Baer Testifies on Examining Capital Regimes for Financial Institutions

On Tuesday, BPI CEO Greg Baer testified before the Financial Institutions and Consumer Credit Subcommittee of the House Financial Services Committee on the state of capital regulation. At the hearing, entitled “Examining Capital Regimes for Financial Institutions,” Baer identified three problems with current capital requirements: they are set too high, subject to too much volatility, and too prescriptive.

BITS President Asks Congress to Streamline Cybersecurity Regulations 

Christopher F. Feeney, President of BITS, the technology division of BPI, testified Wednesday about the complex regulatory environment and the challenges it presents to cybersecurity and protecting personal financial information. Feeney, speaking to the House Committee on Oversight and Government Reform’s Subcommittee on Intergovernmental Affairs, highlighted several duplicative, contradictory, and counterproductive regulations that undermine strong cybersecurity protections. “On an individual basis, many of the regulatory requirements financial firms must meet are beneficial and have strengthened firms and the industry,” Feeney stated. “The challenge is that collectively, without harmonization and alignment, the regulations are often counterproductive; creating duplication, conflict and confusion, and place a significant burden on firms’ ability to improve cybersecurity and innovate to stay ahead of threats.”

BPI Events

BPI & TCH Annual Conference 2018

Registration is now open for the 2018 BPI & TCH Annual Conference, the premier gathering for senior financial services executives, regulators, policymakers, and academics focused on the changing regulatory landscape and the future of payments. Register Today!

November 26-28, 2018, The Pierre, NYC

Industry News

Banking Agencies

FRB Vice Chairman Quarles Outlines Plans for Precise Tailoring of Financial Regulation and Supervision

Expanding on the Federal banking agencies joint statement detailing the implementation rules and reporting requirement immediately affected by the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) also known as S.2155. Vice Chairman Quarles outlined more plans for precise tailoring of financial regulation and supervision, based on a number of factors, not just the size of the bank. He indicated that for banks with $100-$250 billion in assets, “it seems appropriate to me that a path forward for tailoring supervision and regulation of large banks should not ignore size, but consider it as one factor – although only one factor – along with other factors,” including cross-border activity, short-term wholesale funding, and non-bank activities. For banks larger than $250 billion in assets, but not GSIBs, Quarles said “…there are material differences between … firms that qualify as U.S. G-SIBs and those that do not .. [and] the supervision and regulatory framework for these firms should reflect that [fact]. … [Currently,] many aspects of our regulatory regime treat any bank with more than $250 billion in assets with the same stringency as a G-SIB… [and] there should be a clear differentiation.”

Fed and FDIC Publish Living Will for Four FBOs

On July 9, the Federal Reserve and FDIC posted on their websites the public portions of the living wills for Barclays, Credit Suisse, Deutsche Bank, and UBS’s living wills on the agencies’ websites. The resolution plans, required by the Dodd-Frank Act, are broken up into public and confidential sections. The public section include a summary of how the resolution plan would be executed. The plans can be accessed online here.

International Developments

BCBS Finalizes its Revised GSIB Methodology

On July 5, the Basel Committee on Banking Supervision (BCBS) released its final revisions to the GSIB methodology that were proposed for comment in 2017. One of the most noteworthy outcomes is the revised methodology maintains the cap on the substitutability category at this time. However, the just released methodology notes that they will complete their next review of the GSIB framework by 2021 and that they will “pay particular attention to alternative methodologies for the substitutability category, so as to allow the cap to be removed at that time.” The revised framework has an implementation date of 2021.

In November of last year, BPI’s Francisco Covas published a research note explaining the rationale for keeping the cap on substitutability category. He detailed how the substitutability scores of a few U.S. institutions are disproportionally large, and the cap prevents it from having a disproportionate impact on the overall measure of systemic risk, as acknowledged by the BCBS in its finalization of the GSIB framework in 2014. His findings indicate that removing the cap on the substitutability score would reduce the economic and statistical significance of the substitutability category in explaining systemic risk. As a result, the cap on the substitutability category score makes the overall score more accurate in achieving its stated goal.

Capitol Hill

Powell Testifies Before Senate Banking and House Financial Services Committees

This week, Federal Reserve Board Chair Powell testified before the Senate Banking and House Financial Services Committees to give the Federal Reserve’s Monetary Policy Report. While Powell focused his remarks on monetary policy, members of both committees frequently questioned the Chair on regulatory and supervisory issues. Outside of the issues covered below, members questioned the Chair about wage growth, income inequality, trade policy, and the impact of the recently passed tax bill.

In one noteworthy exchange, Senator Tester asked Powell to confirm that stress testing will continue as the Fed implements 2155. Powell said that they would, and that they would not be weakened. During multiple exchanges with Senators, including with Warren, Powell defended the current framework by noting that this year’s CCAR was the most stringent test yet, calling it a “material increase” in the effective aggregate capital requirement of firms subject to the test.

The House Passed the JOBS and Investor Confidence Act of 2018 by a Vote of 406-4

The bill is comprised of 32 pieces of legislation that have passed the Financial Services Committee previously, including theFinancial Institution Living Will Improvement Act of 2017. The legislation requires financial institutions to submit resolution plans every two years, and that the Fed and FDIC provide feedback on the plans within six months of a firm’s submission. It also would require the Fed and FDIC to publicly disclose the assessment framework used to review the plans. 

Next Week in Washington


  • Senate
  • Senate Banking Committee will hold a nominations hearing — July 24, 10:00am.The committee will consider the nomination of Mr. Elad L. Roisman, of Maine, to be a Member of the Securities and Exchange Commission; Mr. Michael R. Bright, of the District of Columbia, to be President of the Government National Mortgage Association; Ms. Rae Oliver, of Virginia, to be Inspector General, U.S. Department of Housing and Urban Development; and Dr. Dino Falaschetti, of Montana, to be Director, Office of Financial Research, U.S. Department of the Treasury.

 Research Rundown

NBER Working Paper: Liquidity Regulation, Bail-ins, and Bailouts (Dewatripont and Tirole)

The authors develop a framework to study the interaction between liquidity regulation and solvency concerns. Their framework provides support for the existence of a liquidity requirement; however, the requirement should depend on the availability of high-quality liquid assets in each jurisdiction.  In addition, the liquidity requirement should account for interbank exposures and eliminate the differential treatment between retail and wholesale deposits.

NBER Working Paper: Judging Banks’ Risk by the Profits they Report (Meiselman, Nagel, and Purnandam)

This working paper shows empirically that high accounting profitability prior to a crisis helps explain the cross-sectional variation in banks’ stock returns during the crisis. The impact is stronger if pre-crisis profits are driven predominantly by noninterest income or such profits are paid out in the form of dividends or management compensation.

Liberty Street Economics Blog: Tax Reform’s Impact on Bank and Corporate Cyclicality (Aragon et al.)

In this blog post the authors argue that the elimination of net operating loss carrybacks and limits to net interest expense deductions instated by the Tax Cuts and Jobs Act (TCJA) are procyclical, especially for banks and highly-levered corporations. The procyclical impact of TCJA may be reduced in the longer-run as banks and highly-levered corporations reduce their leverage in response to the lower tax rate.

CGFS Papers: Financial stability implications of a prolonged period of low interest rates (Committee on the Global Financial System)

The working group presented findings on whether prolonged low interest rates induce fragility in the financial system. They concluded that though overall there has been little correlation between interest rate movements and measures of bank stability and risk-taking activity, they did identify a few risks to financial stability. For example, 1) Bank profits are more likely to be suppressed by low interest rates depending on their business model and 2) Banks may shift towards more risk-taking and loans with longer tenors to offset the downward pressure on returns and profitability.

FEDS Notes: (Don’t Fear) The Yield Curve (Engstrom and Sharpe)

The near term forward spread, which is currently used as a proxy for the market’s expectations of Federal Reserve policy actions, shows that the market is skeptical about the odds of a rate cut over the next four years. This spread was shown to have more predictive power than the long-term yield spread, and provided clear signs leading up to historical recessions.

ECB Working Paper: Monetary policy and household inequality (Ampudia et al.)

In this working paper, the authors show how monetary policy affects different euro area households based on income and wealth demographics. They conclude that the indirect income channel is a significant driver of changes to consumption in response to monetary shocks, especially in households that have fewer liquid assets.

ECB Working Paper: Benefits and costs of liquidity regulation (Hoerova et al)

The authors assess the costs and benefits of liquidity regulation and conclude that liquidity tools such as the liquidity coverage ratio, leverage ratio, and net stable funding ratio are not sufficient enough to supersede the need for a lender of last resort (LOLR). Results show that if European banks fully complied with Basel III liquidity standards, they still would have needed central bank assistance during the Global Financial Crisis and Sovereign Debt crisis.