BPInsights: July 24, 2021

Stories Driving the Week

What is the Break-Even Cost of Small-Dollar Loans?

Policymakers have rightly intensified their focus on affordable credit access for low- and moderate-income consumers, and banks want to serve those communities’ needs. Legislation proposed in Congress would impose a 36 percent rate cap on consumer loan interest rates. But that limit applied arbitrarily across the full spectrum of consumer credit products would constrain safe, affordable small-dollar lending offered by banks that helps low-income consumers cover emergency expenses. Rate cap proponents often quote interest rates using APR, a widely-used measure in consumer loans, but, when used to illustrate the overall cost of small-dollar, short-term loans, APR can make the cost of those loans appear misleadingly high. For example, a $500, 3-month loan that costs $55 would have a 44% APR, whereas a $100, 3-month loan that costs $35 has a 140% APR. Both rates are far lower than the typical payday loan rate, as noted in this data. In order to help meet the financial needs of vulnerable consumers living paycheck-to-paycheck, banks want to offer responsible small-dollar loans with a simple and transparent pricing structure as a safe alternative to predatory and reckless payday lenders. The infographic explains how much it would typically cost for a bank just to break even on a small-dollar loan and how APR may be a misleading depiction of their affordability. The proposed rate cap legislation could hinder banks’ ability to offer certain types of these safe alternatives to payday loans by essentially requiring them to take a loss – rather than break even – on some of these products.

‘Banking the Unbanked’ Hearing Highlights ‘Bank On’ Program  

The House Financial Services Subcommittee on Consumer Protection and Financial Institutions this week held a hearing on “Banking the Unbanked.” BPI CEO Greg Baer released the following statement in anticipation of the hearing: “The Bank On program, which connects banks with unbanked and underbanked consumers, has shown notable success in expanding access to low-cost, no-overdraft bank accounts, particularly in predominantly minority and low-income communities. Currently, more than 100 banks, comprising 52 percent of national deposits, offer Bank On certified accounts. During 2019, the most recent data available, those banks added nearly 2 million new Bank On certified accounts.

“As described in a BPI blog post published this week by SVP of Research Paul Calem, new data suggests that Bank On take-up is greater in places with a larger concentration of unbanked households. In particular there is a significant positive correlation between rate of Bank On account openings and the proportion of unbanked households across states – suggesting that the program reaches the communities that need it most, and that it has the scale to make a meaningful impact on financial inclusion. Policymakers should encourage broader use of the program, which enables underserved Americans to build financial stability and security for their families.”

BPI Welcomes Banking Agencies’ Unity on CRA

BPI SVP and Associate General Counsel Dafina Stewart released a statement this week on the banking agencies’ CRA announcement. “BPI applauds the decision announced by the Federal Reserve, FDIC and OCC that they will commit to a joint CRA rulemaking,” Stewart said. “We also welcome the OCC’s steps to rescind its standalone CRA rule. BPI has long argued that the application of inconsistent CRA standards to banks regulated by different federal banking agencies would harm the banking industry’s ability to work together with the communities it serves to identify and execute on meaningful community reinvestment opportunities. We look forward to a coordinated interagency approach, which will produce the best outcomes for low- to moderate-income and underserved minority communities.”

CECL and Capital Relief: A Choice Between Doing the Right Thing for the Right Reason or the Wrong Thing Based on a Misunderstanding

The COVID pandemic’s onset made clear the CECL accounting standard’s procyclicality – its constraint of lending when the economy is stressed. As the economy stalled, banks had to increase their allowances for credit losses substantially, reducing their capital and as a result their ability to lend. What is happening now is procyclical in another form: banks releasing those reserves into income amidst robust economic growth, thereby boosting their capital and allowing them to lend more. But there’s another factor at play, a new BPI blog says: a key regulatory modification has allowed banks more room to support the economy in stress and less room to lower standards in good times.

At the outset of the COVID crisis, federal banking regulators limited how much a change in allowance could affect banks’ regulatory capital ratios. As banks increased loan reserves, regulators allowed them to add back a quarter of that increase to bank capital. That change reduced the bank capital decrease and boosted banks’ lending capacity – but currently, the adjustment is having the opposite effect, with their capital not rising to the full extent it would without the adjustment. The banking agencies’ CECL adjustment makes just as much countercyclical sense in recovery as it does in stress. While the change could face political opposition because of some observers’ false notion that it constituted capital “relief,” that mistaken impression should not inhibit the banking agencies from making it permanent.

‘Taming Wildcat Stablecoins’ Paper Offers Options for Crypto Wrangling 

A new paper by Harvard’s Gary Gorton and the Federal Reserve’s Jeffery Zhang compares stablecoins – digital assets meant to maintain a stable value by being pegged to a fiat currency like the dollar – to the run-prone early “wildcat” currencies of the antebellum United States, demand deposits before federal insurance, and money market mutual fund shares. The authors argue that based on historical lessons, privately produced forms of money like stablecoins are not an effective medium of exchange because they may not be accepted at face value without question and are subject to runs. They propose different options for mitigating stablecoins’ systemic risks, including: regulating stablecoin issuers as banks or issuing a central bank digital currency.  They liken stablecoins to deposits based on a 1970s DOJ analysis under section 21 of the Glass-Steagall Act – still on the books – that distinguishes deposits from money market mutual funds based on the underlying agreements between the relevant parties.  Depositors are creditors of banks, yet holders of MMMF shares are owners of the fund.  Under this analysis, most stablecoin owners are creditors of the issuers and thus those issuers appear to be accepting deposits.  Coin holders do not own the issuers, but rather, they retain the right to redeem the value of their coins at par.
The paper comes as the President’s Working Group on Financial Markets met this week to discuss stablecoin regulation, and in the wake of Federal Reserve Chair Powell’s recent message to Congress that if stablecoins become entrenched in the payments landscape, they warrant a defined regulatory framework.

In Case You Missed It

Cyber Breach Notification Bill Stokes Debate

Sens. Mark Warner (D-VA), Marco Rubio (R-FL), Susan Collins (R-ME) and others introduced bipartisan legislation this week to require critical infrastructure firms, government agencies and contractors to report cyber breaches within 24 hours, according to Inside Cybersecurity. The bill has been referred to the Senate Homeland Security and Governmental Affairs Committee. The House Homeland Security Committee is working on its own language, with the effort led by cyber subcommittee Chair Yvette Clarke (D-NY). The Senate bill, which offers some liability protection for attacked companies, has garnered critiques that it casts too wide a net, does not target serious incidents narrowly enough and that the 24-hour reporting period is inoperable. Cyber breaches are attracting legislative attention after several prominent ransomware attacks and other incidents have infiltrated important supply chains. BPI is encouraging lawmakers to ensure that any new cyber incident reporting requirements are aligned to what banks and other financial institutions already comply with and require greater bi-directional information and intelligence sharing on threats.

Former Banking Committee Aide Tapped for Treasury Bank Reg Role

Graham Steele, a Stanford University professor and former staffer of the Senate Banking Committee and its current Chairman, Sen. Sherrod Brown (D-OH), was nominated this week for Assistant Secretary for Financial Institutions at the Treasury Department. You can see more about Graham here: he’s a proponent of designating climate risk as a systemic risk to the financial system, triggering greater regulation; he promotes policies to shrink the largest banks, largely through increased capital requirements and more stringent resolution planning review; he’s guardedly suspicious of private cryptocurrencies; and he writes about the risk of the nation’s largest money managers. The nomination comes as Treasury continues to fill top roles – Nellie Liang, Under Secretary for Domestic Finance, was recently confirmed to her position. 

Joint Trades to Banking Panel Leaders: 36% Rate Cap Harms Credit Access, Consumers

A proposed 36% interest rate cap on consumer loans, as defined under the Military Lending Act, would prevent banks from offering responsible, transparent small-dollar loans to help consumers cover unexpected expenses – therefore harming the consumers the legislation seeks to protect, BPI and several financial trades wrote in a letter to Senate Banking Committee Chairman Sherrod Brown (D-OH) and Ranking Member Pat Toomey (R-PA) opposing a rate cap bill. The cap would preclude banks from breaking even on short-term, small-dollar loans and limit choices in the marketplace, particularly for underserved consumers with less-than-pristine credit histories. The proposal in question also uses flawed mathematical calculations that overstate the cost of credit. The joint trades urge the lawmakers to reject the legislation, which would reduce access to credit, including safe bank products with affordable terms and transparent, consumer-friendly features, for underserved consumers.

FSB’s Domanski: Government Intervention, Regulation Helped Financial System Weather COVID Shock

In a speech at the Finance China 2021 conference, Financial Stability Board Secretary General Dietrich Domanski attributed the financial system’s pandemic resilience to unprecedented government intervention and post-Global Financial Crisis regulations. “These combined actions were effective in easing financial strains and in ensuring the continued supply of financing to the real economy,” he said of the government policy responses. “Crucially, this policy response was supported by the stringent regulatory standards put in place by the G20 and coordinated through the FSB following the 2008 financial crisis.” Domanski also highlighted areas where the FSB aims to strengthen resilience going forward, such as implementing remaining elements of the G20 reforms and ensuring parts of the regulatory framework work as intended; enhancing the resilience of money market funds; safeguarding cybersecurity; and addressing climate change risk. Areas for potential regulatory change include the role and usability of capital and liquidity buffers, countercyclical elements in prudential regulation, and potential remaining sources of procyclicality masked by the large-scale government intervention last year, he said. 

Ballard Spahr Q&A with BPI’s Angelena Bradfield

Ballard Spahr this week published a Q&A with BPI’s Angelena Bradfield, SVP of AML/BSA, Sanctions & Privacy. The Q&A featured questions on the Corporate Transparency Act, FinCEN’s new beneficial ownership database and other topics pertaining to the new AML law and its rollout.

Fed Staff Paper: In Pandemic, Banks Near Their Buffers Reduced Certain Kinds of Lending

Banks close to their regulatory capital buffers reduced loan commitments to small and midsize businesses during the pandemic, particularly to private, bank-dependent firms, firms with young lending relationships and firms whose credit lines were up for renegotiation, according to a paper by Federal Reserve staff. These buffer-constrained banks reduced loan commitments by an average of 1.4 percent more and were 4 percent more likely to end pre-existing lending relationships during the pandemic compared to banks not constrained by buffers. “While the post-2008 period saw the rise of banking system capital to historically high levels, these capital buffers went effectively unused during the pandemic,” the authors wrote. They characterized the study as the first to empirically test the usability of Basel capital buffers in a downturn. BPI has argued that buffers can constrain lending in a downturn because banks are reticent to draw them down under stressful conditions.

Op-Ed: LIBOR is Dead. Long Live Choice.

Banks should be free to choose among LIBOR replacement rates and not be confined to SOFR, J. Christopher Giancarlo — former CFTC Chairman and now an independent director on the board of the American Financial Exchange, publisher of Ameribor, one of the replacement rates in the market — wrote in an American Banker op-ed this week. Any LIBOR legislation should make clear that Congress supports that freedom of choice for new obligations, he said. While SOFR is emerging as a major post-LIBOR benchmark in the derivatives markets, many banks have gravitated toward options like Ameribor or BSBY that include a credit risk component in order to hedge against higher bank funding costs in stress. Regulators have sent mixed messages about whether they can use such rates without examiner signoff.

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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.