Highlights from the Fed’s Capital Conference
The Federal Reserve Board hosted a conference on Tuesday on the capital framework. The conference convened public sector officials, academic experts and industry practitioners to discuss perspectives on the regulatory capital framework, including interactions between different capital requirements, consequences of capital regulations and changes that may warrant consideration. The conference comes as federal banking regulators are considering adjustments to various capital requirements, such as the enhanced supplementary leverage ratio, the supervisory stress test and Basel III Endgame. Here are a few key moments.
- Setting the stage: Federal Reserve Chair Jay Powell’s opening remarks stressed the importance of a holistic view of the overall capital framework. “A great benefit of this conference is the chance to consider all elements of the capital framework in concert, rather than look at each in isolation,” he said. He also said regulators “need to make sure that our supervisory practices focus on the critical areas that determine safety and soundness.”
- Treasury view: In remarks the night before the conference, Treasury Secretary Scott Bessent expressed hope that a revamped Basel proposal would “simplify and rationalize” the capital framework. He critiqued the “dual stack” approach to capital requirements in the July 2023 Basel proposal, which he said “was motivated simply to reverse-engineer higher and higher capital aggregates. It also was at odds with capital reform as a modernization project because it would have preserved the antiquated capital requirements as the binding floor for many, perhaps most, large banks,” he said. “Bank regulators should consider abandoning this flawed dual-requirement structure.”
- Market risk: Sheara Fredman, Goldman Sachs’ chief accounting officer, explained how market-risk capital requirements overlap, and how the stress tests’ Global Market Shock incorporates outdated assumptions. Basel Endgame and the stress tests “both stand to benefit from a really deep dive” to ensure that the assumptions, shocks and other elements used in these measures are consistent, Fredman said. The GMS still uses assumptions from the Global Financial Crisis “despite how far we are removed from the financial crisis, and more importantly, how much reform has happened since the financial crisis” – for example, securitized mortgages, whose underwriting standards have significantly improved since the crisis. Fredman also aptly noted with respect to framework overlaps, applying both FRTB and GMS to a securitized asset means that for about 15% of recently underwritten products, banks would have to hold more capital than the asset’s value—for instance, holding $120–$130 million in capital against a $100 million bond. If the asset’s value is written to zero, capital is actually released, highlighting that current rules are miscalibrated for a significant portion of the market.
- Stacks and pillars: One panel featured CFOs’ discussion of different paths for capital requirements – dual or single stacks; Pillar 1 or Pillar 2. A capital stack is a mix of minimums and buffer requirements relative to risk-weighted assets that banks must maintain to avoid negative consequences. The two current stacks are the legacy standardized approach (requirements based on regulatory risk weights for consistency and comparability across banks; includes a bank-specific requirement determined by stress test results) and, for GSIBs, the advanced approaches (reliant on banks’ internal data and models or tools to quantify risk and set risk weights). The largest banks calculate capital ratios using both stacks and use the lower ratio of the two calculations to determine whether they comply with risk-based capital standards. When the Basel proposal is reproposed, policymakers could choose a single- or dual-stack approach, and they may wish to reconsider whether to continue to embed supervisory stress test results as requirements in “Pillar 1” (binding capital requirements) or “Pillar 2” (which allows more supervisory discretion for bank-specific requirements). Assuming that regulators go with a single stack approach, a Pillar 1 approach is superior to Pillar 2, said Morgan Stanley CFO Sharon Yeshaya. Pillar 2 “can create a lot of questions around who your supervisor is, … the supervisory guidance an individual bank may get, and where there might be certain biases that come out from a supervisory perspective,” Yeshaya said. “So I do think a Pillar 1 approach is better from a practitioner point of view, but also from an investor point of view, particularly within the United States.” Pillar 1 allows better capital planning, particularly with a stress capital buffer (a requirement determined by stress test results), she said.
- Decoupling, accountability: One topic that emerged was whether stress tests should be “decoupled” from the core part of capital requirements or be moved to the more discretionary Pillar 2 segment. John McDonald, senior analyst of large-cap banks at Truist Securities, said: “There’s an overriding concern that pushes most of the U.S. banks and many investors to the side of keeping stress testing as the driver of Pillar 1 requirements … moving off of that, moving to a fixed CCB system, could have the effect of empowering and perhaps pressuring supervisors back to adjusting capital requirements in Pillar 2.” There’s an incentive for accountability if stress tests drive Pillar 1 requirements, he said: “A lot of supervisory activity happens behind closed doors, without disclosure, transparency or accountability. Keeping public stress tests as a driver of Pillar 1 capital requirements does hold the supervisory system accountable. And both banks and investors want capital minimums to be driven by a process, not by people or politics.” He noted that banks and investors carry “emotional scar tissue” from an earlier era of stress tests; “that fear of moving back to a Pillar 2 system has most banks voting against decoupling.”
- ‘Unexplained volatility’: McDonald also highlighted that the issue with the SCB is not just “volatility,” but “unexplained volatility” in stress test results. He noted that banks with similar risk profiles can show very different SCB outcomes in the same year, and individual banks experience significant swings—sometimes over 100 basis points—in their minimum requirements without any visible changes in their risk profiles. This “unexplained volatility” has undermined the credibility of the stress test process among investors. Consequently, there is strong investor support for “transparency,” with a simple belief that “sunlight is the best disinfectant.” McDonald advocated for making models and scenarios publicly available to enable scrutiny and foster a public debate on the risks tested and the impact on business activities each year.
- AI, innovation and the future: Sam Altman, CEO of OpenAI, joined Vice Chair for Supervision Michelle Bowman for a fireside chat, in which they discussed artificial intelligence and its implications for the financial industry and society in general. Altman raised concerns about growing sophistication in fraud and scams, warning about the use of voice authentication in phone calls. Watch the discussion here.
Five Key Things
1. The Problems with ‘Capital Neutral’
A biologist, a chemist, and a statistician are out hunting. The biologist shoots at a deer and misses five feet to the left. The chemist takes a shot and misses five feet to the right. The statistician yells, “We got ’em!”
Among global regulators, “capital neutral” has become popular shorthand. Easily said, it sounds reasonable and measured, particularly when mentioned by people who are reasonable and measured. Start peeling the “capital neutral” onion, though, and one discovers that there is really nothing at its core. If the goal of policymakers is to stimulate economic growth while maintaining a safe and sound banking system, then the right path requires an honest look at the costs and benefits of every capital requirement that is long overdue, and the pursuit of “neutrality” is only an unhelpful detour. Read BPI’s new post here.
2. Joint Trades Respond to Fintech Industry’s False Assertions on Data-Sharing Rule
A united front of banking and credit union groups responded to the many misstatements included by the fintech and other associations in their recent letter to the White House on the Section 1033 data sharing rule. Read the statement here
3. BPI and TCH Defend Federal Reserve’s 2011 Debit Interchange Rule in Corner Post
BPI and The Clearing House Association defended the Federal Reserve’s 2011 rule governing debit card interchange rates in oral arguments this week in Corner Post, Inc. v. Board of Governors of the Federal Reserve System.
“Government-imposed caps on debit card processing fees benefit the big-box retail lobbyists behind this case, not the American consumer,” BPI stated after the oral arguments. “Interchange fees enable banks to offer free or low-cost checking accounts and invest in combating rising fraud. Undercutting banks’ ability to recover expenses for offering these services to retailers won’t eliminate the cost, it will simply shift the burden onto American consumers. Meanwhile, large retailers will inevitably pocket the difference, just as they did when these rules were first imposed in 2011.”
4. A Bank Restructuring Shows What’s Wrong with Supervision
Flagstar Financial Inc., the holding company for Flagstar Bank, this week announced that it will reorganize, absorbing the holding company into the bank. Flagstar specifically flagged eliminating “duplicative supervision and regulation” as a goal of the merger. Under the reorganization, Flagstar’s principal subsidiary, Flagstar Bank, N.A., will become the top-tier entity and will continue to be primarily regulated by the OCC.
BPI recently recommended reforming Federal Reserve examination practices to eliminate redundant, extralegal supervision of bank holding company subsidiaries, particularly bank subsidiaries. For banks with all or almost all their assets in their principal bank subsidiaries, the Fed could rely on the agency responsible for the bank to conduct almost all examinations.
5. The Crypto Ledger
Here’s the latest in crypto.
Market structure: Now that the GENIUS Act has been signed into law, Congress’ attention now turns to crypto market structure, the subject of a new discussion draft circulated by Senate Banking Committee Chairman Tim Scott (R-SC), along with Sens. Cynthia Lummis (R-WY), Bill Hagerty (R-TN) and Bernie Moreno (R-OH). The discussion draft builds on the House-passed CLARITY Act. The senators issued a request for information seeking public feedback on the draft and a range of related questions.
Crypto charter pushback: A group of banking trades, led by the American Bankers Association, urged the OCC to postpone consideration of applications by various crypto firms to obtain national trust charters. Such bids pose “significant policy and legal questions,” according to the coalition’s letter. BPI filed extension requests for comment deadlines of the five charter applications for entities that would engage in “novel activities.”
In Case You Missed It
Takeaways from McKernan Nomination Hearing
Jonathan McKernan, President Trump’s nominee as Under Secretary of Domestic Finance at the Treasury Department, testified at a nomination hearing this week before the Senate Finance Committee. McKernan has served as a director at the FDIC and was previously tapped to lead the CFPB before being selected for the Treasury nomination. Here are some notable moments from the hearing.
- Track record: Finance Committee Chairman Mike Crapo (R-ID) praised McKernan’s track record of “support for sound and balanced regulation.” At the FDIC, McKernan “opposed burdensome rulemakings, such as the Basel III Endgame proposal, which would have hindered economic growth and reduced lending to households and businesses in America,” Crapo said.
- Treasury market: In his opening statement, McKernan laid out goals of promoting economic growth in policymaking and preserving Treasury market functioning. “The Treasury market is the deepest, most liquid in the world, and it must continue to function well, even during periods of stress,” he said.
- Tailoring: McKernan emphasized the need to revisit regulatory requirements to ensure they are “aligned with the actual risk that we’re trying to regulate.” He said that “tailoring … really is a guiding star here.”
- Concrete examples: McKernan mentioned tangible examples of tailoring priorities, such as a recent FDIC proposal to index regulatory thresholds to inflation and focusing anti-money laundering screening on higher-risk activities.
Tailoring, Discount Window Bills Advance Through House Committee
Measures on bank examination tailoring, the Fed’s discount window and CFPB authority advanced through the House Financial Services Committee this week. The panel approved a bill to raise the examination threshold for smaller banks; to require a review of the Fed’s discount window to improve access and reduce stigma; and to remove the CFPB’s voting power on the FDIC board. Other measures advanced during the same markup include legislation to end penny production and promote the formation of new banks.
BPI Expands Research Team with 3 New Hires
BPI announced the hiring of three new members of its Research team on Monday. Evan Sekeris and Daniel Grodzicki will each join BPI in the role of Senior Vice President, Senior Economist. Laurence (Laurie) Bristow will be a Vice President and Research Associate. Evan started on July 21; Daniel and Laurie will start in September.
Senate Intelligence Reauthorization Bill Features 10-Year CISA 2015 Extension, As Lawmakers Press To Meet Sept. 30 Deadline
The Senate Intelligence Committee has advanced an intelligence reauthorization bill that includes a 10-year extension of the Cybersecurity Information Sharing Act of 2015, ahead of its Sept. 30 expiration. The law provides liability and antitrust protections for companies sharing cyber threat data with DHS. On the House side, Homeland Security Chair Andrew Garbarino (R-NY) called preventing a lapse a “top priority,” warning that failure to act would significantly disrupt public-private information sharing.
- Timeline: Senate Homeland Security and Governmental Affairs Committee Chairman Rand Paul (R-KY) said this week that the panel will aim to mark up the bill “in September before it expires.”
- Other legislative developments: The House appropriations bill for financial services passed out of committee this week included a provision barring funding for enforcing the SEC’s controversial cyber disclosure rule.
Senate Considers Plankey Nomination for CISA Chief
The Senate Homeland Security Committee held a nomination hearing on Thursday for Sean Plankey as Director of the Cybersecurity and Infrastructure Security Agency. Here are some highlights.
- CISA reauthorization: In response to Sen. Bernie Moreno (R-OH), Plankey explained the role of the Cybersecurity Information Sharing Act (a distinct “CISA” from the agency he is nominated to lead) in enabling information sharing to protect critical infrastructure from attacks and coordinate across businesses and between industry and government. Plankey described the implications of letting CISA expire without reauthorization: “If that was left to expire, in particular in the financial sector, who does some of … the most prevalent amount of information-sharing, they would experience difficulties in sharing, in community protection of information security. And then other industries would as well.” He noted that Homeland Security Secretary Kristi Noem supports reauthorizing the law.
- Protecting the greater good: In response to Sen. James Lankford (R-OK), Plankey laid out how the law works: “So a business that … experiences an issue, a breach, detects an adversary, that type of information, they can share it without feeling pressure of liability across to other businesses, so that they may protect themselves and also to the government, so the government may then distribute that information in a way that protects the greater good of America, and that’s contained in the CISA 2015 bill.”
Hacks, Bank Runs and Currency Plunge: What ‘Predatory Sparrow’ Attack Says About Cyber as a Weapon
A recent Wall Street Journal opinion piece examined the policy implications and drastic fallout of an Israel-linked hacker group’s takedown of a key Iranian bank, which triggered a nationwide bank run and currency collapse. The hacker group, known as “Predatory Sparrow,” also successfully targeted a parallel financial network that Iran had built based on stablecoins, implying that such infrastructure may not provide its intended backup benefits. The op-ed discussed lessons learned from the strike and recommended “shifting U.S. cyber policy from passive support to active partnership in offensive operations.”
Traversing the Pond
Here’s the latest in international banking policy.
- Tom Hayes’s Libor-Rigging Conviction Overturned: Tom Hayes, a former trader convicted in the Libor scandal, had his conviction overturned by a UK court this week. The former UBS and Citigroup trader had been found guilty in 2015 of manipulating the London interbank offered rate (Libor), a benchmark used in financial contracts. While Hayes was presented as a ringleader, several other alleged co-conspirators tried in the U.K. were all acquitted. Several similar convictions of traders in the U.S. were overturned. The panel of judges ruling on Wednesday said it had been wrong for the judge in Hayes’s trial to tell the jury that a bank couldn’t consider its commercial interests and still submit a genuine rate. Hayes spent five and a half years in prison prior to the conviction being overturned.
- Bank of England May Scrap Digital Pound Plans: Bank of England officials are reconsidering whether to move forward with a digital pound as skepticism grows over its benefits, according to Bloomberg. Instead, the BOE is urging banks to accelerate private-sector payment innovations that could achieve similar outcomes without a central bank digital currency. “If that’s a success, I question why we need to introduce a new form of money,” Governor Andrew Bailey said.
Hurley Confirmed as Treasury Point Person for Intelligence
John Hurley was confirmed by the Senate this week as Treasury Department Under Secretary for Terrorism and Financial Intelligence, a leading role in national security policy. The vote was 51-47.
Goldman, BNY Launch Tokenized Money Market Fund Product
Goldman Sachs and BNY have jointly launched a digital token initiative that will use blockchain technology to record customers’ ownership of certain money market funds “in a significant step towards enhancing the utility and transferability of existing MMF shares.” The tokens aim to speed up settlement times and improve collateral efficiency.
