BPInsights: July 31, 2021 - Bank Policy Institute

Stories Driving the Week

The CECL Adjustment is Even More Countercyclical for Consumer Banks

Federal banking agencies adopted an adjustment to the current expected credit loss (CECL) accounting standard at the onset of the pandemic to combat the procyclical effects of CECL and to encourage necessary lending to the broader economy. As shown by a recent BPI analysis, the CECL adjustment is currently reducing regulatory capital by limiting how much capital increases as banks release their allowance for credit losses.

At the time of publication of BPI’s first post on July 20, the only data available was that of the largest banks. Now that additional data has been made available, we show that a similar pattern can be observed for all large lending banks. In addition, we find that the countercyclicality of the CECL adjustment is twice as large for consumer banks.

Predicting Stablecoin Regulation: Key Takeaways from Gorton and Zhang’s ‘Taming Wildcat Stablecoins’

The economics underlying stablecoins isn’t new. Rather, stablecoins are just the latest iteration of a ‘subpar medium of exchange’ subject to destabilizing runs if left unchecked, according to a recent paper from Yale economist Gary Gorton and Federal Reserve attorney and economist Jefferey Zhang. BPI’s post this week summarizes the five key takeaways from this thoughtful and thorough analysis. The authors address whether stablecoins meet a key principle of money – the “no questions asked” principle — a willingness by recipients to accept the currency without worrying about its fluctuating value. While insured deposits meet this principle, the authors conclude that stablecoins do not, because like money market mutual funds before them, any uncertainty about the assets backing stablecoins will lead to runs. The authors also note the similarities between deposits and certain stablecoins and conclude that some stablecoin issuers may thus be in the business of taking illegal deposits under Section 21 of the Glass-Steagall Act.

Stablecoins present real risks to the financial system, the authors argue, so policymakers should consider how to properly address these risks. The authors recommend several alternatives:

The government could begin to treat stablecoins as bank deposits and require banks that offer these products to carry FDIC insurance or partner with an FDIC-insured institution;
FSOC could designate stablecoins as systemically important payment instruments, thus giving the Fed authority to mandate risk management standards;
Congress could adopt a uniform national framework to prevent regulatory arbitrage and eliminate legal loopholes; and/or
The Federal Reserve could reimpose a monopoly on money issuance and adopt a central bank digital currency with Congressional approval.

While the authors do evaluate some of the drawbacks of a CBDC, they understate the resulting reduction in lending and economic growth that would take place should a CBDC become a reality. BPI recently published a series of research and analyses addressing these complex costs and benefits and addressing whether the Federal Reserve currently has the legal authority to issue a CBDC.

HFSC Advances LIBOR Transition Legislation to House Floor

The House Financial Services Committee convened July 28 and July 29 to markup a long list of legislation, including H.R. 4616, the “Adjustable Interest Rate (LIBOR) Act of 2021” that would seek to provide markets with additional certainty as LIBOR benchmarks phase out in mid-2023. The legislation will importantly help to address the issue of ‘tough legacy contracts,’ which refers to existing contracts running past 2023 that set rates based on LIBOR and failed to include fallback language. In response to the passage of the LIBOR legislation, BPI issued the following statement:

BPI commends the House Financial Services Committee for passing legislation that will provide certainty for the market and customers on tough legacy contracts that utilize LIBOR. Along with the continuing development and market uptake of alternative reference rates, today’s legislation will greatly help banks continue to serve their customers in the ongoing transition from LIBOR.

HFSC Subcommittee Convenes Debate on ‘Promises and Perils’ of CBDC

The House Financial Services Subcommittee on National Security, International Development and Monetary Policy hosted a hearing on July 27 to discuss the “Promises and Perils of Central Bank Digital Currency.” Lawmakers debated the merits of whether CBDC adoption in the U.S. was warranted and whether failure to act would put the U.S. at a competitive disadvantage with its foreign adversaries, particularly China. Some lawmakers pointed to recent remarks by Fed Chairman Jerome Powell, who stated in a recent speech that the role of the dollar in the global economy was unlikely to be threatened because of the U.S.’s “rule of law, our democratic institutions – which are the best in the world – our economy, our industrious people, all the things that make the United States the United States.”

Learn more about BPI’s previous research and analysis on central bank digital currencies by clicking the links below:

Federal Reserve Announces Permanent Repo Facility to Backstop Money Markets During Stress

The Federal Reserve announced on July 28 that it was opening a standing repo facility that would provide overnight loans to primary dealers in the form of repos against Treasuries, Agencies, and Agency Mortgage-Backed Securities. The interest rate on the facility will initially be set at 25 basis points, somewhat above the general level of overnight rates. The facility began operation on July 29. The Fed also announced that it was making permanent a facility at which it extends similar overnight loans to foreign and international monetary authorities (FIMA rep facility). According to the Fed, the facilities “…will serve as backstops in money markets to support the effective implementation of monetary policy and smooth market functioning.”

These actions align with recommendations published in a G-30 report on July 28 to improve Treasury market functioning. BPI’s Senior Fellow Pat Parkinson served as the project director.

In Case You Missed It

SBA Seeks to Simplify PPP Loan Forgiveness for Small Businesses and Reinforce Ongoing Bank Efforts

The Small Business Administration announced two new measures on July 28th to streamline the PPP loan forgiveness process for loans of $150,000 or less, which will enable lenders of all sizes to more quickly help small businesses and their employees obtain much-needed economic relief. First, the SBA will allow borrowers to apply for forgiveness directly through an SBA portal, rather than going through their bank as an intermediary. Second, the SBA will reduce the reporting burden on these small borrowers by waiving a requirement that they demonstrate that their business suffered a 25% reduction in revenue in 2020. In response BPI stated, “We appreciate the actions the SBA has taken to streamline the PPP forgiveness process, thereby enabling lenders of all sizes to more quickly help small business and their employees obtain much-needed economic relief.”

Sen. Sherrod Brown Calls on the CFPB to Address Rising Consumer Complaints Against FinTech Chime

FinTech app Chime is facing additional criticisms from Washington following an influx of consumer complaints filed against the company with the Consumer Financial Protection Bureau (CFPB) related to ‘abrupt’ customer account closures. Sherrod Brown (D-OH), chairman of the Senate Baking, Housing and Urban Affairs Committee, sent a letter to the CFPB on July 27 calling on the Bureau to provide clarification on how it plans to address these complaints. ProPublica reported on the letter and indicates that the company has received over 920 complaints with the CFPB since 2020, 4,439 complaints at the Better Business Bureau and they indicate that Chime was previously in violation of California state law by falsely claiming to be a bank.

Lawmakers Turn to Crypto to Help Pay for Infrastructure Deal

Lawmakers are proposing to require increased reporting to the IRS for cryptocurrency and other digital assets to help pay for a substantial new infrastructure deal. The new proposal would mandate the reporting of any digital-asset transactions over $10,000 and requires any company in the business of facilitating crypto transfers to report the transactions to the IRS. The proposal is expected to raise approximately $28 billion over ten years.

States Challenge Whether FinTechs Offering High-Interest ‘Savings’ Violate Securities Laws

FinTechs seek to attract depositors with interest rates that are much higher than yields on safe assets, but they provide little transparency into how the deposits are invested to generate such yields. Unless the laws of finance have been repealed, high yields are only earned by taking high risks.

Regulators from several states recently expressed concerns over one such provider, BlockFi, whose business model they claim can carry significant risks and can “leave investors extremely vulnerable,” reported American Banker. New Jersey issued a cease-and-desist order against the company, while Alabama and Vermont have issued ‘show-cause’ orders requiring the company to demonstrate that it is not in violation of securities laws. Texas has announced an October hearing to determine whether to impose a cease-and-desist order on the company.

Stablecoin Operator Tether Subject of DoJ Probe for Bank Fraud

Stablecoin operator Tether is reported to be the subject of a recently launched Department of Justice probe into whether company executives committed bank fraud. Tether, launched in 2014, reportedly had trouble finding a financial institution willing to bank the company in its infancy due to concerns by regulated institutions that the currency could be used as a vehicle to conduct illicit activities. To circumvent these challenges, the probe alleges that company executives tried to mislead banks and hide the fact that transactions were linked to cryptocurrency.

The announcement comes on the heels of a meeting held by the President’s Working Group on Financial Markets held on July 19 that centered around the potential risks of stablecoins and the need for a more defined regulatory framework. It also follows a statement made at a July 27 hearing on cryptocurrency by Richard Downing, deputy assistant attorney general with the Justice Department’s criminal division, that cryptocurrency is helping to facilitate the proliferation of ransomware.

Banks Shrinking Reliance on FICO Could Lead to Better Access to Credit

Consumer credit is becoming less and less reliant on traditional FICO scores as more large lenders have begun to deemphasize FICO in favor of alternative lending factors in underwriting decisions, according to a recent Wall Street Journal article. The article indicates that as larger swaths of data become available, banks can make consumer lending determinations based on ‘alternative metrics’ such as account history, consistency of paying cell phone or utility bills on time and other factors. These efforts will undoubtedly benefit consumers who have low- or no-credit history, which WSJ estimates to be around 53 million U.S. adults.

OCC Appoints First-Ever Climate Change Risk Officer

The Office of the Comptroller of the Currency announced on July 27 the appointment of Darrin Benhart, a long-time OCC staffer currently responsible for supervising Bank of America, as its Climate Change Risk Officer. In its release, the OCC indicates that this is a newly created position where Benhart will be responsible for promoting ‘improvements in climate change risk management at banks.’

The OCC also indicated as part of the announcement that it would be joining the Network of Central Banks and Supervisors for Greening the Financial System (NGFS), a voluntary collaborative of central banks and regulators around the world launched following the Paris One Planet Summit in 2017. The OCC will join the Federal Reserve, which announced its commitment to join in Dec. 2020.