Stories Driving the Week
Banks Show Strength in Stress Tests
The annual DFAST 2022 stress test results released this week demonstrate that large U.S. banks are highly resilient in the face of an extreme stress scenario. Despite the sharp deterioration in economic and financial conditions assumed in this year’s stress test scenario, banks still had more than twice the minimum capital required. As a result, large banks continue to be in an excellent position to lend to households and businesses and support U.S. economic growth.
The scenario considered in this year’s stress tests is much more severe than any post-World War II recession, including the 2007–2009 global financial crisis. To be precise, this year’s stress scenario assumes a 5¾-percent jump in the unemployment rate, accompanied by a 3½-percent decline in real GDP. The scenario also includes a collapse in asset prices: a nearly 40-percent fall in commercial real estate prices, a 28-percent drop in house prices, and a 55-percent decline in the stock market. This year’s scenario also featured more severe trading shocks for several benchmark indexes compared with last year’s. The Federal Reserve has also tested large banks’ resilience to rising interest rates through higher Treasury rates and MBS spreads in this year’s global market shock.
The tougher assumptions in this year’s stress scenario resulted in higher projected loan losses compared with last year’s stress tests. Lower allowances for credit losses at the start of the stress tests raised projected provisions for loan losses further. For the banks subject to the global market shock, the more severe shocks in this year’s scenario drove increased trading and counterparty losses. By contrast, projections of pre-provision net revenue rose compared with last year’s test. However, the increase in banks’ balance sheets during the pandemic continued to cause the Federal Reserve’s projections to overstate noninterest expenses (including losses from operational-risk events) and a few fee income components.
Overall, the maximum decline in the aggregate common equity tier 1 capital ratio increased 0.3 percent compared with DFAST 2021, which will likely translate into higher stress capital buffer requirements for many of these banks in the fall – in other words, this year’s stress test will result yet again in higher capital requirements for U.S. banks. Raising bank capital requirements as the economy slows down due to higher interest rates, will cause banks to tighten lending standards at the wrong time and could undermine the Federal Reserve’s objective of avoiding a recession in the U.S. economy over the next year. In addition, the volatility in capital requirements from year to year hinders banks’ ability to manage their capital effectively and the need for banks to hold extremely high levels of capital both to be above all regulatory capital buffers and account for the volatility of stress tests come at a real cost of economic growth.
- Deep dive: Learn more from this Reuters explainer, which notes the stress tests’ evolution from a pass-fail model to a more mechanical link between the stress test results and banks’ regulatory capital buffers.
Bank, Credit Union and Consumer Groups Support Committee Vote to Close the ILC Loophole
The U.S. House Committee on Financial Services convened this week to mark up a series of proposed laws, including a bill to close the industrial loan company (ILC) loophole. The ILC loophole allows Big Tech and other nonbank companies to offer financial products and services without complying with the safeguards and oversights required of bank holding companies. The “Close the ILC Loophole Act” (H.R. 5912) now heads to the floor for consideration by the entire legislative body.
Americans for Financial Reform, Bank Policy Institute, Center for Responsible Lending, Consumer Federation of America, Credit Union National Association, Independent Community Bankers of America, Mid-Size Bank Coalition of America, National Association of Federally-Insured Credit Unions, National Community Reinvestment Coalition, National Consumer Law Center and U.S. PIRG previously submitted a joint letter of support to the Committee in advance of the vote, and issued the following statement in response to its passage:
“With this week’s vote, the Committee is one step closer to strengthening the financial system by closing the ILC loophole, and we call on Congress to take up this legislation without delay. The current version of the legislation helps preserve the longstanding separation between banking and commerce and restricts Big Tech companies from circumventing existing rules by using a loophole to enter the banking system. This effort reflects the extraordinary bipartisan work by Representatives Jesús “Chuy” García and Lance Gooden to collaborate with stakeholders to reach a solution, and it serves as an acknowledgment that there is no justifiable reason for two similar institutions offering indistinguishable products or services to be treated differently under the law.”
The legislation would help eliminate legal disparities between bank holding companies and ILC parent companies by imposing consistent regulatory and supervisory expectations.
To learn more, please click here.
FDIC Keeps Public in the Dark on Appeals Process and Discards Due Process Protections
A coalition of trades representing banks this week objected to the FDIC’s recent decision to overhaul its supervisory appeals process without proper public notice and comment. The FDIC violated longstanding norms of transparency with its move to eliminate the Office of Supervisory Appeals and reinstate the Supervision Appeals Review Committee as the final review in supervisory appeals by FDIC-supervised banks (e.g., which include appeals of CAMELS ratings assigned by FDIC examiners). In the process, FDIC has discarded certain due process protections. To learn more, click here.
Digital Assets, Master Accounts: Takeaways from Powell’s Testimony
Federal Reserve Chair Jerome Powell testified on Capitol Hill this week in the regular Humphrey-Hawkins hearings. Many lawmaker questions centered on inflation. Here are other key takeaways from Powell’s testimony.
- Financial stability: In light of recent market volatility, Rep. Jim Himes (D-CT) questioned Powell about potential financial stability risks. “The financial markets have been functioning well and the banking system, in particular, is very strong, well-capitalized, lots of liquidity, [with a] better understanding and management of its risks,” Powell said. “Systemically, liquidity in the Treasury market has come down from where it was, and we’ve been looking for some time at ways to address that,” he said, but “markets are clearly functioning reasonably well.”
- Master accounts: The Federal Reserve Board sets rules, but the Reserve Banks make decisions about granting Fed master accounts subject to those rules, Powell said at the Senate hearing. “We actually think we can improve on that system with the current proposal we have, and are considering comments on that right now,” he said. He was responding to Sen. Cynthia Lummis (R-WY), who said master account applicants are “getting whipsawed” between the Board of Governors and the Reserve Banks. She called the process a “black hole.” Lummis has been a vocal advocate of crypto banks in her home state of Wyoming, some of which are seeking master accounts.
- Crypto custody: Lummis also asked Powell about the SEC’s staff accounting bulletin 121, which would require banks to hold digital assets in custody as a liability on their balance sheets. He said the Fed is working on the issue alongside other federal banking regulators. “My understanding of it is the same as yours … which is that custody assets are off-balance-sheet, have always been,” Powell said. “The SEC made a different decision as it relates to digital assets for reasons it explained, and now we have to consider those.”
- CBDC: Powell reiterated, in the House hearing, that a CBDC would need congressional authorization. He also said that any U.S. CBDC should be run by the Fed, not private sector stablecoin issuers.
- Stablecoins: In response to Rep. Josh Gottheimer (D-NJ), who has introduced draft legislation on stablecoins, Powell said it’s important to ensure that such assets are appropriately regulated. He acknowledged that there are “different approaches” circulating, such as the President’s Working Group recommendation that only insured depository institutions issue stablecoins.
- Transparency: Sen. Thom Tillis (R-NC) expressed concern about the Fed and its regional banks “stonewalling reasonable requests for information,” citing requests from Senate Republicans to the Kansas City Fed for details on its decision to revoke fintech Reserve Trust’s master account. The Reserve Trust issue arose during Sarah Bloom Raskin’s nomination process to be vice chair for supervision of the Federal Reserve. Tillis said Congress should subject Fed regional banks to FOIA, ban the Fed from using FOIA exemptions to withhold information from any member of Congress and consider making regional Fed presidents presidentially appointed and Senate-confirmed posts.
- LIBOR: In response to Rep. Brad Sherman (D-CA), who co-sponsored bipartisan LIBOR legislation enacted this year, Powell said he is “assured that people are working very hard” at the Fed to finish a LIBOR rulemaking by mid-September.
Treasury Seeks Input on Potential Treasury Market Trading Data Release
The Treasury Department this week unveiled a request for information seeking public input on additional post-trade data transparency in the Treasury securities market. The measure is part of a broader effort in the department to boost resilience in the crucial Treasury market. Any new trading data transparency should consider the differences among security types and trading venues, Treasury said in the RFI. Other considerations are how to measure liquidity; the timing of reporting of transactions and the potential for subsequent revisions to reports; security characteristics, market structure features and other factors; and recommendations to ensure the public release of information balances the benefits and risks.
BPI Releases Statement on McHenry Draft Bill on Financial Institutions and Privacy
The Bank Policy Institute welcomes draft legislation released this week by House Financial Services Committee Ranking Member Patrick McHenry (R-NC) to update the federal privacy requirements for our nation’s financial institutions. The draft bill seeks to build on the Gramm-Leach-Bliley Act, which provides a robust federal framework for protection of consumers’ data. Financial services is one of the rare industries already covered by federal privacy laws. Given Congressional interest in companies’ use of consumer data, any proposals to change the foundational framework should ensure all financial firms—both banks and nonbanks—have a clear blueprint for safeguarding consumers’ privacy. While we are still reviewing the draft in detail, we appreciate the Congressman’s thoughtful proposal to enhance the protection of customers’ data.
In Case You Missed It
The Crypto Ledger
Do Kwon, the South Korean entrepreneur behind the crumbled Terra crypto empire, is trying to rebuild after the collapse. Here’s what else is new in cryptocurrency this week.
- Bankman-Fried steps in: FTX founder Sam Bankman-Fried is providing lines of credit to crypto firms under pressure in order to stem contagion in the volatile digital-asset market. BlockFi and Voyager Digital are among the firms that received credit lines.
- CBDC’s questionable inclusion benefits: A U.S. CBDC could fall short on its promise to broaden access to financial services in underserved populations, experts said in a recent Bloomberg piece. The article quotes a recent letter from BPI and other trades noting that CBDC’s displacement of bank deposits would drive up the cost and curtail the availability of credit for households and businesses, undermining the goal of financial inclusion.
- Celsius deposits frozen: Celsius Network founder Alex Mashinsky’s firm is facing a crisis. The high-yield crypto lender has frozen as much as $8 billion in deposits as it halted its hundreds of thousands of users from withdrawing their funds, according to The Washington Post.
- Miners’ loans under pressure: Bitcoin’s prolonged slump in value is putting pressure on miners’ ability to repay up to $4 billion in equipment-backed loans, according to Bloomberg. The stress poses a potential risk to major crypto lenders.
- Crypto bill outreach: The co-sponsors of new crypto legislation, Sens. Kirsten Gillibrand (D-NY) and Cynthia Lummis (R-WY), are using fresh tactics to solicit public feedback. The senators posted the bill on GitHub, a software development collaboration platform, to seek comments from users.
CFPB Revisits Credit Card Late Fees Under CARD Act
The CFPB this week issued a proposal to assess whether credit card late fees are “reasonable and proportional” under the Credit Card Accountability, Responsibility and Disclosure (CARD) Act. The advance notice of proposed rulemaking also seeks information on card issuers’ revenue and expenses, the potential deterrent effect of late fees and the role of late fees in credit card companies’ profitability, according to the Bureau.
The Failed Postal Banking Experiment
Postal banking costs more than private-sector check cashers, according to a chart tweeted recently by the Cato Institute. The statistic provides useful context for the failed postal banking pilot program, which attracted only six users.
Grisi Tapped as Next Santander CEO
Héctor Blas Grisi Checa was nominated as new Santander group CEO effective Jan. 1, 2023, according to a recent announcement. Grisi, the current CEO of Santander Mexico and head of North America, will succeed José Antonio Álvarez.
