BPInsights: June 5, 2021

Stories Driving the Week

Quarles Sits Down With BPI’s Greg Baer

In a speech and Q&A with BPI CEO Greg Baer at this week’s BPI/SIFMA Prudential Regulation Conference, Federal Reserve Vice Chair for Supervision Randal Quarles discussed the balancing act of making banking rules both efficient and safe, a process he compared to the historical evolution of airplanes from early crash-prone craft to the pinnacle of safe, quick travel. Quarles named several examples of policies he sees as balancing efficiency with safety, such as the tailoring framework; the decision to group foreign banks in the U.S. into their own supervisory tranche to compare them with each other; and Volcker Rule changes that allow banks to investment in entrepreneurship and underserved rural businesses. He also defended the decision not to turn on the countercyclical capital buffer in the U.S. “There were many calls from outside the Fed for us to activate the CCyB in the years before the COVID event,” Quarles said in his speech. “It is clear now that those calls were mistaken.”

In the Q&A portion, Quarles said the ad hoc restrictions to banks’ capital distributions last year were “clearly not costless.” He said the cost of capital for the European banking system, where restrictions were more stringent, was elevated because of their distribution curbs. That higher cost of capital made financing more expensive for European businesses, he said. He noted that last year should fuel confidence in the stress capital buffer, a recently finalized framework that governs bank capital levels in stressful conditions by tying capital requirements for each bank closely to its stress test results. Under that framework, banks in distressed condition would face stricter shareholder payout limits than the “belt and suspenders” restrictions applied ad-hoc last year, he said. 

Quarles also said the countercyclical capital buffer is “not a panacea,” and it wasn’t obvious last year that turning the buffer down, in countries where it had been activated, would spur much more lending. He said the U.S. banking system effectively already has an extra capital cushion turned on because of how high the fixed capital requirements are. He also noted the growth of the nonbank financial system and how its fragmented nature affects its impact on financial stability.

Second Circuit Hands OCC a Procedural Victory in FinTech Charter Litigation, But Merits Yet to Be Decided

A Second Circuit court decision this week in Lacewell v. Office of the Comptroller of the Currency eliminated one barrier for the OCC to issue special-purpose national bank charters to FinTech firms, but the ultimate fate of FinTech charters may hinge on new Acting Comptroller Michael Hsu’s view of these charters, which he plans to consider as part of his broader evaluation of recent OCC actions. The ruling reversed the lower court’s decision to bar the OCC from issuing special charters to FinTech firms that engage in lending, payments or both, but don’t take deposits. The Second Circuit decision did not address the district court assertion that the “business of banking” under the National Bank Act requires the receipt of deposits. The decision could undermine the Conference of State Bank Supervisors’ standing in its legal challenge to the SPNB and the Figure application in the U.S. District Court in the District of Columbia. Figure plans to accept deposits without deposit insurance.

BPI’s Bill Nelson, Pat Parkinson Discuss Treasury Markets at BPI/SIFMA Conference

At this week’s BPI/SIFMA Prudential Regulation Conference, BPI Chief Economist Bill Nelson and Senior Fellow Pat Parkinson participated in a panel discussion on the Treasury market along with Stanford University’s Darrell Duffie, Goldman Sachs’ Beth Hammack and JPMorgan’s Thomas Pluta. Parkinson discussed his recent Brookings Institution paper coauthored with Nellie Liang that offers potential fixes for some of the structural issues that surfaced in the March 2020 Treasury-market meltdown. The proposals focus on increasing the supply of liquidity in the Treasury market, which has not kept pace with the rapid growth of outstanding marketable debt, in part because leverage requirements have discouraged banks from allocating capital to intermediating the Treasury and Treasury repo markets.

The conference also featured a Q&A with Sen. Bob Menendez (D-NJ), remarks from BPI General Counsel John Court and a panel on stress testing with BPI Head of Research Francisco Covas. The stress testing panel included a discussion on lessons learned during the COVID event and expectations on how the stress capital buffer framework is expected to drive banks’ capital planning going forward. Panelists generally agreed with the need to increase the number of scenarios in the stress tests and find ways to reduce SCB volatility. It was also suggested that it was time for the Federal Reserve to update its pre-provision net revenue models that are being used to project revenues associated with capital market activities in the stress tests.

Fed Seeks Feedback on Fund Transfer Rules for Faster Fed Payments Rails

The Federal Reserve is seeking public input on a proposed rule to govern funds transfers over its upcoming FedNow service, set to be launched sometime in 2023, the central bank announced this week. Many parts of the proposal are similar to provisions that govern the existing Fedwire service, the Fed said. FedNow will be a 24-hour, seven-days-a-week service that supports real-time payments in the U.S.

Another Leak of Confidential Supervisory Information

The Federal Reserve warned Deutsche Bank recently that it is failing to address persistent problems in its AML controls, and the bank could face fines, according to The Wall Street Journal. The article marks the latest instance of a leak of confidential supervisory information that is meant to be kept private between banks and their examiners.

BoE’s Bailey: Need for Climate Capital Requirements ‘Yet to Be Clearly Established’

Climate risk as part of the bank capital framework should hinge on solid data and avoid unintended consequences, Bank of England Governor Andrew Bailey said this week. “Any incorporation of climate change into regulatory capital requirements would need to be grounded in robust data and be designed to support safety and soundness while avoiding unintended consequences,” Bailey said in a speech, according to Reuters. “In my view, the case for this has yet to be clearly established and possibly may never be.” He added later in a Q&A that he is “against setting either capital requirements or capital incentives … for reasons that are not directly linked to our objectives.” BPI published a recent blog post arguing that climate capital requirements would make the low-carbon transition more costly rather than supporting it.

Separately, OCC Acting Comptroller Michael Hsu said in a Reuters interview this week that it would be hard to avoid incorporating climate risk into capital requirements at some point. “It would be hard for it not to be, because exposure is exposure and you have to risk manage and capitalize for that,” Hsu said, adding that regulators still have more research to do before factoring in climate risks to capital rules.

In Case You Missed It

White House Memo to Businesses Underlines Ransomware Focus  

The White House this week issued a memorandum to corporate executives and business leaders outlining steps firms can take to better protect themselves from ransomware. The Memorandum urges businesses to: implement best practices outlined in the President’s Executive Order on Improving the Nation’s Cybersecurity; back up data, test backups and keep backups offline; update and patch systems promptly; test the incident response plan; check the security team’s work; and segment networks. The memo solidifies the U.S. government’s priority of strengthening the nation’s resilience from cyberattacks and underscores the private sector’s critical responsibility to protect against ransomware threats.
Ransomware attacks continue to be pervasive across financial services and other critical industries, increasing the potential impact on firms and customers, and creating the need for additional focus on this area. Considerations for managers may include the effects of ransomware on clients, the decision whether or not to pay a ransom and how the move of customer data to cloud providers may shift responsibility and liability during a ransomware attack. BPI has published a Ransomware Resource Guide and recently published a blog detailing top facts to know about ransomware and cryptocurrency. 

BPI Blog: Counterproductive Countercyclical Capital Buffer

Federal Reserve Governor Lael Brainard recently pointed to the countercyclical capital buffer (CCyB), an adjustable capital requirement surcharge imposed on large banks on top of existing capital requirements, as an important tool to address financial stability risks and enable monetary policy to focus on its core goals. Looking at the health of American banks, it’s hard to conclude their capital requirements aren’t high enough – they are liquid, well-capitalized and overall robust – but other monetary-policy dynamics may be at play in the prospect of raising the CCyB, a new BPI blog by Chief Economist Bill Nelson explains.
FOMC participants calling for tighter monetary policy are likely arguing that low interest rates are supporting asset price bubbles, whereas those who favor the status quo may be promoting the CCyB as a tool to address bubbles, rather than tapering asset purchases and raising interest rates. But, as the Fed’s financial stability report observes, it’s not clear whether low interest rates actually cause bubbles or, if they do, that banks are exposed to the fallout from the bubbles popping. If low interest rates don’t contribute to financial risks, or if banks are not exposed to those risks, then requiring banks to fund themselves to an even greater extent with capital would be a drag on economic growth without a net benefit. Therefore, if the Fed raises the CCyB to keep its monetary policy easy, that action would undercut the growth that the easy monetary policy aims to support.

FT: LIBOR’s US Replacements: No One Rate to Rule Them All 

Several different benchmarks are vying to replace LIBOR as a key reference rate in the U.S., according to an in-depth review of the issue in the Financial Times.  The article notes that while in the UK a relatively simple transition from LIBOR to SONIA is occurring, a very different banking system in the U.S. is generating a need for credit-sensitive rates, and market participants are producing them.  In particular, most U.S. banks do not rely heavily on Treasuries for short-term funding, and SOFR is not universally representative of their funding costs; Ameribor, BSBY, and ICE’s BYE are sensitive to credit risk, though based on shallower markets than SOFR.  Market competition in reference rates is likely to mean that even after LIBOR ceases, competition among alternative rates will continue at least for some time and perhaps indefinitely, the FT’s Claire Jones writes, though market participants do not view this competition as a problem.

OCC’s Hsu Not Reviewing ‘Valid-When-Made’ Rule

Acting Comptroller Michael Hsu said the OCC is not including the “valid-when-made” rule in its ongoing review of agency rules, according to American Banker. The rule allows for broader, more efficient access to credit by affirming that an interest rate on a loan that is valid when the loan is initially made will continue to be valid if sold to another lender. That longstanding principle keeps the secondary market, where loans are sold and packaged, humming, and keeps credit flowing. BPI recently filed an amici brief in support of the FDIC’s affirmation of the rule.

Fed to Unwind Corporate Debt Facility

The Federal Reserve will begin to sell off a portfolio of corporate bonds that it amassed in the pandemic as businesses struggled to access financing, according to an announcement. The facility marked an unconventional central bank intervention in the capital markets as the Fed essentially became a buyer of last resort for corporate debt, some of it less than investment-grade.

American Banker: Michael Hsu Q&A

Acting Comptroller Michael Hsu said in an American Banker Q&A this week that the interim nature of his position will leave less pressing decisions to his Senate-confirmed successor. This view shows stark contrast to his predecessor, Acting Comptroller Brian Brooks, who took an aggressive approach to changing policy, even in an acting role. In the interview, Hsu also said he’s reviewing the prospect of FinTech charters in a broader context to “ensure that the holistic view is consistent with the micro decisions on the charters,” and that revisiting Brooks’ fair access rule is “just not a priority.”

FSB Releases LIBOR Roadmap 

The Financial Stability Board urged financial firms in a statement this week to stop using LIBOR in accordance with the timelines set by home authorities in the latest regulatory warning underscoring the need to transition away from the rate. The statement expressed support for U.S. banking supervisors’ recent guidance that banks should stop entering into new LIBOR contracts by the end of 2021 and that any new LIBOR-based contracts after that date could pose a safety and soundness risk. The FSB’s “roadmap” released this week includes prudent steps to be taken for the LIBOR transition to mitigate the risks inherent in LIBOR cessation. The LIBOR reference rate, a widespread cog in the financial plumbing of the global market, is set to be phased out by mid-2023. The FSB also released a paper on overnight risk-free rates and term rates, emphasizing that transition away from LIBOR should not wait for the development of term rates.

Quarles May Stay on as Fed Governor After VC Term Expires

Federal Reserve Vice Chair for Supervision Randal Quarles suggested at an event this week that he may stay on as a Fed governor even after the term for his current Vice Chair for Supervision post expires, according to a POLITICO Q&A as reported by The Hill. He also indicated he would serve his full FSB chairman term through December.  Quarles said he hadn’t yet decided how long to stay after his current term expires in October, but referred to “close familial precedent” for staying on at the central bank after a chair or vice chair term lapses, an apparent reference to his wife’s great-uncle, Marriner Eccles, a Federal Reserve Board chair who stayed on as a governor after his chairmanship expired.

JPMorgan Opening Hundreds of New Branches

JPMorgan Chase is halfway through a push to open 400 new branches across the U.S., approaching the milestone of being the first U.S. bank with a brick-and-mortar presence in every continental state, according to Reuters. The campaign to open hundreds of branches in new markets began in 2018.

Huntington Launches ‘Standby Cash’ Emergency Credit Product

Huntington Bancshares this week unveiled a new “Standby Cash” product that provides an emergency line of credit for unexpected expenses. The feature, part of Huntington’s “Fair Play Banking” initiative and aimed at expanding access for underserved customers, offers access to up to $1,000 with no interest or fees if customers use automatic payments or a 1 percent monthly interest charge otherwise. The product is centered on how customers use their checking account, not on credit scores: Consumers can qualify based on consistent monthly deposits of $750 or more for three or more months and maintaining a positive checking balance, among other factors such as overdraft history.

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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.