BPInsights: March 16, 2024

FDIC Cost Confusion Raises Growing List of Questions

The FDIC’s actions in the wake of the spring 2023 bank failures raise key questions about its handling of bank resolutions, analysis of the costs associated with those resolutions, and how these activities are managed and overseen. Not only did the FDIC revise its estimated cost of the special assessment on large banks up to 25% higher, it also may have increased the costs of resolving the failed banks by borrowing from the Fed, according to an ABA analysis. Unfortunately, the details of its decision-making are not clear – there has been a marked lack of transparency around what happened during SVB resolution weekend and beyond. Lack of accountability is particularly concerning given staffing and management issues cited in recent FDIC Inspector General reports.

  • ‘Very significant mistake’: Karen Shaw Petrou, founder of Federal Financial Analytics, said the $4 billion difference in the special assessment cost estimate is a “very significant mistake” that calls into question the FDIC’s credibility in gauging the cost of bank resolutions.
  • Congressional scrutiny: A recent letter from Sen. Bill Hagerty (R-TN) questioned FDIC Chair Martin Gruenberg about the sale of a Signature Bank loan portfolio. “Various sources indicate that the bid chosen by the FDIC was not the highest offer submitted,” Hagerty wrote. “If these reports are true, this decision raises serious questions about the FDIC’s auction process and its justification for imposing unnecessary costs on taxpayers.” Hagerty cited reports that Brookfield Property Group submitted a higher bid than Related Fund Management, the winning bidder, and that political endorsement from New York City Mayor Eric Adams could have led to Related Fund Management’s selection. Hagerty posed a series of questions to Gruenberg on the handling of the portfolio.

Five Key Things

1. Bank Trades, Business Groups File Suit Against CFPB Late Fee Rule, Seeking Preliminary Injunction

Two days after the CFPB’s adoption of an $8 cap on late fees, the U.S. Chamber of Commerce, Fort Worth Chamber of Commerce, Longview Chamber of Commerce, Consumer Bankers Association, American Bankers Association and Texas Association of Business filed a lawsuit against the CFPB in the U.S. District Court for the Northern District of Texas. The complaint and a request for a preliminary injunction can be found here.  

The Bank Policy Institute filed an amicus brief in support of the merits and the request for preliminary injunction, which can be found here. The opposition to the motion from the CFPB can be found here.  The Chamber et al’s reply brief can be found here.  On Thursday, the judge originally assigned to the case recused himself, and the case was reassigned. 

2. Fed’s Top Lawyer on Tailoring, Basel Proposal Response

The Federal Reserve is “very focused” on heightened litigation risk, according to a Q&A this week with the Fed’s general counsel, Mark Van Der Weide. He also weighed in on the Fed’s legal culture. “The Fed’s had a pretty conservative legal culture, I would say, for its entire existence,” he said. “We’re going to keep that conservative legal culture, and make sure that all the rules that we do comply with the statutory authority that we’ve got — and comply with all the different requirements of the [Administrative Procedure Act].”

  • Tailoring: Van Der Weide expressed support for tailoring regulations to banks’ size and risk profile. ““It’s a requirement of law … but it’s also good government, I think,” he said. “Putting tougher requirements on the larger firms makes a ton of macroprudential sense. And providing regulatory relief, to some extent, for the smaller firms also makes a ton of regulatory sense. It’s a more efficient way to run a regulatory railroad.” This will be a key aspect that regulators contemplate as they finalize capital and long-term debt rules, he said.
  • Unique response: Van Der Weide also emphasized the rare deluge of feedback on the Basel capital proposal, which has included “tons of negative comments” alongside “a few positive comments, but not very many.” “I’ve been a regulator for 26 years, and the response to the universe of the proposal has been unique, shall we say,” Van Der Weide said.

3. Bank Capital Requirements Are Top Issue Facing Global Derivatives Market

Bank capital requirements and their impact on derivatives trading and clearing are a top concern for the derivatives market, according to a new report by Coalition Greenwich. Half of respondents in the report’s survey identified bank capital requirements as an important issue facing the global derivatives market this year. This was the top issue identified on the list of concerns, followed by “the regulatory agenda in the EU and U.S.” identified by 43% of participants. Other concerns included geopolitical conflicts, operational failures and cyber risks.

  • Exacerbating the challenge: “In the United States, the Federal Reserve and other banking regulators have proposed new rules that could make it far more expensive for banks to clear derivatives for their clients,” the report said. “The industry is already concerned about constraints on clearing capacity. The banks that would be affected by these proposals are among the largest providers of clearing services, raising concerns that an already difficult situation could get worse.”
  • End users concerned: “Our research reveals that the banks are not the only market participants concerned,” the report said. “Fifty-eight percent of end users also flagged the issue, showing a roughly equal level of concern. Those participants are aware that the consequences will be passed through to them, and many worry that some clearing providers may simply exit the business.”

4. International Climate Disclosure Framework Should Be Reproposed

Global bank regulators’ proposed climate disclosure requirements could mislead investors rather than providing them clarity on climate-related financial risks, BPI said in a comment letter on the Basel Committee on Banking Supervision’s Consultative Document seeking input on a proposed Pillar 3 disclosure framework for climate risks. BPI warned that the framework suggested in this document could lead to disclosure of a swath of unreliable, nonmaterial climate data that does not reflect a bank’s risk exposures or capital adequacy. Ultimately, such disclosures would undermine rather than promote market discipline. The disclosure framework could also expose banks to heightened legal and reputational risks, the letter said.

  • Inconsistent approach: The proposed disclosure framework diverges from the way the Basel Committee has previously addressed effective oversight of climate-related financial risks and won’t provide meaningful information to investors.

The solution: The BCBS should revise the proposed requirements and re-propose a Pillar 3 climate disclosure framework that more closely aligns with the objective of informing investors with meaningful information. BPI recommends that policymakers keep these principles in mind when re-proposing the framework:

  • It should be consistent with the BCBS Principles on Effective Management and Supervision of Climate-related Financial Risk, which appropriately recognize climate-related financial risks as drivers of traditional risk types rather than a standalone risk type.
  • Any qualitative or quantitative disclosure in any re-proposed Pillar 3 climate disclosure framework must be a meaningful indicator of a bank’s risk exposures and capital adequacy and reflect that climate-related financial risks are drivers of traditional risk types.
  • All re-proposed Pillar 3 climate disclosure requirements should be subject to jurisdictional discretion, considering differences in jurisdictional regulators’ respective mandates.
  • All re-proposed Pillar 3 climate disclosure requirements should be subject to a materiality threshold consistent with the objectives of Pillar 3 disclosures.
  • Any re-proposed Pillar 3 climate disclosure framework must be based on a realistic understanding of the significant limitations on data availability and quality, methodologies and modeling capabilities. 
  • Any re-proposed Pillar 3 climate disclosure framework should incorporate a sufficient level of flexibility and avoid overly prescriptive requirements.
  • The BCBS should only finalize a Pillar 3 climate disclosure framework if the benefits of the framework clearly outweigh the costs.

5. Hsu Floats New Operational Resilience Rules

Acting Comptroller Michael Hsu suggested this week that regulators may consider new rules to bolster banks’ “operational resilience,” or the ability to weather significant disruptions like cyberattacks or system outages. Such new requirements would build on the banking agencies’ existing framework governing cybersecurity and third-party risk management, Hsu said. “Domestically, the federal banking agencies are considering what changes to our operational resilience framework might be appropriate,” he said. “Such baseline requirements could include establishing clear definitions for identifying critical activities and core business lines; defining tolerances for disruption; requiring testing and validation of resilience capabilities; incorporating third-party risk management expectations; stipulating clear communication expectations among stakeholders and counterparties; and addressing expectations for critical service providers, with emphasis on governance and risk management expectations.”

  • Not a capital solution: Operational resilience is “not a problem that capital or liquidity can solve,” Hsu said. This remark is interesting given the outsize role of operational risk – the risk posed by threats such as cyberattacks or outages – in the banking agencies’ Basel capital proposal. The operational risk charge would impose a tax on basically all banking products and services.

In Case You Missed It

Michael Wong Joins BPI Government Affairs Team

Senate staffer Michael Wong will join the Bank Policy Institute as a Senior Vice President of Government Affairs. Michael brings over 10 years of legislative experience, most recently as Senior Advisor, Policy & Strategy to Sen. Kyrsten Sinema (I-AZ). He will start the position on April 8.

“We are excited for Michael to join the BPI team,” said BPI Executive Vice President and Head of Public Affairs Kate Childress. “He is a trusted staffer who will bring his Senate experience to bear on behalf of our members.”

How to Fix What Ails the Fed’s Discount Window

At a recent Brookings Institution event, Susan McLaughlin, a 30-year veteran of the Federal Reserve Bank of New York, offered ways to fix problems with the Fed’s discount window. Here are some key takeaways.

  • The problems: There are two significant problems with the discount window – clunky operations, and stigma surrounding borrowing from it. Federal Reserve Chair Jerome Powell acknowledged these issues in a recent Congressional hearing. “If banks are ready, but not willing to use the window, then the discount window can’t do its job in mitigating systemic risk,” McLaughlin said. “And importantly, stigma actually undermines the cause of bank readiness. So if I’m a bank and I know my management doesn’t really want me to use this, or I’m going to get criticized by my supervisors if I use it, I won’t want to use it, and I’m probably not going to be preparing to use it.”
  • Contradiction: There is a disconnect between Fed officials’ encouragement of banks to use the window and the way discount window borrowing capacity is treated in supervision of banks’ liquidity risk management, McLaughlin said. Internal liquidity stress tests, resolution funding plan requirements and requirements for banks to hold high-quality liquid assets to cover sudden deposit outflows don’t allow banks to include discount window borrowing capacity as a source of contingent liquidity. Liquidity regulations and central bank lending tools should work together in the same direction.
  • Easier pledging: The Fed should improve its infrastructure and discount window operations to enable banks to pledge collateral and borrow more easily.
  • Other recommended improvements: McLaughlin also suggested other ways for the Fed to improve the discount window, including administering secondary credit separately to avoid “muddying of the waters” between weak and healthy banks borrowing from the discount window.

GAO Calls for Clarity on Federal Anti-Money Laundering Efforts

A Government Accountability Office report recommended that FinCEN provide more detail on its progress in implementing federal anti-money laundering reforms and improve the reliability of its law enforcement surveys. The GAO also suggested that the Department of Justice coordinate with other agencies to produce government-wide data on illicit finance investigation outcomes. “More complete disclosure of FinCEN’s progress implementing the act would provide greater transparency and accountability,” the report said. The report also flagged potential issues with FinCEN’s law enforcement surveys that could yield unreliable information.

  • Broader context: The Anti-Money Laundering Act aims to combat illicit finance more effectively through improved coordination across government, law enforcement and the business community. Key products of this legislative reform include a database of beneficial ownership information for U.S. businesses. But the implementation process has been time-consuming, and banks – eager to work closely with their partners to combat financial crime – are still confronting a fragmented AML system.
  • Court case: The Corporate Transparency Act, a central part of the AML overhaul, has been blocked by a federal court ruling on constitutional grounds. The Treasury Department is appealing the ruling.

FDX Offers Security, Empowers Consumers in CFPB Financial Data Rule

CFPB Director Rohit Chopra previewed the Bureau’s Section 1033 rule in an address delivered this week at the Financial Data Exchange Global Summit. His remarks emphasized the potential future role of standard-setting bodies like FDX in making it safer for aggregators and other third parties to access consumer financial data. Paige Pidano Paridon, BPI senior vice president and senior associate general counsel, issued the following response:

“We encourage the CFPB to recognize the Financial Data Exchange as an authorized standard-setting body in its forthcoming rules governing the handling of consumer financial data. FDX makes the financial system safer by transitioning the industry away from risky screen scraping, and toward a secure API developed from the contributions of over 200 bank and nonbank participants of all sizes. These industry best practices enable consumers to continue using the apps and services they value with the peace of mind of knowing that their sensitive financial data is safer and more secure.”

To learn more about FDX and how it empowers innovation and safety, click here

The Crypto Ledger

Here’s what’s new in crypto.

  • Currency crisis: “Crypto gets blamed for a real-life currency crisis,” according to the Wall Street Journal this week. Authorities in Nigeria detained two senior Binance employees after blaming the crypto exchange for crashing the naira.
  • Terrorist use of crypto: The U.S. government is probing terrorist group Hamas’ use of cryptocurrency before the Oct. 7, 2023 attack on Israel. The Treasury Department is investigating $165 million in crypto-linked transactions that may have helped finance the group.
  • Still a mystery: The inventor of bitcoin, known by the pseudonym Satoshi Nakamoto, remains a mystery – in a case about who invented Bitcoin, a London court ruled against Australian computer scientist Craig Wright who has long claimed to be the inventor behind the cryptocurrency.

The ECB Takes a Step Closer to Shrinking

The European Central Bank this week took a step closer to becoming smaller. One goal of the central bank’s change in monetary policy operations – announced this week after more than a year of anticipation – is to spur more short-term lending among banks and other financial institutions. This return to a more robust interbank market would restore normalcy to a market that largely dried up after the Global Financial Crisis. “As it stepped in to restore trust and stability during recent crises, the ECB became a huge presence in the economy, warping how financial institutions behave,” the Wall Street Journal reports. “The new changes aim to tame this gravitational pull.”

  • How it works: The ECB will continue to steer borrowing costs through the deposit rate, but will shift its focus toward its regular money auctions, where banks bid for cash at a fixed rate. The revised framework aims to motivate banks to look beyond the ECB for borrowing opportunities. The central bank will still maintain a sizable bond portfolio, but will not loom quite as large as it recently has in the market.
  • Meanwhile, at the Fed: This change raises the question of how the Fed will proceed with similar plans to engage in quantitative tightening, or the shrinking of its balance sheet, which has ballooned in the years post-crisis. BPI Chief Economist Bill Nelson recently published a working paper on how the Fed got so huge, and why and how it can shrink. The time is ripe for the Fed to consider shifting away from its ample reserves – or “excessive” reserves – system, the paper suggests. It offers ways that the Fed could shrink while maintaining liquidity in the banking system, with a key role to play for the central bank’s discount window.

Goldman Sachs, BNY Mellon and Other Firms Test Blockchain Network

Goldman Sachs, BNY Mellon, Cboe Global Markets and other partners completed a round of pilot tests on the Canton blockchain network, which aims to link different banks and financial institutions. The tests mark one of the largest-scale blockchain experiments in capital markets. The ultimate goal of the exercise is to explore potential benefits like reducing counterparty and settlement risks.

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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.