Stories Driving the Week
Five Things to Know from Powell and Yellen’s Hill Testimony
Federal Reserve Chair Jay Powell and Treasury Secretary Janet Yellen testified before the House Financial Services Committee and Senate Banking Committee this week on oversight of the CARES Act, a central pandemic-rescue law. Here are five top takeaways from their testimony.
- Buybacks: The day before the Federal Reserve announced that it would lift its additional capital distribution restrictions on most firms after June 30, Yellen said in response to a question about whether buying back stock would help the economic recovery: “I had been opposed earlier when we were very concerned about the situation that banks would face about stock buybacks, but the financial institutions look healthier now, and I believe they should have some ability to, provided by the rules, to … make returns to shareholders.” The Fed had eased restrictions on bank capital distributions after strong December stress test performance, but left some limits in place.
- Asset managers and systemic risk: Yellen indicated the Financial Stability Oversight Council, a panel of regulators headed by the Treasury Secretary, will opt to target certain risky activities such as mass asset selloffs rather than branding firms systemically important as it weighs the risks of large asset managers like BlackRock. House Financial Services Committee Chairwoman Maxine Waters (D-CA) recently suggested that Citadel Securities, the large market maker under scrutiny amid the GameStop stock frenzy, could also pose a systemic risk. FSOC will discuss hedge fund and mutual fund activities, a source of chaos during last year’s Treasury market turmoil, during its March 31 meeting.
- Prudential regulation: Powell said the central bank will invite public comment on potential changes to the supplementary leverage ratio “relatively soon.” The Fed announced last week that exclusions of Treasuries and bank reserves from the SLR — a measure of capital compared to total on-balance-sheet and off-balance-sheet assets that treats all assets the same regardless of risk level – will expire at the end of March. As the government supports the economy by issuing debt and the Fed buys lots of it, Treasuries and reserves flood the banking system – a situation he said the Fed wants to address with potential changes.
“[B]ecause of the substantial increase in reserves and Treasuries, the leverage ratio is rapidly becoming the binding constraint from a capital standpoint and that wasn’t our intention at the Fed from the beginning,” Powell said. “We like risk-based capital to be binding because it forces banks to manage their risks more carefully.” BPI recently wrote a blog encouraging the Federal Reserve to recalibrate leverage ratios as a backstop in light of the projected levels of reserves and Treasuries relative to levels when the Fed adopted the requirements in 2014.
Powell also affirmed that tailoring capital and liquidity regulation to a bank’s business model and systemic footprint is an appropriate approach and that there has not been any demonstrated negative impact to the U.S. economy because of tailoring. The tailoring framework which was implemented by rule in 2019 is the product of a 2018 bipartisan bill that refines the enhanced prudential standards for the largest banks holistically based on a number of risk-based thresholds that measure systemic risk, in addition to size.
- LIBOR: Yellen called for federal legislation to smooth the transition away from the London Interbank Offered Rate for contracts that mature after it ends but lack clear language about what should replace it. Powell had expressed support for a legislative solution in congressional testimony last month.
- Climate: Powell reiterated that the central bank is in “early stages” of examining climate-related risks to the financial system and said it can only weigh climate-related risk within the bounds of the Fed’s mandates. Yellen has recently suggested that the Treasury Department may be able to facilitate climate scenario analysis.
Fed Will Lift Pandemic-Related Capital Distribution Restrictions for Banks That Pass June Stress Test
In the third quarter, the Federal Reserve will remove the additional restrictions on bank dividends and share buybacks for banks that pass the June stress test, bringing an end to the pandemic-related restrictions on bank capital distributions, the central bank announced March 25. The additional restrictions, which were announced in connection with last year’s June stress test results, will continue to apply during the second quarter. All Federal Reserve Governors supported the decision to lift the restrictions on capital distributions. Federal Reserve Vice Chair for Supervision Quarles stated that the banking system continues to be a source of strength when the decision was announced.
If a bank remains above all its minimum risk-based capital requirements in this year’s stress test, the restrictions will end after June 30. The restrictions will also end for banks subject to a two-year stress testing cycle with SCB requirements based on the June 2020 stress test effective after June 30.
However, banks subject to the Federal Reserve’s stress test would still be bound by the existing capital regime. Specifically, banks will remain subject to the normal restrictions of the stress capital buffer, which places increasingly strict limits on capital distributions for firms inside the buffer set by a conservative stress test. A bank with capital below its minimum risk-based requirements based on this year’s stress test will remain subject to the additional restrictions for another three months until Oct. 1. The Federal Reserve also noted that if a firm remains below the capital required at that time, the framework of the SCB regime will impose even stricter distribution limitations than the current restrictions.
The move brings all banks closer to being governed by the stress capital buffer, a conservative framework finalized just last year that sets a new buffer for each bank based on stress test losses, and requires banks to pre-fund four quarters of dividends. The stress scenarios are quite stringent in the June 2021 stress tests, and the degree of severity is in line with last year’s June stress scenarios.
The Fed’s action came the day after Treasury Secretary Yellen responded to a question during Senate Banking Committee testimony about the impact of stock buybacks on the economic recovery saying that she “believe[s] they should have some ability to, provided by the rules … make returns to shareholders.”
BPI President and CEO Greg Baer emphasized in a May 2020 Financial Times op-ed that bank dividend bans are bad policy. BPI also published a Stock Buyback ABCs guide explaining how banks decide to distribute capital to their shareholders.
Last week, BPI published a blog, “The Importance of Moving to the Stress Capital Buffer,” which concluded: “The longer the SCB is kept on hold, the more its credibility is undermined, and the more cautious banks are likely to be in meeting credit demands when the economy rebounds. In the SCB, the Federal Reserve has created a highly effective framework for limiting capital distributions to the extent necessary to ensure that banks can continue to function effectively, even under severe stress. It needs to demonstrate its confidence in the efficacy of its creation.”
Senate Passes PPP Extension
The Senate on March 25 passed legislation to extend the Paycheck Protection Program two months until May 31. The measure now heads to the White House for presidential approval.
BPI supports Congress’s extension of the PPP application deadline and the additional timing to allow lenders and the SBA to process those applications, BPI said in a statement upon Senate passage. Borrowers in urgent need of funds should not be denied access to this program due to administrative and technical challenges that have slowed the SBA’s loan processing efforts. Banks are committed to helping ensure these funds reach America’s small businesses and their employees as they continue to weather the negative economic effects of the pandemic.
Climate Change, Hedge Funds and Mutual Funds Featured on Next Week’s FSOC Meeting Agenda
Financial regulators will discuss climate-related impacts on financial stability and hedge fund and mutual fund performance during the pandemic at a Financial Stability Oversight Council meeting next week, according to a Treasury Department announcement. The panel, created by Dodd-Frank, convenes financial regulatory officials led by the Treasury Secretary to oversee risks to the financial system. The agenda comes as financial regulators focus new attention on climate issues and weigh liquidity problems at mutual funds and hedge funds during last year’s Treasury market turmoil.
LIBOR Will Soon Be Gone for Good, Fed’s Quarles Stresses
Banks should wean off the London Interbank Offered Rate, avoid entering new contracts based on it no later than year-end and have clear plans in place ahead of its departure from global markets, Federal Reserve Vice Chair for Supervision Randal Quarles said in a speech this week that emphasized the certain end for USD LIBOR in mid-2023. LIBOR, soon to be replaced in the U.S. by the Secured Overnight Financing Rate, underpins trillions of contracts in the world economy. He also called for legislation providing a backup plan for the roughly $90 trillion in LIBOR-based contracts without clear fallback language that won’t mature until after the rate ends, a sentiment echoed by Federal Reserve Chair Jay Powell and Treasury Secretary Janet Yellen in recent congressional testimony. New York state lawmakers this week passed legislation to smooth the turnover for those contracts governed by New York law. Congress may begin to consider legislation similar to the New York passed bill in the months ahead.
Brainard Announces New Fed Panel on Climate, Financial Stability
The Fed is launching a new committee, the Financial Stability Climate Committee, to analyze climate-related risks to the financial system, Federal Reserve Gov. Lael Brainard announced in a speech this week. The new panel’s macroprudential approach will look at big-picture risks to the financial system as a whole. It will complement the central bank’s recently formed Supervision Climate Committee, which weighs climate-related risk with a focus on individual firms, Brainard said. She added that scenario analysis, a modeling tool that aims to predict responses to stress in various hypothetical situations, could prove useful at the Fed for analyzing climate risk.
BPI has written about the challenges of predicting an uncertain future amid climate change. Those challenges, such as unreliable data and long time horizons, make stress testing an ineffective method of addressing climate-related risks in the banking system. BPI CEO Greg Baer laid out those limitations in a November op-ed. It’s also important that carbon-emitting businesses get financing to enable them to transition to greener business models, rather than being deprived of funding, BPI’s Lauren Anderson wrote in a recent op-ed.
In Case You Missed It
Adeyemo Confirmed as Treasury No. 2 Official
Adewale “Wally” Adeyemo was confirmed as Deputy Treasury Secretary by the Senate this week in a bipartisan vote, according to a Treasury Department announcement. Adeyemo is expected to take a close look at sanctions policy, among other duties in the top role. “Wally is everything the Treasury Department needs right now: He has spent his career working at the intersection of America’s national security interests and our economic ones,” Treasury Secretary Yellen said in a statement following his confirmation. Adeyemo is the first Black official to hold the position.
Powell Says Digital Dollar Would Need Congress’ Backing
Fed Chair Jay Powell said a U.S. central bank digital currency would require legislation to move forward, according to The Wall Street Journal. The U.S. is still in early stages of exploring the option of a digital dollar, an initiative that would also require support from the public and the White House, he said at a Bank for International Settlements event this week. Powell also said in congressional testimony later in the week that the central bank must balance privacy with transparency: an anonymous digital dollar system wouldn’t work, but the lack of privacy in the Chinese e-yuan is “just not something we could do here.”
How to Regulate Big Tech? The BIS Has Some Ideas
As Big Tech grows bigger than the largest banks in terms of market capitalization, global regulators are weighing how to oversee the risks it poses, according to a Global Association of Risk Professionals article this week highlighting views from BPI, the Bank for International Settlements, Congress and international regulators. The article includes BPI’s keepbankingsafe.com website, which reveals the dangers of special charters allowing Big Tech and FinTech firms to emulate banks while avoiding banking supervision. The piece captures a global debate about how to control the pervasive reach of companies that own the digital fabric of daily life for an ever-growing cache of consumers around the world. The answer may entail a multi-pronged international approach that blends financial regulation, antitrust, traditional telecom oversight and the concept of systemic risk, according to the article.
Summary of a Recent BPI Symposium on Financial Market Developments
On Monday, March 22, BPI hosted an informal symposium to discuss financial market developments with market participants, academics and former Fed officials, summarized in a new BPI blog. Half of the discussion was devoted to money market developments, specifically how the money markets were likely to absorb the massive ongoing increase in reserve balances, especially with the temporary exclusions of reserve balances and Treasury securities from the calculation of the supplementary leverage ratio expiring at the end of March. The other half was devoted to a discussion of longer-term interest rates, the outlook for inflation and Fed communications.
BPI, ABA, ICBA Urge OCC to Withdraw Bank Premises Proposal Amid Uncertain Post-Pandemic Office Reality
BPI, the American Bankers Association and the Independent Community Bankers of America sent a joint comment letter calling on the OCC to withdraw its Notice of Proposed Rulemaking on National Bank and Federal Savings Association Premises. The proposal would abandon a flexible, principles-based approach to regulating what banks can do with their buildings, land and facilities that has worked well for decades, and instead adopt a bright-line, rules-based approach, the groups said in a joint press release this week. The lack of flexibility in the proposal would diminish the ability of banks to adapt to the post-pandemic transformation of work and business environments as well as other changing circumstances in the future.
“In any case, as they consider changes to space needs and use, banks need flexibility to adapt to an uncertain future,” the groups said in the comment letter. “Implementing the Proposal now would interfere with banks’ ability to adapt to changing premises needs and arrangements in a post-pandemic working environment, detracting from their ability to hire competitively.”
The letter received coverage in American Banker.
FinCEN To Seek Input On Rules Targeting Shell Companies
The Financial Crimes Enforcement Network will soon seek public input on new requirements in the Anti-Money Laundering Act of 2020 targeting shell companies, FinCEN Director Kenneth Blanco said at a Florida International Bankers Association event this week. The new law, the first major overhaul of anti-money laundering rules in decades, takes aim at anonymous shell companies by requiring certain U.S. businesses to register their beneficial owners with FinCEN. BPI strongly supported the legislation that includes this new requirement.
5th Annual Columbia SIPA/BPI Bank Regulation Conference: Lessons from COVID-19
The fifth annual Conference on Bank Regulation of the Bank Policy Institute & Columbia University School of International and Public Affairs took place over the four Fridays in February. Each year, the conference – highlighted in a new BPI blog summary — brings together academics, banking agency economists, and market participants to discuss the latest research on banking and bank regulation. This year’s overarching theme was lessons learned from the COVID-19 crisis for banking and financial markets under stress.
Former Fed Employee Admits Stealing Stress Test Data
Venkatesh Rao, a former Federal Reserve employee, admitted stealing sensitive stress test documents from the central bank after he decided to quit his job, according to the Justice Department. Rao pleaded guilty to theft of government property charges on March 18. After deciding to resign from the Fed following poor performance reviews, Rao printed more than 50 restricted documents at work and took them home in November 2019, according to the DoJ press release. He faces a maximum sentence of one year in federal prison.