BPInsights: March 9, 2024

Powell on Capitol Hill: Basel Will Likely Undergo ‘Broad and Material’ Changes

This week, Federal Reserve Chair Jerome Powell testified before the House Financial Services Committee and Senate Banking Committee at semiannual oversight hearings. The Basel capital proposal was a frequent topic of discussion. Here are some key takeaways.

  • Reproposal on the table: Powell said he expects “broad and material changes” to the Basel proposal and that the final rule will generate “broad support” both within the Fed and “in the broader world.” Powell said that reproposal of the rule is a “very plausible option,” though he noted the Fed has not made a decision yet. He noted that they still need to evaluate the changes they will need to make, but if a reproposal “turns out to be the appropriate thing, we won’t hesitate to do it.” Ahead of the hearing, all the Republican members of the House Financial Services Committee in a letter called for a reproposal of the rule – sentiments echoed in Rep. Andy Barr (R-KY)’s statements at the hearing noting that 97% of the public comments across the ideological spectrum expressed disapproval of the proposal.  In response to that figure, Powell noted that amount of concern on a rulemaking was “unlike anything I’ve seen.”
  • Broad consensus: Powell told Rep. Andy Barr (R-KY) at the hearing that he had not seen a proposal put forth with this much internal dissent before. When Rep. Barr asked him if he’d received consensus yet, Powell said he is confident they will achieve “very broad support on the Board.”
  • Long-term debt: Rep. French Hill (R-MO) asked Powell if the banking agencies would delay their long-term debt proposal if they repropose the Basel proposal. “We haven’t made the first decision yet,” Powell said. “…But that’s a question we’d be asking ourselves … what would be the implication for other rules including the long-term debt [rule].” Hill expressed concerns about the long-term debt measure. Rep. Roger Williams (R-TX) said that the proposal would undo regulatory tailoring.
  • Debit interchange: Rep. Blaine Luetkemeyer (R-MO) emphasized at the hearing that lowering the debit interchange cap under Regulation II would enrich big-box retailers rather than consumers. The Fed is currently considering reducing the cap. Reg II has affected low-cost banking services for lower-income Americans, Luetkemeyer said. He urged Powell to proceed with caution on any “price control” proposal.
  • Executive compensation: Powell fielded questions on potential executive compensation restrictions from Reps. Rashida Tlaib (D-MI) and Nydia Velazquez (D-NY). Tlaib cited Section 956 of the Dodd-Frank Act, which sets the stage for a rule on executive compensation. That section of Dodd-Frank has not been finalized into regulations. Powell indicated that regulators would be moving carefully and deliberately on any executive compensation rule but would not commit to finalizing a rule by the end of the year. He told Rep. Velazquez that he had not seen a proposal on it yet. Incentive compensation was not a key factor in the SVB failure, Powell said.
  • Liquidity: Rep. Ritchie Torres (D-NY) pointed out that the Basel proposal addresses different risks than the liquidity and interest rate risk at the center of SVB’s failure. Powell said: “I agree with that, but I would say that we are working on a package of liquidity measures which directly addresses the Silicon Valley Bank situation. We’ve also taken a lot of supervisory actions with other medium and small sized banks” with real-estate portfolio issues and significant uninsured deposits.
  • Exodus: Intermediation is moving out of the regulated banking system, Powell told Sen. Mark Warner (D-VA), who flagged the rise of nonbank lending in the financial system.
  • Discount window: Sen. Warner noted his legislation to require mandatory use of the discount window. He expressed concern about the stigma associated with borrowing from it. “There’s a lot of work to do on the discount window,” including bringing it into the “modern age” from a technology standpoint and reducing stigma, Powell said.

Five Key Things

1. CFPB Finalizes Rule to Increase Costs for Responsible Consumers that Pay Bills on Time

The Consumer Financial Protection Bureau finalized a regulation this week that will impose arbitrary new limits on the amount that banks can charge for credit card late payments. The final rule reduces the existing limit — the “safe harbor” — to $8 from its current levels of $30 for the first violation and $41 for subsequent violations without justification or adequate data to support the change — data gaps that the CFPB acknowledged but failed to address.

What BPI is saying: BPI President and CEO Greg Baer issued the following statement in response: “This week’s announcement is a prime example of how the CFPB has been politicized, and how its regulatory actions promote rhetoric over analysis and data, and perceived short-term political gain over the long-term benefits of consumers. As the CFPB guts an important risk management tool using junk economic analysis, all consumers who pay on time will now pay more, and low- and moderate-income borrowers who pose greater risk will lose some access to credit. Given the rule’s multiple deficiencies and shortcomings, its fate is likely to be resolved in federal court.”

Five major problems with the rule:

  1. It harms consumers. Lower late fees will likely cause more consumers to pay late, which risks damaging their credit score and shifts higher costs to consumers who pay on time in the form of annual fees and higher APRs.
  2. It isn’t supported by data. The CFPB failed to publish comprehensive data, analysis or the methodology that led to the rule; the data that was provided is deficient.
  3. It violates the law. This deficient analysis violates the law — reasoned analysis and evidentiary support for rule changes are required by the Administrative Procedure Act.
  4. It disregards congressional intent. The rule portrays fees as inherently bad without acknowledging the important role they play in encouraging responsible financial behaviors and enabling banks to offer maximum benefits at the lowest cost — a statutory requirement outlined in the Card Accountability Responsibility and Disclosure (CARD) Act.
  5. It prioritizes politics over policy. The rule carves out small issuers and only applies the revised regulations to institutions with over one million open accounts. If the CFPB genuinely believed these actions were good policy, it wouldn’t introduce a two-tiered price system, enabling the CFPB’s preferred market segment to maintain the status quo.

To learn more, click here.

2. Junk Analysis: How the CFPB Is Misusing Its Own Data to Misleadingly Claim That Large Banks Charge Higher APRs Than Small Ones

The CFPB asserted in a recent analysis that there is a huge gap between the median APR of large credit card issuers and their smaller counterparts. But the CFPB’s findings fail to hold up to more rigorous examination. The CFPB neglects important factors in its analysis.

  1. Going deeper: An analysis that controls for differences due to credit unions, card program type and program credit risk profile finds that only marginal gaps exist between larger and smaller credit card issuers. For the minimum APR across comparable card programs, BPI analysis finds a median of 18.2% for the largest issuers and 17.0% for smaller issuers. This gap is much narrower than found in the CFPB’s analysis and likely reflects more generous credit limits provided by larger banks. The CFPB study likely overstates the degree to which lower-rate cards are available from smaller issuers.
  2. What’s left is a gap between fact and fiction, not between APRs from large credit card issuers and small ones. Read our full analysis here.

3. The Fed’s Stress Scenario for 2024 Violates Its Own Rule and Is Ahistorical

The Federal Reserve imposes a binding capital charge on the nation’s largest banks each year based on its annual stress test.  By the Fed’s own standard, the macroeconomic shock in the stress test should be characteristic of severe post-war recessions.  Almost all the components of this year’s scenario are far more severe than the average for those severe recessions, and in many cases more severe than any of them.

This error could have been corrected through notice and comment, but the Federal Reserve fails to allow any input into its scenario design.

This brief note shows graphically just how out of whack this year’s scenarios are. 

Bottom line: The Board should amend its macroeconomic scenarios to align with the path of post-war U.S. recessions. Conforming to administrative law and the Fed’s own guidance would enhance the credibility of the process and the appropriateness of the resulting capital charge.

4. BPI Statement on Anniversary of SVB Failure

BPI President and CEO Greg Baer released the following statement ahead of the one-year anniversary of Silicon Valley Bank’s failure:

“Sunday will mark one year since the failure of Silicon Valley Bank, and there is still more unknown than known about how the FDIC managed the resolution. The FDIC has provided very little clarity, but all the available evidence suggests FDIC made missteps throughout the winddown of the bank—starting with the initial failed strategy on resolution weekend, followed by a protracted and confusing process to ultimately find a buyer. Then, late last month, the FDIC revealed its losses related to the resolutions of SVB and Signature could be much higher than previously announced – potentially over $4 billion, or 25%, higher. Analysis this week published by the American Bankers Association finds that the FDIC borrowed from the Fed despite having less expensive alternatives, and this may have added up to $2.5 billion to the cost to resolve the spring 2023 bank failures. These costs will be borne by healthy banks that had nothing to do with SVB’s failure. 

There has yet to be any comprehensive, public review of SVB’s resolution, including the decision to invoke the “systemic risk exception,” which allowed the FDIC to bypass the statutory least cost test and impose costs directly on other banks.

So, we are left with many unanswered questions:

  1. Was there a suitable buyer over resolution weekend that could have taken over SVB and avoided exercising the systemic risk exception?
  2. Was the FDIC welcoming to bids from the outset?
  3. How did the FDIC determine a least cost resolution was not possible and what were the assumptions used in that analysis?
  4. Has the FDIC maximized returns and minimized losses in the SVB and Signature receiverships? Why isn’t more information publicly available?
  5. What was the FDIC’s strategy for selling the large volume of mortgage-backed securities it assumed from the failed banks, and how was that strategy executed and by whom; more particularly, did the FDIC engage in unnecessary fire sales that drove down market values and ultimately reduced significantly the value of the assets it held?

It is no surprise the FDIC Inspector General puts staffing challenges and “readiness to execute resolutions and receiverships” at the top of its list of FDIC management concerns. Deposit holders and the American public deserve more accountability from the FDIC. The full story of what the FDIC has been doing, or failing to do, over the past year is long overdue.”

5. President’s Late Fee Rhetoric Prioritizes Politics Over Good Policy

President Joe Biden pointed to efforts to curb consumer fees, such as travel and online ticket seller fees that are often compulsory and undisclosed, in his annual State of the Union address. Credit card late fees were unfairly grouped with these other fees, even though consumers have a choice on whether to pay late and banks are legally required to disclose all credit card fees upfront. The President’s comments on credit card late fees refer to a recently finalized rule by the Consumer Financial Protection Bureau.

BPI President and CEO Greg Baer issued the following statement in response:

The President’s remarks on credit card late fees are political rhetoric masquerading as public policy. Government imposes late fees on all sorts of activities — parking tickets and tax payments to name a few. The Administration’s policy is divorced from data and relies on junk economics to shift the costs from those who pay late to everyone else in the form of annual fees and higher APRs. The justification that the substantial reduction in credit card late fees is good for America rings hollow because the changes only apply to the largest credit card issuers and carve out small issuers for political expediency.

The CFPB rule substantially reduces the limit, referred to as the “safe harbor,” that the largest banks can charge for credit card late fees. Congress recognized that credit card late fees serve an important deterrent purpose in the Card Accountability Responsibility and Disclosure Act of 2009, a major accomplishment of the Obama-Biden Administration pursuant to which the CFPB has issued the new limitation. Furthermore, banks’ legal requirements to disclose fees are governed by the following regulations:

  • TILA/Reg Z (credit card fees)
  • Truth in Savings Act/Reg DD (deposit account fees)
  • EFTA/Reg E (electronic fund transfer fees)
  • TILA/RESPA (mortgage origination and settlement service fees)

To learn more, please visit bpi.com/FactsOnFees.

In Case You Missed It

BPI’s Greg Baer Talks Basel Endgame on ‘Simply Put’ Podcast

BPI President and CEO Greg Baer discussed the Basel capital proposal on the FHN Financial “Simply Put” podcast in an episode posted Friday. He described the bipartisan Congressional pushback to the proposal and the opposition from a broad coalition of small businesses, consumer and civil rights groups and other stakeholders. “It’s an unprecedented reaction to a regulatory proposal, which I think speaks to just how off-market this proposal is,” Baer said — both regarding what the true risk weights should be and how far the U.S. has deviated from the international agreement. He also discussed the tradeoffs inherent in capital requirements, the bank failures last year and the dynamics of deposits post-SVB.

SEC Issues Climate Disclosure Rule, Omitting Scope 3 Emissions

The SEC on Wednesday approved a rule requiring public companies to disclose material climate risks to investors. Although the final version of the rules is less onerous than the original proposal, there are some elements that might result in further guidance and it is not without problems. The rule has attracted criticism from progressive policymakers, climate activists and Republicans – a group of Republican-led state attorneys general has filed a lawsuit against it. The rule was approved over a spirited dissent by two of the five SEC commissioners and passed on a 3-2 party line vote. It remains to be seen whether there will be further litigation from both opponents of the rules and climate activists who think it has not gone far enough.

  • Changes from the proposal: Perhaps the most significant change from the proposal is the removal of the requirement to disclose so-called Scope 3 emissions — indirect emissions in the supply chain. Companies and business groups, including BPI, opposed this provision due to the uncertainty it could cause, undermining the purpose of providing useful information to investors. There are several other changes, including materiality qualifiers and removal of some of the excessive prescription in the original proposal.
  • Timing: The final rules will become effective 60 days after their publication in the Federal Register publication (usually a few weeks after adoption). The SEC has set out phased-in compliance dates dependent upon registrant status.
  • Scope: There have been some changes to the scope of the rule and there are some exemptions in the rule for certain entities. The SEC declined to adopt substituted compliance for foreign private issuers but did say it might consider accommodations in the future. So, for now, foreign private issuers and U.S. domestic issuers are subject to same climate-related disclosure requirements. 

House Lawmakers Urge Regulators to Tackle Discount Window Stigma Before Changing Liquidity Rules

A group of House Republicans led by Rep. Andy Barr (R-KY) urged bank regulators to reduce the stigma associated with discount window borrowing before revising liquidity rules. Prudential regulators, such as the OCC’s Michael Hsu, have signaled they are contemplating new liquidity requirements in the near future. “Although the discount window can be a lender of last resort, banks must be willing to use the discount window before they turn to a fire sale of assets and pull back on lending,” the lawmakers wrote in the letter to the Fed, FDIC and OCC. This letter follows a hearing in the House Financial Services Committee in February where BPI Chief Economist Bill Nelson testified on ways to better operationalize use of the discount window and how access to the discount window should be recognized in liquidity rules.

GAO Report on SVB, Signature Supervision Calls for Clearer Escalation Framework. The Real Diagnosis Should be Complete Supervisory Failure.

A Government Accountability Office report issued this week said that the Federal Reserve and FDIC’s handling of SVB and Signature Bank suggests that bank supervisors should have a clearer framework for escalating concerns. It says the Fed’s procedures often did not include measurable criteria for examiners to use when recommending enforcement actions. “This lack of specificity could have contributed to delays in taking more forceful action against SVB,” the GAO said. “Better procedures could promote more timely enforcement action to address deteriorating conditions at banks in the future.” The GAO recommended that the Fed revise its procedures to be clearer and more specific and to include measurable criteria.

  • Missing the point: The GAO report assumes that the examiners supervising these banks were always focused on the right issues but did not escalate their concerns quickly enough. But that assumption, at least for SVB, is flawed: Examiners were focused on the wrong issues, not the core problems of liquidity and interest rate risk that ultimately led to the bank’s failure. Fed examiners at SVB were plenty assertive, they were just assertive about the wrong things.  The story of SVB supervision is not one of an unclear rulebook, it’s one of failure to identify risk material to the bank’s financial condition.
  • Noncapital triggers: The GAO report also recommended that Congress consider requiring the adoption of “noncapital triggers that require early and forceful regulatory actions tied to unsafe banking practices before they impair capital,” such as by amending the Federal Deposit Insurance Act to require corrective actions based on indicators like interest rate risk or asset concentration. In reality, federal law already includes a framework for non-capital actions directing the banking agencies to establish safety and soundness standards across a range of areas, including interest rate risk and asset growth – if a bank does not meet these standards, the agency can take actions against it. But the agencies have essentially never established concrete standards in this way.
  • SVB, Signature takeaways: BPI has pointed out that the failures of SVB and Signature demonstrate the need for supervisory transparency and focus: clear guidelines and accountability in examiners’ actions, and a focus on core risks such as liquidity and interest rate risk rather than governance and process concerns.

Commercial Real Estate, Geopolitics: What’s in the Fed’s Latest Monetary Policy Report

Here are some key tidbits from the Federal Reserve’s latest Monetary Policy Report.

  • CRE: Commercial real estate risk in banks’ portfolios has garnered attention recently, and the Fed flagged CRE values in the report. However, the tone of the report appears to suggest cautious monitoring rather than alarm. “Credit quality at banks remained strong, although the quality of CRE loans backed by office, retail, and multifamily buildings continued its decline, a result of the lower demand for downtown real estate prompted by the shift toward telework,” the report said. It specifically mentioned smaller regional and community banks with concentrations of CRE loans.
  • Hedge fund leverage: A risk for the financial system overall is high leverage among hedge funds, the report noted. It also noted low liquidity in the Treasury market: “Treasury securities market functioning has continued to be orderly, but liquidity remained low by historical standards,” the report said.
  • Geopolitical risk: The report also flagged risks arising from various global conflicts, such as in Ukraine and the Middle East. “Geopolitical risks remain salient, including Russia’s war against Ukraine and potential spillovers of the Israel–Hamas war, and could cause strains in parts of the U.S. financial system,” the report said.
  • Funding risks: Liquidity remains ample and deposits have stabilized recently, the report’s section on funding risks and financial stability noted. “The number of banks with large declines in fair value relative to their regulatory capital and heavy reliance on uninsured deposits has declined significantly since March 2023,” it said. Nevertheless, the report concludes that  “Vulnerabilities in the financial sector remain notable, as losses in the fair value of long-dated bank assets remain significant.”

The Collateral Knot That Must Be Untied 

Policymakers have been encouraging banks recently to be prepared to borrow from the Federal Reserve’s discount window including by prepositioning some collateral. If a bank borrows from a Federal Home Loan Bank, its FHLB and Federal Reserve Bank work out an agreement on divvying up the bank’s assets as collateral.  A new BPI post breaks down how that process works.

  • Perfection needed:  Both FHLBs and FRBs will only lend against collateral in which they have a perfected security interest, meaning that if the borrower defaults, they have the clear legal right to acquire the collateral to recover the payment obligation.  Both lend primarily against loans rather than securities. 
  • Blanket problem:  In addition to accepting pledges of specific assets, FHLBs also benefit from a blanket lien against all a borrower’s assets.  That blanket lien can interfere with the ability of the FRB to get a perfected interest in a bank’s loans.
  • Some numbers:  There are 11 FHLBs and 12 FRBs, and their regions are not contiguous. Each bank must enter into a unique bilateral lending, collateral pledge, and security agreement with its FRB and with its FHLB to be able to borrow.  At the end of 2023, there was $527 billion of FHLB advances outstanding to 2,256 banks, more than half of all banks.
  • Deconflicting: If a FHLB member bank wants to maintain collateral at the Fed’s discount window, the FHLB and the Federal Reserve Bank identify certain assets for the bank to pledge to the Fed – then the FHLB relinquishes its claim to those assets under its blanket lien.
  • Key implication: A much larger percentage of commercial bank assets may be encumbered (i.e., pledged to a creditor such as a FHLB) than some may assume. Potentially all the loans of any member bank borrowing from an FHLB could be encumbered, other than those specifically designated for pledging to other creditors.

The Crypto Ledger

Here’s the latest in crypto.

  • Untethering: Stablecoin Tether marked $100 billion worth of coins in circulation this week, but Tether’s rise has highlighted the risks of stablecoins to the broader financial system, Reuters reported.  
  • FTX reaches deal: Bankrupt crypto firms FTX and BlockFi have reached an agreement that FTX will pay BlockFi up to $874 million, according to court documents cited by Reuters this week.
  • Chinese crime gangs: The latest use case for crypto: Chinese crime syndicates laundering money. The illicit funds come from scams or illegal drug sales such as fentanyl, among other uses, according to the Wall Street Journal.

Comerica Bank Celebrates 175th Anniversary

Comerica Bank this week marked its 175th anniversary. On March 5, 1849, the governor of Michigan authorized the formation of the Detroit Savings Fund Institute, today known as Comerica Bank. From six customers on its first business day, it has now grown to operating 407 banking centers across the country.

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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.