BPInsights: May 14, 2022

Stories Driving the Week

Stablecoins Untethered: The Crypto Ledger

The breakdown of stablecoin TerraUSD paints a picture of instability. Here’s what’s new this week in crypto.

  • Destabilized: TerraUSD, an algorithmic stablecoin, lost its peg to the U.S. dollar, triggering a meltdown. The episode sparked urgent calls from lawmakers and Treasury Secretary Janet Yellen to regulate stablecoins. It also called into question the overall stability of algorithmic stablecoins. Following the Terra plunge, stablecoin Tether’s price dropped below its $1 peg. How does this happen if they are backed by “reserves”?
  • Yellen: In addition to calling for bipartisan legislation on stablecoins, Yellen identified “significant risks” in stablecoins, including financial stability risk, risk to the payments system’s integrity and risks associated with increased concentration among stablecoin issuers. The TerraUSD collapse “simply illustrates that this is a rapidly growing product and that there are risks to financial stability and we need a framework that is appropriate,” Yellen said at a Senate hearing this week.
  • Fed warning: The Federal Reserve flagged stablecoin run risk in its regular Financial Stability Report recently.
  • Crypto tax crimes: Tax officials from the U.S., U.K. and other international allies are homing in on potential crypto tax crimes, including one that could amount to a $1 billion crypto Ponzi scheme, according to Bloomberg
  • CFTC: Commodity Futures Trading Commission chief Rostin Behnam said in a recent Bloomberg interview that in the absence of legislation on crypto, it’s regulators’ “responsibility to work together and to come up with solutions to the extent that we’re able to within the authority that we currently have.”
  • BPI’s take: “I see these instruments as incredibly opaque rather than transparent,” Chief Economist Bill Nelson told Protocol this week. “They end up being held with a lot of leverage and that’s where the danger comes.” Recent crashes may “further stiffen the spine of those who are acting to contain this risk to the financial system,” Nelson said in POLITICO this week.
  • The fallout: Investors found out this week what happens when a stablecoin loses its underpinning, the Wall Street Journal Editorial Board noted. Tether’s chief technology officer, in a Financial Times piece, declined to give details on its U.S. government bond portfolio, saying he didn’t want to share its “secret sauce.” (Spoiler: There are no trade secrets involved in holding a safe and liquid portfolio of Treasury bills.) Meanwhile, Coinbase faces a class-action lawsuit from investors who say the exchange misled them about the stability of stablecoin GYEN.

Lax Supervision of FinTechs Harms Consumers

The CFPB recently announced it will ramp up supervision of nonbank financial firms to help protect consumers and level the regulatory playing field between banks and nonbanks. That’s good news, because FinTechs claiming to promote financial inclusion and benefit low- and moderate-income households may, in fact, be causing them harm.

What’s happening: Many neobanks and other consumer-facing FinTechs have demonstrated a poor track record with consumers, a picture supported by recent legal and economic research, investigative reporting, complaints, survey data and recent lawsuits. Issues include:

  • Risks to consumers from crypto assets and DeFi
  • Exploiting consumer vulnerabilities
  • Predatory or deceptive practices and hidden costs
  • Fraud and lack of cyber risk safeguards

Why it matters: Many FinTech firms target low- to moderate-income and underserved communities that may be particularly vulnerable to deceptive or exploitative practices.

What the CFPB can do: More aggressive consumer-protection enforcement, regulation and supervision of FinTech lenders can discourage and mitigate the harmful practices that have been observed.

To learn more, click here.

OCC’s Hsu: ‘Time is Ripe’ for Bank Merger Changes

The “time is ripe” to consider changing bank merger review standards, Acting Comptroller Michael Hsu said at a Brookings event this week. Hsu’s remarks come as the Department of Justice and FDIC are also seeking input on the M&A framework. Here are some key takeaways from Hsu’s speech.

  • Big regional resolvability: Hsu reiterated his concern that large regional banks have a “resolvability gap,” and his proposed solution—to apply GSIB resolution requirements such as TLAC and single-point-of-entry resolvability to large regional banks. “The issue for large regional banks can be boiled down to a simple question: ‘If one were to fail, how would it be resolved?’” he said. “If the answer is: It would have to be sold to one of the four megabanks, then, I would posit, we have a financial stability problem.” Of course, Hsu fails to mention that existing large regional bank living will plans propose various resolution options other than selling themselves to one of the “four megabanks,” which, by Hsu’s own reasoning, would suggest there is, in fact, not a “financial stability problem.”
  • A changing competitive landscape: Hsu acknowledged the changes in the financial services marketplace since the DOJ’s bank competition standards were last updated, including the emergence of FinTechs, greater uptake in digital banking and larger nonbank market share in the mortgage market.
  • ‘Granular’ approach: Hsu said he was “drawn” to former Fed Governor Daniel Tarullo’s “granular” approach to competition analysis in bank merger reviews, which Tarullo outlined in a Brookings paper.
  • Public meetings: Hsu said that for “mergers involving larger banks, the OCC is considering adopting a presumption in favor of holding public meetings.”

Financial Trades Encourage SEC to Modify Cyber Incident Disclosure Proposal to Aid Law Enforcement and Support Remediation Efforts

The Bank Policy Institute, American Bankers Association, Independent Community Bankers of America and Mid-Size Bank Coalition of America commented this week on a U.S. Securities and Exchange Commission proposal that would implement new requirements for financial institutions to disclose material cyber incidents, as well as cybersecurity risk management, strategy and governance. The associations support the goals of the proposal and request that the SEC consider several changes to the disclosure timeline to encourage these activities without impeding active law enforcement investigations or introducing new threats that may hinder a bank’s ability to respond.

“We support the SEC’s efforts and recommend changes to the proposal that allow firms to prioritize remediation efforts while at the same time helping give investors more transparency around cybersecurity,” the associations stated. “The proposal should be amended to ensure that information provided to the public cannot be weaponized by malicious actors to further harm an institution or threaten the security of U.S. critical infrastructure.”

To learn more, click here.

BPI Welcomes Bill to Empower Rehabilitated Job Seekers

The House this week passed a bill, the Fair Hiring in Banking Act, sponsored by Reps. Joyce Beatty (D-OH), Jake Auchincloss (D-MA) and Pete Sessions (R-TX), that would enable banks to provide more job opportunities to rehabilitated individuals with criminal records.

What BPI is saying: “This legislation offers a second chance to rehabilitated job candidates whose skills are untapped. It streamlines the hiring process under federal law so that our nation’s banks can offer employment opportunities to people with a diverse range of backgrounds. We urge the Senate to take up and pass this bill.” – President and CEO Greg Baer

To learn more, see our press release and joint trades letter.

Waller: Climate Rules Are ‘Congress’s Job’

Incorporating climate change into the regulatory framework is not the Fed’s job – it’s Congress’s responsibility, Fed Governor Christopher Waller said at a recent event. “When it comes to thinking about regulatory structure and environmental stuff, that’s Congress’s job,” he said, according to American Banker. It is the Fed’s job to tailor its requirements around the outcome of shocks rather than specific causes, he said. He also said markets can price climate risk into asset prices like any other risk, giving an example of waterfront real estate amid rising sea levels.

In Case You Missed It

Fed Board Takes Shape

Lisa Cook and Philip Jefferson were confirmed by the Senate this week as new Fed governors. Cook was confirmed in a party-line vote, with Vice President Kamala Harris breaking the tie.  The Senate confirmed Jerome Powell to serve a second term as Chairman. The Senate Banking Committee also announced it will hold a hearing on Michael Barr’s nomination to be a Member of the Board and its Vice Chairman of Supervision next Thursday.

Crypto, Climate, LIBOR: Yellen at FSOC Hearings

Treasury Secretary Yellen testified at House and Senate hearings on the Financial Stability Oversight Council this week.

  • Crypto: Yellen highlighted the urgent need for stablecoin legislation given the news this week of certain stablecoins such as TerraUSD breaking their $1 peg and emphasized the potential risks that they pose to financial stability. In an exchange with Ranking Member Pat Toomey (R-PA), she committed to working with him on stablecoin legislation that could be passed by the end of the year. In response to questions from Rep. Tom Emmer (R-MN), she noted that FSOC has not designated digital asset or stablecoin activities as a systemic risk.
  • Climate: The SEC’s climate disclosure proposal is “extremely important,” Yellen said, expressing support for the measure. She also said it makes sense for the FSOC to work jointly on designing climate scenarios and collect the necessary data to translate them into concrete assessments of risk to particular banks. At the House hearing, Yellen said “the FSOC and individual regulators are not telling banks what they should or should not do with respect to their investments.”
  • CBDC: One benefit of a U.S. CBDC could be that “it might diminish the proliferation” of risky private stablecoins, though some stablecoins could likely coexist with it, Yellen said. She noted concerns about privacy if a central bank were to issue a digital currency directly to consumers and said an intermediated CBDC would seem more likely. A CBDC “could draw a lot of funding away from the banking sector if it’s a very attractive asset,” she said at the House hearing. Treasury will address the tradeoffs of a potential CBDC, including the prospect of a “very significant impact on the structure of financial intermediation,” in an upcoming report, she said.
  • ILCs: There are reasons to worry about a Big Tech firm controlling an ILC, Yellen said at the House hearing. “One reason that the Fed always worried about is that, when a commercial company owns a bank, that credit decisions can be influenced by issues other than banking and safety and soundness considerations because of incentives that come from the other part of the business, the commercial part of the business,” she said. “In addition, this tends to diminish competition and to promote monopoly and market power and that’s probably more important than it ever was before.  And, if a sufficiently large commercial company were to become dominant in the payment system, I think there certainly could be financial stability risks.”
  • Sanctions: U.S. sanctions are “having a very severe impact on Russia,” Yellen said. The Russian economy is “clearly in a recession,” with inflation high and businesses cut off from goods and services in global markets, she said. The ban on U.S. provision of accounting services to Russia announced last Sunday was meant to preclude Russian oligarchs from using such services to shield their illicit funds, she said.
  • LIBOR: The recently enacted LIBOR transition bill is “really helpful,” Yellen said. “We’re in a transition phase,” she said, with particularly good progress on LIBOR-based derivatives contracts; however, she noted: “We have some concerns that we mention in the FSOC report over credit-related indices that banks may use, but, generally, I’d say the transition is going well.”
  • Capital: Banks had sufficient capital and liquidity to weather the stress of the pandemic market turmoil, Yellen noted.

U.S. Sanctions Russian Bank Executives, Weapons Maker

The Treasury Department imposed new sanctions late last week on top Russian bank executives and board members, a weapons manufacturer and state-controlled TV stations. The sanctions targeted executives and board members at Sberbank and Gazprombank. They also banned Americans from providing accounting, trust and corporate formation and management consulting services to Russia.

U.S. Bank Unveils Five-Year Community Benefits Plan

U.S. Bank this week announced a five-year community benefits plan, developed with community groups as part of its planned acquisition of MUFG Union Bank. The roughly $100 billion plan will support increased mortgage lending to low- to moderate-income communities, small business and small farm lending, and affordable housing and community development, among other efforts.

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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.