BPInsights: May 25, 2024

FDIC’s Gruenberg Plans to Resign—But Not Yet

FDIC Chairman Martin Gruenberg this week announced that he will resign his position “once a successor is confirmed.” The announcement came amid pressure from multiple directions: Senate Banking Committee Chairman Sherrod Brown (D-OH) released a statement on Monday calling for “new leadership at the FDIC,” reversing an earlier position on the matter. The Wall Street Journal reported widespread pushback to Gruenberg’s leadership among employees within the FDIC. And many Congressional Republicans had already called for Gruenberg’s resignation, along with Rep. Bill Foster (D-IL), with Democrats such as Rep. Gregory Meeks (D-NY) expressing strong concerns.

  • What’s ahead: A White House spokesperson said the Administration will soon nominate a new Chair. Reuters reported this week that a senior White House official said the FDIC needs a “fresh start” with a chief who was not part of the leadership presiding over the agency amid its workplace culture issues.
  • When and who: A specific timeline for the nomination is not yet clear, but with Democrats controlling the Senate, there is little cause for delay, assuming a nominee who can gain bipartisan support (or the support of all Democrats).

Five Key Things

1. What’s Next on Capital?

The next steps for the Basel capital proposal are uncertain. Vice Chair for Supervision Michael Barr did not provide a specific timeline for the next stage of the process either in recent Congressional hearings or in a Q&A this Monday, but he reiterated that he expects there will be “broad and material changes” to the proposal.

  • Waller: Fed Governor Christopher Waller, who dissented on the proposal, signaled on CNBC this week that the Fed Board is moving at a deliberative pace. Given the “tepid support” for the proposal when it first came out, “it should not be a surprise that to get something where we could all roughly support it was going to take some time,” Waller said. “On Basel, the same as monetary policy, there is no rush. We can do it, take our time, get it done right. We’re not in any hurry to get it done, just for the sake of getting it done. So that’s my view. If we get to a point where we can all agree on it, then that’s when it will be appropriate to put it out.”
  • Legal perspective: Sullivan & Cromwell Senior Chair Rodgin Cohen weighed in on Bloomberg TV this week on the legal dilemma regulators face with the Basel proposal. “The agencies have a real dilemma here,” Cohen said. “Number one, they can simply adopt a final rule. That is susceptible to legal challenge, because significant changes typically require a new proposal, not just adoption. Or they can repropose, but that requires substantial time –probably delays a final rule until 2025.”

2. Fed’s Barr Previews ‘Targeted Adjustments’ to Liquidity Framework

The Fed is considering “targeted adjustments” to the liquidity framework, Federal Reserve Vice Chair for Supervision Michael Barr said at an Atlanta Fed conference this week. The changes under consideration would ensure that banks have readily available liquidity at the Fed’s discount window. “Incorporating the discount window into readiness requirements would also reemphasize that supervisors and examiners view use of the discount window as appropriate and unexceptional under both normal and stressed market conditions,” Barr said, also noting that bank feedback will be important to help the Fed “further prioritize operational improvements.” He also made comments on capital and stress tests.

  • Fighting stigma: The notion of prepositioning collateral at the discount window should hopefully reduce stigma surrounding the window, Barr said. He also noted that “in all my public remarks, I make it very clear that it’s fine for banks to use” the window. “We’re sending that message to supervisors as well.” When asked if banks can count on the discount window or the standing repo facility in their internal liquidity stress tests, Barr said “There is a limited ability to do that now. So banks can use these facilities as part of both the LCR and the ILST, but with essentially a factor that adjusts for the run risk of those facilities. So … there is an ability to use it, but there’s a limited ability to use it.”
  • Other changes considered: Barr said regulators are also considering restrictions on how much large banks rely on held-to-maturity securities in their liquidity buffers, such as in the LCR and the internal liquidity stress tests. Policymakers are also rethinking the treatment of deposits from “high-net-worth individuals and companies associated with venture capital or crypto-asset-related businesses” in the liquidity framework and assumptions about their outflows.
  • Interest rate risk: Barr was asked if the Fed is considering a new capital charge based on interest rate risk. “Historically, when we’ve looked at that, the Fed has had a hard time coming up with a rule that we think actually would be effective in that space beyond the AOCI pass-through provision,” Barr said. “We are looking at ways that we might strengthen our interest rate risk guidance to be more explicit — the way in which we expect banks to stress test their portfolios for that kind of risk, and we have included in the exploratory scenarios for the stress tests this year an explicit funding shock.”
  • Basel and stress tests: When asked if the Fed is willing to address the overlaps between Basel and the stress tests, Barr responded that “we’re looking at different parts of the capital stack,” with the Basel proposal being a static approach to risk and the stress test being a dynamic tool. He also mentioned the leverage ratio. “Those three kinds of capital requirements together, I think, produce a more resilient financial system, one that is more robust to model failure, more robust to not being sure what the right way of measuring risk is,” he said. “And so I think those approaches are quite complementary.”
  • Stress test models: When asked about the Fed’s approach to stress test modeling, Barr said one of the checks against model risk “is not to rely too much only on one model.” He alluded to the multiple exploratory scenarios as a way to avoid reliance on a single model. “Challenging ourselves to be more creative in thinking about the kinds of risks that might be out there, I think is also an important mitigant,” Barr said.

3. Climate Change Doesn’t Put Banks’ Capital at Risk

The Federal Reserve required several large banks to conduct a pilot climate scenario exercise in September 2022. The exercise aimed to enable the Fed to evaluate banks’ ability to measure climate risks. The Fed specified the scenarios in more detail in 2023:

  • Physical risk scenarios requiring banks to measure how extreme weather events like hurricanes affect the credit risk of their commercial and residential lending exposures.
  • Transition risk scenarios requiring banks to measure effects on their corporate and commercial real estate lending exposures from a sudden, global climate policy shift.

What’s happening now: The Fed recently released the results of this exercise. A new BPI analysis reviews these results and explains what they mean for bank risk management and the safety of the financial system.

Capital context: BPI’s analysis puts the scenarios into context by comparing them to the results of the Fed’s stress tests, which measure banks’ capital adequacy.

  • The exercise showed that banks’ climate risk practices and methods vary and that significant model and data limitations are a challenge in measuring climate risk.
  • These results add to the growing evidence that climate risks do not threaten the adequacy of banks’ capital like the risk of a severe recession does. Climate risks are like any other typical risk: they should be monitored and managed, but not elevated to a big-picture, existential risk level more important than other risk factors.

Unrealistic: Many factors in the scenario exercise are unrealistically severe, yet it’s still clear that climate risks don’t pose a capital threat.

  • The physical risk exercise is a Rip Van Winkle scenario: The global economy falls asleep in 2022 and wakes up in 2050, with everything the same except the climate. There are no mitigating factors to climate change, such as more stringent building standards to account for higher risk of hurricanes. This is an unrealistic scenario. However, even under these extreme circumstances, the results don’t even get close to the probability of default changes in the stress tests.
  • This conclusion reflects the fact that a financial crisis scenario, like in the stress tests, reflects losses from a deep and long-lasting recession; that capital-level risks are universal and affect all asset classes simultaneously, as opposed to a localized natural disaster; and that large banks tend to diversify their real estate exposures, so a physical risk scenario like a hurricane has limited impact on the overall bank.
  • Transition risk also does not rise to the level of a capital threat. Transition risk is concentrated in a few areas such as CRE and corporate lending exposures. In both cases, the effect of transition risk on the exposures is much lower than the risks the Fed assumes in stress test calculations.

What should regulators glean from this?
Climate change isn’t a systemic risk. Climate scenarios cannot create risks of sufficient magnitude that affect all asset classes simultaneously. Regulators should avoid assuming that climate change may constitute a risk to banks’ capital. The results of the scenario exercise show that this belief is unfounded. Instead of continuing to require banks to run large-scale climate scenarios, they should treat climate risk more like other risks that banks must manage, encouraging banks to develop stressful but realistic, targeted climate scenarios in certain cases.

4. WSJ: Washington’s Pivot on Bank Rules Could Free Up Tens of Billions

If regulators make significant changes to the capital increases in the Basel proposal, it would “likely free up a lot of money that banks might have otherwise been using differently,” according to Telis Demos of the Wall Street Journal. Demos explains that the large increase in capital — equity funding — under the proposal could be put to better use for customers and investors if the rules are modified. Banks could, for example, charge lower rates on loans, make more of the most capital-intensive types of loans like mortgages to lower-income people or otherwise extend credit to the economy instead of locking up capital to meet regulatory minimums. “[T]rying to answer the question of why any change to big banks’ funding mix is needed now might be proving harder after 2023’s bank failures than it was after the 2008 global financial crisis,” Demos writes. “The next crisis might again be sparked by a big bank. But the last one wasn’t.”

5. Senate Staffer John Partin Joins BPI Government Affairs Team

John Partin will join the Bank Policy Institute as a Vice President of Government Affairs, BPI announced this week. John currently serves as a professional staff member for Senate Banking Committee Ranking Member Tim Scott (R-SC) and has deep experience on banking issues in both the House and Senate, including Basel Endgame and other regulatory topics. He will start the position on June 3, 2024. 

“John’s primary responsibilities in his Senate position involved coalition building and member services: skills that will serve him well when advocating for our members,” said Executive Vice President and Head of Public Affairs Kate Childress. “He’s well versed in both politics and policy on banking issues, which will make him an asset to our organization.”

“John’s experience handling complex banking issues and his entrepreneurial spirit will make him an adept advocate on behalf of our members,” said Senior Vice President and Head of Government Affairs Erik Rust. “We’re fortunate to have John on the team.”

In Case You Missed It

BPI’s Bill Nelson Discusses Discount Window, Liquidity at Atlanta Fed Conference

BPI Chief Economist Bill Nelson participated this week in the Federal Reserve Bank of Atlanta’s 28th Annual Financial Markets Conference. Nelson discussed the Federal Reserve’s discount window and the liquidity framework. Here are some key takeaways:

  • Historical context: Nelson provided historical context that the discount window was created to provide banks a reliable source of funding and so allow banks to hold a smaller quantity of reserves.  He also noted that before the Global Financial Crisis, a bank’s liquidity was judged based on its having diversified sources of funding, including access to the discount window, but after the GFC, the key measure was a bank’s stockpile of high-quality liquid assets, he noted.
  • Treasurer views: Nelson discussed some of the feedback he has heard from bank treasurers surrounding liquidity regulations and deposits. Treasurers identified a disconnect between how they deal with their internal liquidity stress tests versus how they deal with liquidity risks, he said. “The way they’re forced to do the stress tests are basically divorced with how they would deal with liquidity risks,” he said. Treasurers also uniformly reported that examiners did not want them to use the discount window.
  • Stigma: He observed some of the exacerbating factors of discount window stigma, such as the requirement that the names of borrowers be released to the public. Even on a lagged basis, this requirement contributes to stigma, he said. Nelson noted that bank treasurers are particularly concerned about stigma from their investors regarding discount window borrowing.
  • Liquidity rule changes: As regulators consider new liquidity requirements, Nelson said it’s good to ensure banks are able and ready to borrow from the discount window, but “such a new requirement needs to be instituted with a lot of care and thought … about unintended consequences.” Nelson said, “I fully support the idea of adding a new requirement that banks have enough cash and discount window borrowing capacity to meet a run on their deposits and … this is something that’s actively being discussed. I do think it’s important that it’s not written as a simple fraction of uninsured deposits for a variety of reasons.” He reiterated some points from his recent note on pitfalls to avoid when formulating liquidity requirements. He also observed that: “It’s clearly the case that a bank that is prepared to borrow from the discount window is more liquid than one that is not prepared to borrow from the discount window.”

Bank Runs in March 2023 Were Worse than Had Been Thought

A new paper from Federal Reserve Bank of New York staff examines bank runs during the March 2023 banking turmoil. The paper traces deposit flows, identifying 22 banks that suffered runs – “significantly more than the two that failed but fewer than the number that experienced large negative stock returns.” A few interesting takeaways from the paper:

  • Runs were driven by large institutional depositors rather than a mass of retail depositors. This strikes a contrast with the traditional image of the bank run on George Bailey’s small Savings and Loan in It’s a Wonderful Life.
  • Banks that survived a run did so by borrowing new funds and then raising deposit rates, rather than selling securities. This seems relevant to the liquidity regulatory framework, which places a great deal of emphasis on banks’ stockpiles of high-quality liquid assets such as Treasuries.
  • Banks borrowed funds first and foremost from FHLBs, but those banks that experienced the largest runs borrowed large amounts from the discount window (regular discount window, not the Bank Term Funding Program).
  • Banks that suffered runs were disproportionately publicly traded. Several banks with “fundamental” characteristics just as poor as the banks that suffered runs weathered the turmoil without depositors fleeing. This suggests an effect from public “signals,” such as Twitter chatter among stock investors, in driving runs. A bank being publicly traded appears to increase the risk of suffering a run.
  • Questions for further research from the paper include: “What makes public companies more vulnerable to runs — is it the common signal in the stock price movements, associated news coverage or the read(ier) availability of SEC filings relative to bank regulatory data? These results are not consistent with informed retail depositor monitoring of bank fundamentals. Is there any scale of shock that would induce widespread retail depositor runs?”

CFPB: Buy Now, Pay Later Counts as a Credit Card Loan

The CFPB this week issued an interpretive rule deeming that buy now, pay later lenders count as credit card issuers under key lending laws. The CFPB argues that the digital user accounts provided by BNPL lenders are credit cards under Regulation Z. Typical BNPL products offer customers the ability to pay in four or fewer installments without interest charges, and they are subject to some, but not all, of this federal regulation. The CFPB stated that BNPL lenders must: investigate customers’ disputes; refund returned products or canceled services and provide billing statements. BNPL lenders are generally not subject to penalty fee limits and ability-to-repay requirements, according to the CFPB. Comments on the interpretive rule are due Aug. 1, 2024.

BPI’s Nelson Joins AEI Panel on the Fed and Financial Stability Risk

BPI Chief Economist Bill Nelson participated this week in a panel discussion at an American Enterprise Institute event on the Federal Reserve and financial stability risk. Here are some highlights.

  • Spring 2023: Nelson discussed the banking turmoil last spring and the Fed’s role in it. He suggested that Fed examiners were not focused on the core risks that ultimately brought down SVB, such as interest rate risk and reliance on uninsured deposits. He observed that rapid rate rises in response to inflation contributed to market turmoil. He also flagged problems with banks accessing the discount window as a factor in the SVB failure. “SVB failed awash in liquid assets but with concentrated unreliable funding and unable to borrow from the discount window,” Nelson said.
  • Macroprudential policy: Nelson said that the spring 2023 turmoil added to his growing skepticism that the Fed can successfully execute dynamic macroprudential policy. One tool of such policy in the U.S. is the countercyclical capital buffer, or CCyB. “To execute such a policy, it is necessary for the macroprudential policymaker to see the crisis coming,” Nelson said. “I’m no longer confident that such foresight is sufficiently possible to warrant giving the Fed the mandate of managing the financial cycle.”
  • Financial stability concerns: Nelson also raised his current concerns with financial stability. He predicted that commercial real estate losses will rise, but banks have prepared for this scenario. “In general, financial stability risks arise from investments that are perceived as safe – like deposits at prime money market funds in 2007 and uninsured deposits at SVB in 2023 – not investments seen as risky,” he said. One key risk he identified is a banking system without robust regional banks: “More broadly, the tightening of regulations on regional banks that seems in train combined with the government’s antipathy toward bank mergers, has put the regional bank model under threat. Government policies seem to be pushing us toward a barbell banking system, with thousands of community banks and a few large international banks. While not obviously a financial stability risk, regional banks are important lenders to small and medium-sized businesses, so their loss would reduce the growth and vitality of our economy.” He also pointed to the possibility of the Fed tightening further, and the supplementary leverage ratio’s constraining effects on Treasury market functioning.

The Crypto Ledger

Here’s the latest in crypto.

  • Legislative moves: The House this week passed a crypto market structure bill that would give the CFTC a key role in digital assets oversight. The bill received strong bipartisan support.
  • Crypto PDF? Ethereum trading platform Uniswap Labs disputed the SEC’s pending enforcement action against it by saying that crypto tokens are more like PDFs than securities. The SEC has accused the platform of operating an unregistered exchange and broker-dealer.
  • Crypto in Washington: The crypto industry is amassing a PAC war chest in the hopes of influencing Washington policy, the Wall Street Journal reported.

Citi Ranked Top Affordable Housing Lender

Citi was named the #1 Affordable Housing Lender in the U.S. for the 14th year in a row, the bank announced this week. Citi Community Capital financed $6.5 billion in affordable housing last year, up from $6.3 billion in 2022. The financing includes support for thousands of affordable apartments for families, seniors and veterans.

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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.