BPInsights: November 10, 2023

How the Basel Proposal Overcharges U.S. Credit Card Consumers

The Basel capital proposal is set to impose excessive capital requirements on consumer loans, which would make credit more expensive and especially more challenging for the most vulnerable American customers to build or rebuild credit or cover emergency expenses, a recent BPI blog post explains.

• How? The proposal would impose unduly high capital charges for credit cards, accounting for both the risk of default (credit risk), and operational risk, which is a universal charge that applies to all banking products and services. The risk weights for credit cards in the U.S. Basel proposal are excessively high when compared to historical losses, especially when combined with the buffer for net stress losses from the Fed’s stress tests and operational risk charges. Combined, the capital requirements for operational and credit risk of consumer cards can range between about 200 percent and 250 percent.
• Credit invisibles: The higher costs would hit “credit invisibles” – people with limited or no credit history – particularly hard. These customers could include young people starting to build credit, lower-income households or recent immigrants. It could become more challenging for such customers and those with impaired credit histories to access affordable cards. Credit cards are a key building block for consumers’ credit profiles. The proposal’s charge for unused portions of lines of credit could lead to banks reducing credit limits or canceling infrequently used lines. This could harm customers’ credit scores and their access to a backup source of financing for emergency expenses.
• Small-dollar loans: The proposal could also harm another safe source of emergency financing for low-income households: banks’ small-dollar loan programs. These loans serve as a safer alternative to predatory payday lending to meet urgent cash shortfalls. The capital proposal could curtail progress banks have made in recent years in expanding their offerings of small dollar loans.

Five Key Things

1. Bipartisan Basel Concerns Continue at Latest House Hearing

Both Democratic and Republican lawmakers expressed strong concerns about the impact of the Basel Endgame proposal at a House hearing this week. The House Financial Services Committee’s Subcommittee on Financial Institutions and Monetary Policy held a hearing on Tuesday entitled “The Tangled Web of Global Governance: How the Biden Administration is Ceding Authority Over American Financial Regulation,” featuring witnesses from academic institutions, Americans for Tax Reform and Americans for Financial Reform. Here are some key highlights.

• Mortgages: Democratic lawmakers continued to emphasize the proposal’s potential impact on mortgage lending. “The Federal Reserve is being pulled in two separate directions,” Rep. David Scott (D-GA) said at the hearing. “On the one side, the critical strengthening of our banking system, but on the other preserving the ability for underserved African Americans and other minority borrowers to obtain a mortgage and purchase a home.” Scott and Rep. Juan Vargas (D-CA) expressed particular concern about mortgages for first-time homebuyers.
• Green energy: The Basel proposal’s drastic increase in capital charges for certain renewable energy equity investments has attracted scrutiny from Democratic lawmakers. Reps. Brad Sherman (D-CA) and Sean Casten (D-IL) called attention to this aspect of the proposal at the hearing.
• ‘Red herring’: The Basel proposal would increase costs for small business loans and lending to low- and moderate-income households, Rep. Young Kim (R-CA) said at the hearing. “And unfortunately, here, the SVB failure is being used as a red herring to increase capital requirements by as much as 16 percent,” she said. SVB’s failure was caused largely by management and supervisory failures, she said.

2. BPI Response to CFPB Proposal to Improve Oversight of Big Tech

This week, the CFPB proposed new rules concerning the supervision and regulation of larger nonbank companies that offer digital wallets and payment apps. Paige Pidano Paridon, BPI senior vice president and senior associate general counsel, issued the following statement in response: “We strongly support the CFPB’s commitment to consistent regulatory principles for regulating nonbanks — if it walks like a bank and talks like a bank, regulate it like a bank. Maintaining trust in the U.S. financial system is paramount, and any Big Tech firm engaged in these activities must be required to not only follow the same rules, but also demonstrate ongoing compliance through regular direct supervision.”

3. Was Basel Endgame About SVB?

Vice Chair for Supervision Michael Barr and Acting Comptroller Michael Hsu addressed the Basel Endgame proposal this week at the D.C. Fintech Week conference. One interesting theme that surfaced: the role of capital in the SVB failure and its ensuing lessons, and whether it’s relevant – or not — to the Basel Endgame proposal.

• ‘Classic case’: Barr characterized the Silicon Valley Bank failure as a traditional bank collapse in many ways. “In some ways, the lessons are very, very old,” Barr said. “The bank failed because of classic case of interest rate mismanagement and liquidity risk mismanagement; those are core issues in banking. They’ve been around since the beginning of banks; they relate to exactly what banks are set up to do.” The interconnection in SVB’s depositor base is a newer issue in bank failures, he said. He appeared to link SVB with capital: “It reinforces the need for sound interest rate management, sound liquidity management, and robust capital so that banks are safe,” he said.
• Conflating: Michael Hsu drew a line between the spring banking failures and the Basel proposal. “There’s the Basel III proposal, which was actually put into motion well before the events of the spring,” Hsu said at the conference. “So I’m glad you didn’t conflate those things, because a lot of folks are conflating that.” Hsu said regulators are looking for feedback and said they are looking to make the rules durable.
• ‘Building codes’: Hsu compared capital regulations to “building codes” in his comments, saying “The building codes don’t tell you what building to build … [They] say if you build to these specs, that building will stand, and it will stand in good weather, in bad weather, through stresses, through shocks. You don’t have to worry about it.”

4. Bowman Sounds Alarm on Capital, Broader Regulatory Path  

Federal Reserve Governor Michelle Bowman expressed concerns about the Basel capital proposal and the bigger picture of federal banking agencies’ rulemaking efforts. The Basel proposal could have harmful unintended consequences for bank customers, she said. “I am skeptical of assertions that the costs of the proposal are justified by the benefits,” Bowman said in a speech this week. “The proposed capital increases, if implemented, would have a tangible effect on banking activities and unintended—but predictable—consequences” such as market liquidity and lending impacts, banks exiting certain markets, reduced credit availability and increased costs of credit, she said. These effects “could disproportionately harm underserved markets, businesses, and communities.”

• Above and beyond: The U.S. Basel proposal “far exceeds” the internationally agreed Basel standards, Bowman pointed out. “Instead, the scale of the increase is driven by deliberate policy choices to significantly increase capital requirements for U.S. banks over $100 billion, even for those that are not internationally active,” Bowman said.
• Need for data: On capital, Bowman noted that “there has been growing support for improving the proposal’s quantitative, analytical foundations, including the need for and impact of capital increases of this scale.”
• Consensus: Bowman also indicated that her support of the final rule is an open question: “Although I did not support the initial proposal, I will reserve judgment for my support of a draft final rule. I look forward to engaging with my colleagues to improve the initial proposal, and then consider whether a final rule sufficiently addresses my concerns.”
• Big picture: In her speech, Bowman also expressed concerns about various aspects of other rules, such as the final CRA rule and the Fed’s proposed changes to the debit interchange fee cap. The capital proposal cost analysis must include the broader context of other ongoing regulatory changes, she said: “The analysis must include the new long-term debt proposal for all firms with more than $100 billion in assets, and the other existing rules that affect capital and firm incentives, like the stress capital buffer and the supplementary leverage ratio,” she said. “Meaningful, accurate input can only be provided if regulators are clear about the desired end state of reforms and how they would work together to complement the framework, avoiding conflicting or contradictory requirements. Approaching reform in a piecemeal manner increases the risk of arriving at a capital end state that is inefficient, redundant, and unfair to those subject to the regulation and harmful to banks, their customers, and the broader economy.”
• Overlapping: Bowman also described how the confluence of proposals limits regulators’ ability to predict consequences: “The recent volume and materiality of new reforms implemented and under consideration by the federal banking agencies is significant, with nearly 5,000 pages of rules and proposals published since July. While the unintended consequences of these reforms may not be clear at the outset, our ability to predict these consequences is even more limited when the reforms overlap or conflict. The sheer volume of change presents significant challenges for banks, who will be required to prioritize the implementation of new and revised requirements, with the risk of being distracted from more material concerns or supervisory issues.”

5. Basel Proposal Would Hurt Small Businesses’ Access to Capital

The Basel capital proposal would harm U.S. small businesses’ access to capital, adding pressure to an already-challenging economic environment, Karen Kerrigan, president and CEO of the Small Business and Entrepreneurship Council, wrote in an American Banker op-ed. “Not only are these regulations misplaced and inappropriate, but they also come at a horrible time for small businesses, when headwinds remain relentless, and capital and credit are becoming more difficult and expensive to access,” Kerrigan wrote. The proposal would “shred access to capital for American entrepreneurs” by driving up the cost of lending, she wrote.

In Case You Missed It

BPI Responds to FSOC Guidance on the Designation of Systemically Important Nonbanks

BPI Executive Vice President and General Counsel John Court issued the following statement late last week in response to guidance issued by the Financial Stability Oversight Council related to the financial stability risks of non-banks: “As U.S. bank regulators look to squeeze more and more risk out of the banking sector by imposing higher and higher capital requirements, it’s only natural for U.S. officials to worry about where that risk is going, how it’s being managed and whether there’s any decent oversight. And it’s an acute worry given that the government’s safety net has been extended to shadow bank firms in recent crises.”

BITS Hires Greg Williamson as SVP, Fraud Reduction

BITS, the technology policy division of BPI, announced this week that Greg Williamson will join the team as senior vice president, fraud reduction. Greg will lead BITS’s fraud prevention and mitigation initiative and develop advocacy positions that align regulatory expectations with industry best practices. His most recent role was with PNC Bank where he served as head of digital identity product and strategy.

“Greg brings with him over two decades of experience executing fraud prevention programs at the world’s leading financial institutions, which will serve as a significant benefit to both BPI members and policymakers,” stated Chris Feeney, BPI Executive Vice President and President of BITS. “His fraud and technical expertise in identity and authentication will be invaluable as industry works hand-in-hand with regulators to protect consumers against fraud and promote public trust in the financial system.”

BNYM Report: Reshaping Treasury Market at Turbulent Time Requires Caution

The Treasury market has experienced notable volatility and liquidity strains over the last decade. This turmoil has sparked concerns from several U.S. government agencies about the resilience of this critical global market. Among other policymaker actions, the SEC plans to expand central clearing of Treasury securities. The agency believes this expansion will bolster Treasury market resilience through improved default management processes, smaller settlement flows and reduced settlement fails. But, according to a recent report by BNY Mellon’s Nate Wuerffel, it could add more pressure to the market by restructuring the way the market functions during a time of turbulence. “Central clearing will strengthen the market’s core attributes of safety and liquidity in times of stress,” Wuerffel wrote. “But implementation will be difficult and will reassemble the way the Treasury market functions at a time of heightened volatility. The rule is likely to be finalized soon, and the implementation timeline may be shorter than expected. Market participants would do well to prepare.”

• Potential changes: According to the report, the economics of the Treasury market could change in response to central clearing in ways such as
  • Lower risk of counterparty default and fire sales, meaning markets are less likely to pull back in times of stress
  • Greater balance sheet capacity for intermediaries
  • Likely higher transaction costs due to cost of clearing and risk management, with wider bid-ask spreads
  • Low-margin or high-volume trades and leverage will become more costly, widening spreads, and liquidity in normal times may be less continuous.

FHFA: Federal Home Loan Banks Should Clarify Lending Role

The Federal Housing Finance Agency released a report this week on the Federal Home Loan Bank system. Among other recommendations, the report made clear that the FHLBs should play a role distinct from the Federal Reserve’s role as the lender of last resort to banks under stress. This recommendation is relevant given the banking turmoil this spring and the failing banks’ efforts at that time to borrow from the FHLBs. The financial system needs a clear and suitable lender of last resort, and that is not a role the FHLBs should play.

• Drawing clear lines: “The role of the FHLBanks in providing secured advances must be distinguished from the Federal Reserve’s financing facilities, which are set up to provide emergency financing for troubled financial institutions confronted with immediate liquidity challenges,” the report said. “Due to operational and financing limitations of the market intermediation process, the FHLBanks cannot functionally serve as the lender of last resort, particularly for large, troubled members that can have significant borrowing needs over a short period of time. To address this, the FHLBanks should coordinate with their members’ primary regulators and the regional Federal Reserve Banks to ensure financial institutions’ borrowing needs continue to be met when they no longer meet the FHLBanks’ credit criteria. Moreover, the FHLBanks’ model of providing liquidity primarily through secured advances should be accompanied by a thorough and regularly updated credit evaluation of their members to avoid encouraging excessive risk taking.”
• BPI analysis: A BPI note in April 2023 analyzing the government’s lender of last resort function and lessons from the spring bank failures also recommended clearer distinctions between the FHLBs and the Federal Reserve. “Apart from the tiny seasonal credit program, the Fed only lends to meet contingencies or crises,” the note said. “Instead, the FHLBs have evolved into the instrument by which the government provides ongoing funding to banks.  Federal Home Loan banks are ill-suited to be the LOLR, however, and this division of responsibility interferes with the Fed’s ability to do so.”

The Crypto Ledger

In the wake of Sam Bankman-Fried’s fraud conviction, Reuters published a roundup of other crypto bosses on U.S. authorities’ radar, including Binance chief Changpeng Zhao. Here’s what else is new in crypto.

• Barr on stablecoins: Vice Chair for Supervision Michael Barr said at the D.C. Fintech Week conference this week that private sector-issued stablecoins are essentially borrowing the trust of the Federal Reserve, and “we think there’s a very strong interest in having strong federal regulation of stablecoins.”
• CBDC authorization: Barr also said “if we did decide it made sense to do, for example, a retail central bank digital currency, we would only do that if Congress and the executive branch clearly authorized us to do that step.” On payments more generally, Barr said the U.S. needs a payments infrastructure that promotes financial inclusion and protects privacy.
• BIS: A BIS paper entitled “Will the real stablecoin please stand up?” lays out a grim reality: not a single stablecoin in the study has been able to maintain constant parity with its peg. “This is irrespective of a coin’s size or type of backing,” the authors observe. “Moreover, there is currently no guarantee that stablecoin issuers could redeem users’ stablecoins in full and on demand. For these reasons, the stablecoins in circulation today do not meet the key criteria for being a safe store of value and a trustworthy means of payment in the real economy.”
• UK and stablecoins: The Bank of England and Financial Conduct Authority have published discussion papers setting out their regulatory vision for fiat backed stablecoins. Comments are due Feb. 6, 2024. The focus is on retail use and sterling denominated stablecoins. The Financial Times comments that the UK regulators are proposing to bring stablecoins into the real economy as a payment option.
  • The BoE proposal sets out the proposed regulatory and supervisory framework for payment systems using stablecoins that, if widely used for retail payments in the UK, could pose risks to financial stability (termed ‘systemic payment systems using stablecoins’) and related service providers. The Government has enacted legislation that will allow the Bank to regulate these entities once they are recognized by UK HMT.
  • The FCA’s proposal sets out their proposed regulatory approach to stablecoin issuers and custodians. HMT will bring the use of fiat-backed stablecoins in payments, and the activities of issuing and providing custody services to UK-based ‘fiat-backed stablecoins’ into the FCA’s regulatory remit.
  • The UK PRA has sent a “Dear CEO” letter to deposit takers regulated by the PRA on use of stablecoins, e-money and tokenised deposits.  For banks, the current regulatory regime for banking will need to be applied and tokenised deposits and other new forms of digital money will be subject to the approach set out in the letter. The letter sets out how the PRA expects banks to address the risks that arise from issuing multiple forms of digital money.

Goldman Sachs Teams Up with Basketball Hall of Famer Dawn Staley to Address Racial Wealth Gap

Goldman Sachs is partnering with Hall of Fame women’s basketball coach and player Dawn Staley to draw attention to the racial wealth gap as part of its One Million Black Women initiative. Goldman is launching a TV advertisement with Staley as part of a broader campaign building on its commitment to help narrow opportunity gaps and amplify the voices of Black women in the U.S. to catalyze policy change.