BPInsights: November 14, 2020

Avanti’s Wyoming Bank Charter Journey: Bigger Risks in a Shinier Package

Avanti Financial, a cryptocurrency firm, recently got Wyoming’s approval to take deposits like a bank, but its boasts of being “100 percent backed by reserves” belie its real risks to customer deposits, BPI wrote in a blog post Nov. 9. 

Wyoming regulators approved the FinTech company for a special-purpose depository institution charter, a license recently granted to fellow FinTech Kraken Financial, whose structure is similarly risky. Avanti will take deposits, but instead of making loans with them, it will buy corporate bonds, munis, Treasuries and other assets. The problem comes when customers demand a withdrawal. Those assets can rapidly drop in value and might not be worth the $100 or $10,000 the customer originally deposited. Such discrepancies between deposits and what backs them can lead to disaster scenarios like bank runs, especially when the deposits are uninsured by the FDIC like Avanti’s.   

Avanti’s whole concept appeals to many critics of the way banks work. Avanti boasts that its deposits are 100 percent reserve-backed, but they’re really talking about assets rather than reserves.  Reserves don’t go up and down in value in the same way other assets can. The average U.S. bank’s assets exceed its deposits by more than 25 percent, as of late October. Critiques that banks shouldn’t create money by taking deposits and lending to other customers also fall flat – Avanti is just taking deposits and making loans in a different way by buying bonds, which is just another way to lend a firm funds that the firm pays back later with interest.  Read more >>

Lawmakers Question Regulators on Stress Tests, GSIB Surcharge, Relief Program

The Federal Reserve will use its latest stress test results, which will be publicized on a firm-by-firm basis in mid-December, to decide whether to ease caps on bank dividends and buybacks for next year, the central bank’s Vice Chair for Supervision Randal Quarles said at a Senate Banking Committee hearing on financial regulatory oversight on Nov. 10. Bank shareholder payouts have been restricted during the pandemic’s economic distress – a tactic that doesn’t actually prompt banks to lend more in stressful times, a recent BPI blog post argues.  
Quarles declined to provide the same relief for large banks on the GSIB surcharge, an added layer of capital the world’s biggest banks must hold, as the Fed did for the supplemental leverage ratio due to the pandemic. He said while there was an analogy there, the Fed would evaluate the GSIB surcharge in the next year as it finalized Basel III rules. “If we were hearing from a lot of firms that there was a real problem that was arising, as we were hearing with respect to the supplemental leverage ratio, that might be a different story, but at the moment, we’re not,” he said.  
Legislative changes wouldn’t be necessary for the Fed to evaluate climate change risk to U.S. banks and the Fed has additionally applied to be a member of the Network for Greening the Financial System (NGFS), Quarles said at the hearing, which also included the OCC, FDIC and National Credit Union Administration chiefs. The FDIC and OCC heads faced critiques from Sen. Bob Menendez (D-N.J.) that minority small-business owners did not access enough small business assistance loans during the pandemic, noting a report released by the House Coronavirus Select Subcommittee asserting that Treasury had provided informal guidance to banks to serve existing customers. Menendez pointed to banks directing loans to existing customers as a potential reason, but the regulators noted that they had encouraged banks to lend outside their customer base.  
Additionally, Sen. Pat Toomey (R-PA), who would chair the panel if the GOP maintains control of the Senate, recommended that regulators stop pandemic-related lending programs authorized by the CARES Act under the Fed’s 13(3) authority, including the Main Street Lending Program, citing thriving banks and a lower-than-expected unemployment rate as evidence that the private sector can handle boosting the pandemic-stricken economy.

Bank of England Previews Next Steps for Climate Stress Testing

The Bank of England will launch its climate change stress test in June 2021, Gov. Andrew Bailey announced in a speech Nov. 9. The exercise will evaluate how banks’ business models and balance sheets handle climate-related risks as the global economy moves toward greener energy sources. While the stress test will not be used to set bank capital requirements, banks should consider climate risks as they plan their rainy-day funds, Bailey said. He added that the central bank will share more details on the stress test data requirements and scenario variables this week. 

Climate change stress tests can gather useful data about where banks face emerging risks, but long time horizons and limited historical data present challenges for such tests and they shouldn’t form the basis of capital requirements, Francisco Covas, BPI’s head of research, wrote in a recent blog post.  

The Federal Reserve mentioned climate change for the first time in its Financial Stability Report this month, but the central bank emphasized it is still in the early stages of parsing the implications of climate risks to U.S. banks. Learn More >>  

Fed Nominee Judy Shelton to Get Senate Vote as Early as Next Week

Senate Majority Leader Mitch McConnell (R-KY) took the first step for the upper chamber to confirm Federal Reserve nominee Judy Shelton to the Board of Governors as early as next week, Bloomberg reported Nov. 12. Shelton is one of two of President Donald Trump’s outstanding nominees to the central bank along with Christopher Waller, research director at the Federal Reserve Bank of St. Louis. If either nomination fails to move forward during the Senate’s lame duck session, President-elect Joe Biden would be able to fill seats with his own nominees next year. Learn More >>

GSIBs Want Relief on Fed’s Systemic Buffer

The Fed excluded U.S. Treasuries and deposits at a Federal Reserve Bank from leverage capital requirements earlier this year to make room for banks to function as intermediaries in the government bond market amid pandemic market stress. But the GSIB banks are unlikely to get similar relief from the so-called GSIB surcharge, the extra capital buffer that the largest and most complex global banks must hold, according to a Risk article on Nov. 11. The COVID-related asset expansion isn’t as much of a problem under the Basel Committee’s methodology since GSIBs are all growing in tandem, but it can bog down their balance sheets and constrain their lending when based on the Fed’s current scoring system. 

“That would be a huge help, but we haven’t heard anything from the Fed. I think they expect the firms to adjust, as they will have a year [to do so], but I think given the environment we are in, what is most likely to happen is that the firms will shrink [other assets] on their balance sheet to accommodate the increase in reserves,” Francisco Covas, BPI’s senior vice president and head of research, said in the article. Randal Quarles, the Fed’s regulatory point person, said at a Senate Banking Committee hearing this week the Fed was not likely to update the GSIB surcharge until potentially next year. Learn More >>

Nonbanks Pose Risk to Financial Stability, Fed Says

Money market funds, hedge funds and other nonbank financial firms remain vulnerable to sharp drops in the prices of their assets, the Federal Reserve flagged in its Financial Stability Report this week, citing the recent market volatility in March. Nonbanks could struggle to meet sudden demands from investors to cash out their holdings, the report said. 
Government support has cushioned the nonbank sector from market calamity, but such firms would be exposed to more risk in the absence of that support, the Fed said. The central bank and other regulators are weighing policy changes to address weaknesses in the nonbank sector that have required government intervention during COVID-19, the report said. The Fed noted that bank balance sheets are well equipped to withstand stress, as they’ve demonstrated during the pandemic. Learn More >>

POLITICO Pro Q&A: Sen. Pat Toomey

Sen. Pat Toomey (R-PA), who is poised to lead the Senate Banking Committee if Republicans maintain control of the upper chamber, outlined an agenda that includes overhauling housing finance, boosting capital markets, digging into FinTech and encouraging more banks to open in a POLITICO Pro interview. On pandemic relief programs, he cautioned that he “would not want to turn what are supposed to be liquidity backstop credit programs into a fiscal giving away money program.” He also said he doesn’t see the need for new rules to weigh climate change banking risks, a burgeoning financial regulatory topic, particularly in the U.K. and Europe. 

American Banker: BMO Financial Pledges $5 Billion To Tackle U.S. Racial Wealth Gap 

BMO Financial pledged $5.1 billion over the next five years to help close the racial wealth gap in the U.S., American Banker reported in a Nov. 11 article. The Toronto-based firm joins a growing list of banks that are working to extend more credit and services to minority customers. BMO’s effort will include $3 billion of investment in affordable housing and neighborhood revitalization and $500 million for commercial loans to Black- and Hispanic-owned businesses. 

BPI Offers Recommendations to NY Financial Services Regulator on a Re-Proposed Regulation on Disclosure of Confidential Supervisory Information

On Nov. 9, BPI submitted comments to the New York Department of Financial Services (NYDFS) on its re-proposal to introduce a new regulation on the use and disclosure of NYDFS confidential supervisory information (CSI) under Section 36.10 of the New York Banking Law.  BPI’s letter generally supported the proposed revision to the NYDFS CSI framework to allow NYDFS-supervised institutions to disclose NYDFS CSI, such as examination reports, to outside legal counsel, auditors and affiliates without the need to first obtain the NYDFS’ written approval.  BPI believes that the current approach inhibits the flow of CSI between financial institutions and their trusted external advisors and affiliates.  At the same time, however, BPI offered the NYDFS several recommended revisions to the NYDFS’ re-proposed CSI framework designed to facilitate effective and efficient compliance by regulated entities (e.g., by removing unnecessary barriers to sharing CSI with third party service providers as did the Federal Reserve in a recent rulemaking), and promote safety and soundness (e.g., through greater ability to share NYDFS CSI with other bank regulators that have supervisory oversight over the institution and other party(ies) to merger and acquisition transaction). BPI had previously filed an initial comment letter in January on the original proposal.   

American Banker: TD Bank Pledges Net-Zero Carbon Emissions by 2050

TD Bank will tailor its loan portfolio to the Paris Agreement by 2050, according to a Nov. 9 American Banker article. The Toronto-based bank will parse the greenhouse gas emissions of its borrowers and advise its corporate clients on how to reduce their carbon footprints. The bank is a member of the Partnership for Carbon Accounting Financials, a group of banks including Bank of America and Citigroup that is working on how to account for carbon on a balance sheet in a universal way. 

Bloomberg: BofA, Wells Fargo Make Loans in Fed’s Main Street Program

Bank of America and Wells Fargo made loans through the Federal Reserve’s Main Street Lending Program, which aims to support small and midsize businesses struggling in the pandemic, Bloomberg reported Nov. 9. The three loans went to companies in industries hit hard by the pandemic, including a cruise ship company and a business travel company. Bank of America’s loans, for $250 million and $90 million, are the program’s largest. The program, which last month lowered its minimum loan size to $100,000, has faced criticism for low uptake.

WSJ: UK Sets Plan to Keep Up With New York as Financial Center After Brexit

U.K. Chancellor of the Exchequer Rishi Sunak unveiled new finance rules aimed at attracting global financial companies to raise money and put down roots in London as Brexit splinters the European financial landscape, according to a Nov. 9 Wall Street Journal article. The U.K. wants to compete with New York as an international financial hub as the U.K. separates from the European Union. 

Risk: EBA Wants Basel to Revisit Prudential Rules on Software

The European Banking Authority (EBA) wants the Basel Committee to rethink prudential rules on software assets as the EBA drafts its own proposal on the topic, Risk reported in a Nov. 10 article. Currently, EU banks must deduct the full amounts they spend on software from their capital if they record the software as an asset on their balance sheets rather than expensing it – U.S. and Swiss banks, in contrast, only need to hold 8 percent of capital against software assets. The EBA wants to switch to amortizing software assets over three years and deducting the difference between regulatory and accounting value for the software from capital during that time. The amortization periods for U.S. and Swiss banks can last much longer.