BPInsights: November 6, 2021

Stories Driving the Week

Banks, Big Tech: Reading Between the Lines of the PWG Stablecoin Report 

The big news on Monday of this week was the release of the much-anticipated President’s Working Group on Financial Markets report on how the government should contend with risks posed by the growth of stablecoins. In general terms, the report recommended that stablecoins be issued only by insured depository institutions, that custodial “wallet” providers be subject to federal oversight and that stablecoin issuers’ activities be restricted from links to commercial entities.

Our general take:  The recommendation for legislation that only insured depository institutions without commercial affiliations be able to issue stablecoins was a defeat not only for nonbanks hoping to issue stablecoins but also for those seeking novel state or national bank charters that would avoid deposit insurance, and therefore Fed regulation.  While enactment of legislation is unlikely in the short term, the same regulators who signed on to the report are unlikely to be granting novel federal charters to avoid its recommendations (or rewarding novel state charters with Fed accounts), and it seems unlikely that anyone would want to invest in a business model that legislation could outlaw in the medium term.  With everyone on notice, there would be no hope for grandfathering.  Also interesting was that the report clearly declared open season on existing providers, but took no position on whether those products are commodities or securities, and thus whether the CFTC or SEC would be leading the inquisition.  That will be left for those agencies to figure out, and likely for a court to decide when some enforcement action is challenged on grounds that the relevant agency lacks jurisdiction. 

Views from stablecoin issuer community:  Circle CEO Jeremy Allaire in a Q&A this week with the Brookings Institution’s Aaron Klein said the report shows how oversight is being upgraded from the experimental FinTech “laboratory” approaches of state financial regulators to the federal level.  Allaire, whose firm plans to seek a national bank charter, said he agrees with the report’s notion that stablecoin issuers should become more bank-like. The report’s suggestion that stablecoin issuers be limited in their affiliations with commercial entities – like the separation of banking and commerce in banking law – was specifically directed at the company formerly known as Facebook and its stablecoin project, because the idea of a huge Big Tech player usurping fundamental payments infrastructure scared many people in the market, Allaire said. On the issue of reserves and transparency, Allaire said Circle takes a cautious approach by backing its coins fully with reserves, but there are other stablecoin issuers who ignore that entirely. 
Allaire also warned that existing payments system standards have never contemplated a system where fundamental financial infrastructure is outsourced to the open internet. He challenged the assertion that China is surpassing the U.S. in digital money and said the Chinese government’s crackdown on private-sector payment firms is not something the U.S. should emulate. 

Does CRISK Really Measure Banks’ Exposure to Climate Risk?

A New York Fed Staff Report estimates that some large U.S. banks would need to raise tens of billions of dollars in capital to weather a severe climate-related shock – an estimate they call “CRISK.” But it’s unlikely that the paper is measuring banks’ exposure to climate-related transition risks – a type of risk arising from policies aimed at lowering greenhouse gas emissions – and it mixes correlation with causation. The methodology used in the paper needs to provide a tighter link between the impact of climate risks on the value of bank equity, a new post by BPI Research says. 

Democrats Urge Treasury to Speed Up Pace on Shell-Company Law

Congressional Democrats sent a letter to Treasury Secretary Janet Yellen about the pace of implementing the Corporate Transparency Act, which requires certain businesses to disclose their beneficial owners in an effort to root out anonymous shell companies. Treasury is still considering comments from various stakeholders, and the lawmakers – Sen. Sherrod Brown (D-OH) and Reps. Maxine Waters (D-CA) and Carolyn Maloney (D-NY) – expressed disappointment that there had been delays to the rule, but acknowledged that the change in administration, FinCEN leadership and funding constraints were all challenges that the agency has had to overcome throughout this process.

Hsu’s Charter Review, Crypto Sprint Pass Finish Line

In remarks this week on his vision for the future of financial services regulation, Acting Comptroller Michael Hsu stated his belief that large cryptocurrency firms should embrace comprehensive, consolidated supervision as a way to address potential risks in the organization. Hsu warned of the risks of FinTechs, or “synthetic banking providers,” engaging in banking activities outside the “regulatory perimeter” of banking supervision, which include run risk and regulatory arbitrage. FinTechs may choose to avoid a bank charter to save on costs and because the tech banking model is driven by harvesting and selling consumer data rather than managing interest margins or earning fees, he said.  Hsu announced that the OCC’s “crypto sprint” with the Fed and the FDIC is finished and the agencies will communicate results shortly. Hsu’s review of OCC bank charter applications and crypto-related interpretive letters has also concluded, he said, and the content of communication regarding that review would be aligned with his vision for a bank regulatory perimeter that was set forth in his remarks. He also noted that the OCC has started to home in on banks that provide services to large FinTechs and facilitate “synthetic banking” outside of the regulated sphere.

Hsu: FinTechs’ Promise of Inclusion Contrasts with Fraud, Consumer Complaints

FinTechs outside the “regulatory perimeter” of banking supervision tout their role in PPP lending as proof of their value to society compared to regulated banks, but more recent evidence shows higher rates of customer dissatisfaction and suspicious PPP loans facilitated by FinTechs versus those handled by banks, Acting Comptroller Michael Hsu said in recent remarks that highlighted the risks posed by “synthetic banking providers.”

There is also some evidence (see here) that while FinTechs offered PPP loans during the pandemic, their small business lending outside of the program dried up substantially, although bank small business lending did not.  Unlike banks, FinTech lending does not rely on long-term relationships; FinTech lenders do not take deposits and instead finance their lending through debt, loan sales, or equity; in contrast, banks rely on deposits for most of their funding and typically receive large inflows of deposits during a crisis, helping them to fund credit line drawdowns and new loans.  These factors may help explain why, while FinTech lenders extended PPP loans as part of a no-risk government program, they were otherwise unreliable as a liquidity source for small businesses during the pandemic.

Financial Firms Pledge $130T to Net Zero Transition

The Glasgow Financial Alliance for Net Zero, which includes several major banks, pledged this week to commit $130 trillion in capital to aid the transition to net zero greenhouse gas emissions. The announcement came as global leaders and industry executives gathered at the COP26 climate summit in Glasgow. The financial coalition is led by former Bank of England Governor Mark Carney, who is now a UN special envoy for climate action and finance. 

In Case You Missed It

Senators Propose 72-Hour Cyber Reporting Amendment to NDAA

Leaders of the Senate Homeland Security Committee and Intelligence Committee proposed a cyber reporting amendment to the must-pass National Defense Authorization Act. The measure includes a 72-hour incident reporting requirement, consistent with a House bill’s timeline and in line with recommendations made by BPI, and a 24-hour requirement for reporting ransomware payments. The amendment is expected to face a vote in the coming weeks.

BPI, Member Banks Aim for Legislative Fix to Promote Second-Chance Hiring

Banks want Congress to narrow a banking statute in order to provide more employment opportunities for rehabilitated individuals with prior criminal records who pose low risks to the banking system, as covered in a Bloomberg piece this week. The article covers efforts by BPI, member bank JPMorgan Chase and a senior executive at member bank Fifth Third that aim to support more of these “second-chance” hiring opportunities. The need to calibrate Section 19 of the FDI Act has been a BPI priority for several years. “There’s only so far that a regulator can go without going outside the bounds of their authority under the statute,” BPI SVP and Associate General Counsel Dafina Stewart said in the article. “We’re asking for Congress to revisit the statute because there are still adjustments to be made.”  

Senate LIBOR Hearing Calls for Transition Legislation

The Senate Banking Committee this week held a hearing on LIBOR transition that highlighted the need for legislation to smooth the path away from the reference rate for “tough legacy” contracts that can’t easily switch to another benchmark rate. The hearing also touched upon which rate among a menu of options should replace LIBOR in various types of financial contracts. At the hearing, Alternative Reference Rates Committee Chairman Tom Wipf said SOFR largely eliminates a key risk of LIBOR: the use of self-interested judgment as the basis for a rate instead of transaction data. Former CFTC Chairman Christopher Giancarlo said an array of approved benchmark rates must be available, particularly given the diversity of the U.S. economy and the issue of smaller lenders making loans against illiquid collateral. Lenders are in the best position to determine the rates for their customers and the cost of funding, he said. BPI has long supported a legislative fix, and BPI and several financial trades recently expressed support in a letter for bipartisan legislation that will be sponsored by Sens. Jon Tester (D-MT) and Thom Tillis (R-NC) to provide a solution for LIBOR contracts with inadequate fallback language and prevent unnecessary litigation. The House Financial Services Committee advanced bipartisan LIBOR transition legislation this summer.

Biden Administration to Order Federal Agencies to Fix Cyber Flaws

The Cybersecurity and Infrastructure Security Agency issued a new directive mandating that federal agencies patch cybersecurity weaknesses, the Wall Street Journal reported this week. The measure is one of the broadest cybersecurity requirements ever imposed on the federal government, covering nearly 200 known security flaws that pose major risks to government systems. The directive covers software and hardware systems for federal civilian agencies including any systems hosted by third parties. 

NY Bank Regulator to Fold Climate Change into Supervision

The New York State Department of Financial Services has launched a new division to handle climate risk, which will incorporate such risk into bank supervision, according to American Banker this week. The new unit will be led by Yue “Nina” Chen.   

Fifth Third Provides $130,000 in Technology Grants To Boost Access at Young Bankers Club Schools 

Fifth Third announced this week that it is offering 13 technology grants of $10,000 each to schools and nonprofit groups involved with its digital Young Bankers Club program. The program offers financial education to fifth-graders. 

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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.