BPInsights: October 15, 2022

Stories Driving the Week

FDIC Rate Hike Proposal Fails the Test of Time

The FDIC’s proposal to raise deposit insurance assessment rates would hurt lending and credit access at precisely the wrong time for the economy. New data shows that the proposal’s unrealistic assumptions — deposit inflows and zero returns on its portfolio of Treasury securities — do not hold up to reality, clearly demonstrating the proposal is both unnecessary and unjustified, BPI, ABA, CBA, ICBA, MBCA and NBA wrote this week in a supplementary comment letter.

The FDIC has proposed raising deposit insurance assessment rates for banks by 2 basis points, which represents more than a 50 percent increase above the current weighted-average assessment rate that banks pay for deposit insurance. The FDIC wants to raise assessments based on an assumption that the fund will not meet its minimum level until 2027Q2 or 2034Q3. Correcting those assumptions to reflect recently published data on the industry, the trade associations suggest the statutory minimum will be satisfied in just a few months, sometime in 2023Q1. The FDIC’s proposed increase could exacerbate the effects of an economic downturn and would harm businesses and consumers that depend on bank credit, BPI and the broad coalition of banking trades warned in a previous comment letter.

What’s new: Data confirms the FDIC’s two key assumptions are incorrect. The second-quarter FDIC Quarterly Banking Profile and other data that have become available since the formal close of the public comment period on the FDIC’s proposal confirm that a rate increase is unwarranted and could be procyclical — intensifying the pressures of a recession. The QBP shows that deposits are falling, not rising. Moreover, the FDIC’s assumption that it will earn zero on its portfolio of Treasury securities becomes increasingly implausible the further Treasury yields rise. These two contradictions of the FDIC’s assumptions make it clear that the proposed increase is unjustified.

What they’re saying: “The most recent data makes the case against an imminent increase to deposit insurance assessment rates even more compelling and we encourage the FDIC not to implement one at this time.” – ABA, BPI, CBA, ICBA, MBCA and NBA in the comment letter.

The consequences: A rate increase at this time could reduce access to credit for customers and companies amid rising borrowing costs and high inflation. As noted in the initial letter, Congress intended to avoid assessment rate increases that are procyclical and amplify economic stress. An assessment rate increase next year would likely coincide with and exacerbate challenging conditions in the overall economy.

The ask: The FDIC should not increase deposit insurance assessment rates at this time.

The FDIC will vote on the proposed increase Tuesday. New data released by the Fed late Friday demonstrates that the rate increase is unjustified.

Fed Approves U.S. Bank Acquisition of MUFG Union Bank as Fed, FDIC Consider Changes to Large Regional Bank Resolution

The Federal Reserve on Friday announced its approval of U.S. Bank’s proposed acquisition of MUFG Union Bank. The OCC also approved the transaction. The Federal Reserve’s approval order noted that the Fed expects to address questions of financial stability broadly through a forthcoming rulemaking process (noting that “the Board had considered that consolidation among large banking organizations may pose resolvability and related financial stability concerns warranting further consideration”).

The Fed and FDIC on the same day unveiled an advance notice of proposed rulemaking seeking comments on potential changes to large regional bank resolution. The agencies pointed to an increase in the size of banking organizations, driven by recent M&A and organic growth, as a catalyst for the proposal. “As the profile of large banking organizations continues to evolve, with larger balance sheets and increased volume of uninsured deposits, and potentially more complex organizations, the agencies are considering whether additional measures are warranted to address financial stability impacts that might be associated with the failure of such firms,” the regulators said. “This includes whether an extra layer of loss-absorbing capacity could increase the FDIC’s optionality in resolving the insured depository institution, and the potential costs of such a requirement.”

• Worth noting: On the U.S. Bank/MUFG merger approval, Fed Governor Michelle Bowman expressed concern in a statement “that the commitment that could impose heightened prudential standards at a fixed date in the future is inconsistent with the Board’s existing regulatory framework, which imposes tailored requirements based on clear, quantitative measures of the firm’s underlying risk.” U.S. Bank would be categorized as “Category III” under Fed rules, Bowman said, both before and after the transaction is consummated, but the Board’s order suggests that it may require the firm to comply with Category II standards by the end of 2024, “regardless of whether the firm would be subject to these requirements by regulation.” If the Board believes the firm should be subject to heightened prudential standards in the future to address financial stability concerns, its rules and regulations provide a way to make that happen, Bowman said.
• What the Fed is considering: “[T]he agencies are considering the advantages and disadvantages of requiring large banking organizations that meet some specified categorization threshold to maintain long-term debt capable of absorbing losses in resolution,” the proposal says. The agencies are seeking comment on how such a requirement would affect the banks’ funding model and funding costs, and how it would affect the availability and cost of credit.
• Which banks? The resolution proposal refers to “large banking organizations” and would be particularly relevant to large regional banks (non-GSIBs). GSIBs already face TLAC and SPOE resolution requirements.
• Note: BPI has noted that applying GSIB-like resolution standards to large regional banks would not make sense for their risk profiles and business models.

BPI Supports Senate Bill to Enable Second Chance Hiring for Rehabilitated Individuals

BPI this week expressed support for a bipartisan Senate bill that would enable rehabilitated individuals to access high-quality jobs in the banking sector. “It’s a win-win for the country and for banks when rehabilitated people can achieve good-paying banking jobs that give them a second chance for economic advancement,” BPI CEO Greg Baer said in a Senate press release. “We support this bill, which would clear the path to banking employment for people with minor records. Thanks to Sens. Manchin, Tillis, Coons and Van Hollen for prioritizing this important issue.”

On Banks and Crypto, Barr Warns of Potential Pain Points

Federal Reserve Vice Chair for Supervision Michael Barr warned banks of the risks of crypto exposure in a speech this week at the DC Fintech Week conference. “The recent volatility in crypto markets has demonstrated the extent of centralization and interconnectedness among crypto-asset companies, which contributes to amplified stress,” Barr said. “While banks were not directly exposed to losses from these events, these episodes have highlighted potential risks for banking organizations.”

• The risks: Barr warned that “misrepresentations regarding deposit insurance by crypto-asset companies can cause customer confusion and lead to increased withdrawals at banks providing deposit services to crypto-asset firms and their customers during times of stress,” he added.
• Not intended to discourage: “This effort is not intended to discourage banks from providing access to banking products and services to businesses associated with crypto-assets,” he said.
• What’s next: The Fed is working with its fellow bank regulators to highlight crypto risks to supervised banks, such as the heightened liquidity risks banks may face from holding certain types of deposits from crypto-asset companies.  In addition, the Fed may need to provide guidance to banks in the “coming months and years” on additional types of crypto activities, he said.
• Tokenized liabilities: Barr noted some banks’ exploration of tokenized liabilities, which could include deposits, and expressed concern that in some formats that are being explored, the bank may not be able to track who is holding its tokenized liability, or whether its token is being used in risky or illegal activity. “While there is work underway on technical solutions for managing these risks, it remains an open question whether banks can engage in such arrangements in a manner consistent with safe and sound banking and in compliance with relevant law,” he said. “Given these open questions, banks looking to experiment with these new technologies should do so only in a controlled and limited manner.”
• Same activity, same regulation: Barr also called for ensuring that crypto service providers are subject to similar rules as other financial services providers.

Barr also called for Congress to take action “to provide a strong federal framework for prudential oversight” of stablecoins and for regulators to use their existing authorities. He noted that the Fed has not made any decisions on whether to issue a CBDC, but if the Fed did move forward with such issuance, it would want the support of Congress and the Administration.

OCC’s Hsu on Crypto: Rethink the ‘Regulatory Perimeter’

Acting Comptroller Michael Hsu laid out his views on crypto regulation in two recent speeches. Here are some key takeaways.

• ‘Winner’s curse’: In a speech on Tuesday at a Harvard Law School and Program on International Financial Systems event, Hsu identified a flaw in the notion of bringing crypto into the regulatory perimeter: Such an approach, he said, could lead to a “winner’s curse.” “Just as winning an auction can be a sign that the bidder has overpaid, attracting crypto licensees and activities can be a sign that a regulator may have over-accommodated the industry,” he said. To mitigate that risk, regulators should share information with each other, he said. “This is particularly important as long as crypto businesses are not subject to comprehensive supervision where a single authority has a line of sight into a firm’s aggregate activities.”
• FOMO and hype: Hsu reiterated his view that crypto is driven by hype and its promises of innovation exploit people’s “fear of missing out.” He also repeated his principle of a “careful and cautious” approach to crypto.
• Clarity needed: Hsu highlighted three crypto areas that warrant more clarity about supervisory expectations for banks: liquidity risk management of deposits from crypto-asset companies, including stablecoin issuers; finder activities, especially related to crypto trade facilitation; and crypto custody. He said interagency efforts are “fairly advanced” on the first two. He urged the crypto industry to “hold the champagne until they read the fine print” of what the banking agencies release.
• Good brakes: “Banks interested in engaging in crypto will have to develop good brakes by fashioning strong guardrails and gates,” Hsu said, alluding to the saying “the better a car’s brakes, the faster you can safely drive it”. “Those able to do so will be positioned to grow and expand in the future.”
• Resembling the past: In a separate speech this week at the DC Fintech Week conference, Hsu compared crypto’s imitation of some traditional finance features to early Apple iPhone touchscreens, which were designed with familiar-looking features in order to help people understand a brand-new product. However, in crypto, representations of traditional financial concepts are a façade, Hsu said – concepts like ownership and custody of assets in the crypto world may not match such concepts in traditional finance. “Using the familiar to introduce something novel can downplay or mask the risks involved and establish false expectations,” Hsu said. “In time, people get hurt.”
• Integrating:  “Integrating an immature crypto industry with a mature [traditional finance] system without guardrails and gates would be imprudent,” Hsu said. “Any incremental gains in efficiency and convenience would be heavily outweighed by the increase in cross-contagion and systemic risk.” He also warned of the risks of large crypto players providing a broad range of services under one roof.
• Information gathering: Hsu said “further enhancements may be needed” to oversee the risks of banks’ crypto-related activities, in addition to supervisory signoffs. “The OCC is considering ways to support periodic and ongoing information gathering so that we can continue to understand the prevalence and scope of crypto-asset exposures and interconnectedness at our supervised institutions,” Hsu said. He also suggested that the Office of Financial Research could gather data from crypto firms and platforms on their activities with traditional financial institutions.

The World Watches as the Bank of England Stops Buying Gilts

The Bank of England is set to end its emergency purchases of U.K. government debt on Friday. BoE Governor Andrew Bailey ruled out extending the emergency bond-buying program in comments this week. Bailey said the Bank faced two pressures “going in opposite directions,” with the Bank needing to fight inflation and calm the bond market simultaneously, a seemingly impossible task.

• Pension chaos: The gilt market turmoil ignited when British pension funds began selling off assets to ensure they met margin calls on certain interest-rate-sensitive derivatives that they were encouraged to invest in by their regulator which was, in turn, confident the Bank of England would stomp out any volatility. The margin calls were triggered by the U.K. Chancellor’s “mini budget”, the unveiling of which was followed by bond yields rising sharply.
• Moral hazard: The episode has illustrated the consequences – and potential perils – of central bank intervention in the markets. As discussed in a new BPI blog post, the U.K. pension sector debacle is an example of how government policies can create moral hazard and how moral hazard can create systemic risk. This cautionary tale is particularly relevant amid bouts of illiquidity in the U.S. Treasury market, the post said.
• Nonbank risks: While banks are resilient enough to weather a downturn, the recent gilt market dysfunction has exposed vulnerabilities among nonbank financial firms, the Bank of England noted in a recent report.

What’s Ailing the Treasury Market, and What Could Cure It

The Treasury market has doubled in size over the past decade while its infrastructure has shrunk – leverage ratio requirements have constrained primary dealers’ ability to trade Treasuries, a recent Economist article noted. One solution noted in the article: “exempt Treasuries and other safe assets, like bank reserves, from inclusion in leverage ratios.”

• Backing away: “Everywhere you turn, the biggest players in the $23.7 trillion US Treasuries market are in retreat,” a recent Bloomberg article noted. Japanese pensions, life insurers, foreign governments and other important buyers are retreating from the market – not to mention the Fed, which is undergoing quantitative tightening.
• Yellen sounds alarm: Treasury Secretary Janet Yellen expressed concern about a potential decrease in Treasury market liquidity going forward. “We are worried about a loss of adequate liquidity in the market,” Yellen said this week, according to Bloomberg. The article describes the supplementary leverage ratio’s effect on bank intermediation in the crucial safe haven market. Yellen noted that broker-dealers’ capacity to engage in Treasury market-making hasn’t expanded significantly while the overall supply of Treasuries has risen. She also cited the Fed’s standing repo facility as a potential liquidity backstop and said the Group of 30 report had “good ideas” on reforms to bolster the market.

In Case You Missed It

Banks’ Ability to Scale is a Benefit, Not an Inherent Problem

Better Markets CEO Dennis Kelleher claims that several pending bank mergers would create “too big to fail” banks (“Regulators Still Aren’t Serious About Ending Too Big to Fail,” Sept. 30). Kelleher also argued that the bank resolution process needs updating. He is wrong.

• The specific regional bank mergers that Kelleher references would not come close to forming a “systemically important bank,” to use parlance and measures of U.S. policymakers. Kelleher uses the outdated too-big-to-fail vernacular, ignoring that the predominant research demonstrates the perception of too-big-to-fail in the U.S. is over, remedied by post-financial crisis reforms, which Kelleher himself has championed. Kelleher’s assertion that certain large regional bank mergers would create too-big-to-fail banks stands in contrast to language in the Fed’s approval order of the U.S. Bank/MUFG Union Bank merger, which noted that the combined bank would not be highly interconnected, and suggested that the combined bank would be much less complicated to resolve than the largest U.S. banks.
• Kelleher ignores the benefits of scale that mergers create, including lower prices, enhanced financial stability and bolstered cyber defenses.
• Kelleher’s recommendation—approval of a combined post-merger resolution plan on a pre-merger basis as a condition to even file a regulatory application – would be impractical and produce no public benefit, and the regulatory framework already accounts for how mergers affect resolution planning. 

Kelleher shouldn’t assume “big is bad.” Big has benefits. Banks choosing to grow through M&A make that choice in today’s banking reality: thriving competition, rigorous rules and a stable, resilient system.

To learn more, access BPI’s full response here.

Two Important Fed Programs that Should Be Mutually Reinforcing Are in Conflict.  Why?

The Fed requires banks to demonstrate that they can convert the stores of assets they hold for liquidity contingencies into cash. It also offers banks a new permanent standing repo facility to convert the Treasuries and agency mortgage-backed securities that they hold as liquidity reserves into cash. Theoretically, these programs would act as complements. But in reality, there is a conflict: as far as we can determine, the Fed is not allowing banks to point to the SRF in their internal liquidity stress tests as a way that they can monetize their Treasuries and MBS. Partly as a result, no regional banks have signed up for the facility.  Smaller regional banks, which often do not have regular access to the repo market, would particularly benefit from the ability to cite the SRF in their liquidity stress tests.

• The fix: The Fed should publicly state that banks can plan on using the SRF in their internal liquidity stress tests, and that it sees use of the SRF as a normal business decision, not an indication of liquidity stress. Such a statement would help minimize any stigma associated with the facility. 
• Regionals: Encouraging more regional banks to sign up for the SRF would improve the banking system’s liquidity.
• Big picture: A public statement by the Fed that examiners should see use of the SRF as unremarkable and that banks could plan on using the SRF in their liquidity stress tests would help minimize the stigma associated with the facility and encourage more banks to sign up. Such a move would allow the Fed to grow smaller as banks demanded lower levels of reserve balances and ease illiquidity in the Treasury markets by helping avoid repo market volatility.

BankThink: Banks Can’t Have Their Capital and Use It, Too

As the Fed raises interest rates to fight inflation and a potential recession looms, the Fed should make clear how banks should use their capital and liquidity buffers, American Banker Washington Bureau Chief John Heltman wrote in a recent op-ed. “If they are for helping banks weather unexpected losses and preventing insolvency, then there needs to be a permission structure for banks to draw down their capital reserves when those losses are realized and for markets to understand that those drawdowns are normal, acceptable and temporary,” Heltman wrote. If they are, however, for “creating the appearance of stability,” or merely to check a box, “then the Fed needs to come up with some more operational way for banks to keep lending through the business cycle.” Heltman noted the post-Global Financial Crisis first lines of defense – “dramatically increased capital requirements and greatly increased liquidity” – and the supervisory consequences awaiting banks that do not meet those requirements. “In good times, [those consequences make] sense — if the Coast Guard boards your boat and finds that the fire extinguisher is empty, it makes you get a new one. But if your boat is on fire and you’re using your fire extinguisher to put it out, it doesn’t make sense for authorities to board your boat and give you a ticket for not having a full fire extinguisher.”

The Crypto Ledger

In addition to key banking regulators laying out views on crypto in speeches this week, here’s what’s going on in the crypto ecosystem.

• Sanctions: The Treasury Department announced two settlements with crypto exchange Bittrex over sanctions and Bank Secrecy Act violations. The settlements of $29 million and $24 million represent the Office of Foreign Assets Control’s largest digital currency enforcement action to date, the department said, and the first parallel enforcement actions by FinCEN and OFAC in this area. Bittrex failed to prevent individuals located in Ukraine’s Crimea region, Cuba, Iran, Sudan and Syria from using its platform to transact in digital currency, according to Treasury. The platform also violated the Bank Secrecy Act’s AML program and SAR reporting requirements.
• Tornado Cash lawsuit: Crypto policy think tank Coin Center has sued the Treasury Department over its sanctions against mixer Tornado Cash. The lawsuit, which alleges that Treasury’s OFAC overstepped its authority when issuing the sanctions, was filed in federal court in Florida. The lawsuit follows a separate suit backed by Coinbase.
• Gloomy October: This October has become the worst-ever month for crypto hacks, before the month has even ended, according to a CoinDesk report of Chainalysis data. Crypto hacks totaled over $718 million in losses this month, according to the Oct. 13 article.
• Mixers and tumblers: The Department of Justice’s top crypto enforcer, Eun Young Choi, said the DOJ is focused on crypto mixers and tumblers in its enforcement efforts. “We’re really looking at the multiplier effect cases, so things like mixers, tumblers and money laundering,” Choi said at a conference covered by Law360. “[These] platforms are important because they have a multiplier effect. They facilitate all sorts of criminal activity.”

BPI Members Featured in ‘Most Powerful Women in Banking’ 2022

Several BPI member executives were featured in American Banker’s “Most Powerful Women in Banking” roundup for this year. Citigroup’s Jane Fraser, JPMorgan’s Marianne Lake and Jennifer Piepszak, Wells Fargo’s Mary Mack, and Bank of the West’s Nandita Bakhshi made up the top 5. The list also featured executives from U.S. Bancorp, PNC, KeyCorp, Zions, Citizens, Huntington, MUFG, BMO, Goldman Sachs, Regions, Bank of America and Ally.