BPInsights: October 22, 2022

Stories Driving the Week

FDIC Assessment Rate Hike: A Drag on Growth at The Wrong Time, Based on the Wrong Assumptions

The FDIC this week voted to raise deposit insurance assessment rates.

  • Preemptive strike: “We are disappointed that the FDIC has chosen to increase assessment rates based on assumptions that are demonstrably incorrect,” BPI, ABA, CBA, ICBA and MBCA said in a joint statement after the vote. “The latest data indicates that the deposit insurance fund will likely return to its statutory minimum level next year and that banks are in excellent financial condition, so the FDIC’s action is a preemptive strike against a nonexistent threat. This significant, unjustified rate increase could exacerbate the stress of a slowing economy, instead of enabling resilient banks to support economic growth.”
  • Deposit data: Recent Federal Reserve deposit data bolsters the case against the FDIC’s move by contradicting one of the agency’s key assumptions – the data shows that deposits have been falling, not rising.
  • Interest rates: Rising interest rates will boost the yield on the Treasury securities held in the reserve, half of which have maturities of less than one year. The FDIC’s assumption that the yield on their portfolio will be zero forever gets more untenable every day.
  • Bottom line: The rate increase represents more than a 50 percent increase above the current weighted-average assessment rate that banks pay for deposit insurance. This rise would constrain banks’ ability to lend to their customers, and any pressure on lending capacity would particularly hurt the parts of the economy reliant on bank credit as a source of financing, such as the smallest businesses. As the economy likely approaches a recession, the last thing it needs is a drag on bank lending.

FDIC Puts Forward Large Regional Bank Resolution Proposal

The FDIC at its Tuesday meeting also approved a joint Fed-FDIC proposal seeking comment on potential new requirements for large regional bank resolution, namely issuance of long-term debt, akin to the total loss-absorbing capacity (TLAC) requirement for GSIBs. The two agencies cited growing complexity and size among banks as a driving force behind the proposal.

  • M&A implications: The proposal comes as several regional bank mergers are awaiting approval, and it could affect prospective mergers among such banks going forward.
  • Does it fit? BPI has emphasized that GSIB-like requirements like TLAC and single point of entry resolution do not fit the risk profiles or business models of large regional banks. Additionally, large regional banks in crisis scenarios would have a variety of options for their resolution, in contrast to the assumption that the only option would be selling the bank to a GSIB.

CFPB Funding Structure Ruled Unconstitutional

In the case CFSAA v. CFPB, the U.S. Court of Appeals for the Fifth Circuit this week found that the CFPB’s funding structure violates the Constitution’s separation of powers. The CFPB obtains funding through the Federal Reserve rather than from Congressional appropriations. The CFPB’s unusual funding mechanism and single-director leadership structure has long been the target of scrutiny. A few key highlights are:

  • CFPB funding structure is unique, even among other independent agencies: “Even among self-funded agencies, the Bureau is unique . . . The Bureau’s perpetual self-directed, double-insulated funding structure goes a significant step further than that enjoyed by the other [independent] agencies,” Judge Cory Wilson wrote in the decision. And none of those other agencies “wields enforcement or regulatory authority remotely comparable to the authority the [Bureau] may exercise throughout the economy,” he wrote. This suggests the court’s rationale might not apply to other “self-funded” agencies, like the federal banking agencies.
  • Payday rule vacated: The court vacated the CFPB’s Payday Lending rule at issue in the case, finding that “without its unconstitutional funding, the Bureau lacked any other means to promulgate the rule. Plaintiffs were thus harmed by the Bureau’s improper use of unappropriated funds to engage in the rulemaking at issue” and are ‘therefore entitled to “a rewinding of [the Bureau’s] action.’”
  • Broader implications: While the technical scope of the judgment is narrow – it sets aside the CFPB’s Payday Lending Rule, under the court’s reasoning, the implications could be substantial – that nearly everything the Bureau does (and has done) is invalid because it is doing so under an improper Constitutional funding mechanism.  One possibility is that an entity subject to the CFPB’s oversight could seek an injunction against the CFPB in district court in the 5th Circuit, which covers Texas, Louisiana, and Mississippi.  If an injunction were granted, it would hinder the CFPB’s ability to act in the 5th Circuit and potentially even nationwide, depending on the scope of the injunction.  If this were to occur, the CFPB likely would petition the Supreme Court to overturn the 5th Circuit’s decision.  The CFPB also could request that the entire 5th Circuit rehear the case en banc, or it could petition for Supreme Court review within 90 days regardless of whether an injunction is sought or granted.

BPI Response to International Sustainability Standards Board Vote on Scope 3 Emissions

This week the International Sustainability Standards Board (ISSB) voted to include Scope 3 emissions disclosures in the global baseline for climate-related disclosure. BPI, along with other trades, has commented to the ISSB on the standard, noting that mandatory Scope 3 disclosures are premature given significant data and methodological challenges.

Lauren Anderson, BPI senior vice president and senior associate general counsel, issued the following statement in response:

Requiring Scope 3 emissions disclosures now will undermine risk-based investment decisions and create an overly aggressive international baseline that many nations would unlikely follow, leading to less convergence.

Report Flags Risks of Fed Master Accounts for Crypto Firms

A recent nonpartisan Congressional Research Service report outlines the tradeoffs around granting Fed master account access to fintechs without banking supervision. The report describes the Fed’s finalized guidance around account access, which sorts applicants into three tiers. Master account access for crypto firms in particular could present risks, the report states. “Absent statutory changes, the Fed could find itself with limited ability to monitor or mitigate risks after a master account has been granted to an institution with no primary federal regulator,” the CRS report notes. “This raises the question of whether a nontraditional firm should benefit from valuable Fed services without bearing the regulatory costs applied to other users to access those services (and other benefits). Compared to non-crypto fintech payment firms, crypto firms pose additional risk given the extreme volatility in cryptocurrency prices, widespread scams and fraud, regulatory uncertainty, and several high-profile, abrupt failures of crypto firms.”

Bank of England Blog Weighs Challenges of Pegging Bank Risk Weights to Climate Exposures

A recent “Bank Underground” blog post by Bank of England staff David Swallow and Chris Faint explores how U.K. regulators might approach the question of incorporating climate “transition risks” into the risk-weighted asset framework, a key element of capital requirements. The post lays out steps such as understanding how such risks are captured by the current regulatory framework; determining a time horizon; and deciding what risk weights to change and how to calibrate them. “Given the current time horizon over which capital is set, the uncertainty of transition risks over those horizons and the results of regulators’ published analysis – the argument for regulators to apply a compensating adjustment to risk weights now looks challenging,” the authors conclude. “Should the argument become persuasive, further analysis and tools would be required to calibrate any regulatory adjustment.” They also note that “emerging evidence from international exercises so far suggests that banks are unlikely to face significant losses in the very near term.”

Bank Examiners are Obstructing Monetary Policy: BPI’s Bill Nelson’s Latest Macro Musings Podcast

BPI Chief Economist Bill Nelson explained how bank examiner preferences are obstructing monetary policy in a recent episode of the Macro Musings podcast with the Mercatus Center’s David Beckworth. Nelson focuses on two things examiners are doing: favoring reserve balances over other safe assets as a source of bank liquidity; and disapproving of the discount window, collateralized daylight overdrafts, and the standing repo facility as options for banks to include in their liquidity stress tests. “All of the Fed’s policies, monetary policy, lending policies towards the discount window, towards the standing repo facility and towards daylight credit, make it clear that they want banks to be willing to use these things,” Nelson said on the podcast. “But the [examiner’s] raised eyebrow … is preventing banks from being willing to do so. That being the case, banks have to hold a tremendous amount of cash on hand to be sure that they will never have to end up doing so.” To learn more, read Nelson’s recent post on the topic here.

Reuters: How Binance CEO and Aides Plotted to Dodge Regulators in U.S. and UK

A Reuters investigative piece alleged that crypto exchange Binance engaged in complex evasion tactics to avoid scrutiny from U.S. and U.K. regulators. Among the comprehensive report’s revelations: Binance’s plan to “insulate” itself from SEC probing by creating a new U.S. exchange; turmoil and turnover among U.S. compliance officers; a document allegedly backdated to avoid regulatory scrutiny; and intensive secrecy policies for Binance employees. The allegations come as Binance faces a Department of Justice investigation over whether the exchange violated the Bank Secrecy Act.

In Case You Missed It

Fed Paper: Mortgage Approval Racial Disparities Driven by Underlying Risk Factor Differences, Not Discrimination

A new Fed paper found that racial disparities in mortgage denials in recent years largely reflect differences in underlying measures of credit risk, rather than lender bias or discrimination. The paper notes that minority mortgage applicants tend to have much lower credit scores and higher leverage than white applicants. “Overall, we find that differential treatment has played a limited role in generating denial disparities in recent years,” the authors wrote. The study suggests areas that policymakers could target to improve mortgage lending access for minority applicants by addressing the underlying challenges in credit profiles – for example, “gaps in credit scores could potentially be attenuated through education and financial literacy … or through improvements in the quality of credit history data.”

  • Bottom line: “Overall, racially-biased credit decisions appear less common than has been suggested by previous research,” the authors wrote. “Our results imply significant progress in fair lending for mortgages over the last 30 years.”
  • In relation to expanding access to credit, BPI has written about how machine learning (ML) models, especially when applied in combination with alternative credit data, can improve credit decisions and facilitate broader access to credit.

Waller: CBDC Wouldn’t Change Why Dollar Dominates

The introduction of a CBDC would not affect the underlying reasons for the U.S. dollar’s dominant global role, Fed Governor Christopher Waller said in a recent speech. Changing the factors behind the dollar’s dominance – including the depth and liquidity of U.S. markets, the size and openness of the American economy and international trust in U.S. institutions and rule of law – would require “large geopolitical shifts separate from CBDC issuance,” he said. The privacy risks of some foreign CBDCs, such as China’s digital yuan, could make those currencies less appealing to international companies, he noted. He also discussed the risks of a U.S. CBDC including cyber vulnerability and displacing commercial banks as essential intermediaries, “both of which could harm, rather than help, the U.S. dollar’s standing internationally.”

The Crypto Ledger

Bankrupt crypto lender Celsius Network faces multiple investigations from the federal government, according to Bloomberg this week. The scrutiny includes inquiries from the SEC, CFTC and FTC and a subpoena from the U.S. District Court for the Southern District of New York. Here’s what else is new in crypto.

  • ‘Pig butchering’: A form of crypto scam known as “pig butchering” cost one victim $1.6 million, according to The Wall Street Journal. The scam arose through a deceptive text message that culminated in a “friend” duping the victim into sending crypto payments.  
  • Stablecoins: SEC Chair Gary Gensler recently said certain dollar-pegged stablecoins could be securities. This view “could conflict with a push to put them under banking regulation,” according to POLITICO. The comment comes as House lawmakers are working to draft stablecoin legislation.
  • An EU view: EU financial services chief Mairead McGuinness called on U.S. policymakers to regulate crypto. McGuinness said crypto regulation must be global. The official met recently with Rep. Patrick McHenry (R-NC) and Sen. Kirsten Gillibrand (D-NY), who are both working on crypto bills.

Quantum and Ransomware: Q&A with Truist’s Cybersecurity Chief

American Banker recently published a Q&A with Truist Chief Information Security Officer Howard Whyte. Whyte discussed a range of topics in bank cybersecurity, from “bug bounties” to ransomware and the future of quantum computing.

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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.