BPInsights: October 9, 2021

Stories Driving the Week

Memories … and Aging Well

For anyone who has yet to read this fantastic (in every sense of the word) investigative report on Tether, here is the story of how it is run and by whom, and what assets are really backing its stablecoin. 

Reading it, we couldn’t help but remember that in December 2020, then-OCC leadership was touting the benefits of such instruments, dismissing their financial stability risks, and deriding those of us who questioned their backing.  As we wrote at the time in response to such an attack from the OCC’s then-chief economist:

“Mr. Calomiris also dismisses the possibility that a bank funded with stablecoins could face any incentive to invest in risky assets.  It is worth quoting his reasoning at length:

‘Could a risky version of this bank arise in equilibrium (where the stable value coin bank would convert a significant fraction of its cash assets into risky assets)? This seems unlikely. It is hard to see why that would appeal to coin holders. …Furthermore, setting up a risky stable value coin bank likely would not appeal to the bank’s organizers either; note that my model assumes that if the bank is unable to meet its contractual commitment in the secondary market, the preexisting shareholders of the bank would forfeit all of their common stock.

Even if I am missing some reason why a risky version of a stable value coin bank might appeal to coin holders and bank organizers, such a bank would not create any new risks for the rest of the economy from losses it incurs. … Recall that the stable value coin bank modeled here operates under a coin write down protocol that automatically converts preexisting coins into new coins (of lower value) and creates new common shares to replace old ones. Thus, even if a risky stable value coin bank were created for some reason I cannot fathom, given that it does not rely on redeemable deposits, it would not contribute to systemic risk in the way that standard depository banks do.’

We do not find it at all hard to imagine why the investors in a stablecoin-issuing bank would want the bank to invest in riskier assets – riskier assets earn higher yields so the owners of the stablecoins, and the owners of the crypto bank, would make more money if they increased the risk of the bank’s portfolio…. “

We guess that in this case, foresight was 20-20.

Incident Reporting Law Moves Toward Finish Line as Senate Seeks to Advance Sensible Solution

This week, the U.S. Senate Committee on Homeland Security and Governmental Affairs advanced legislation to improve information sharing on cybersecurity threats between the private sector and government partners and strengthen federal cybersecurity. In advance of that vote, BPI Executive Vice President and President of BITS Chris Feeney issued the following statement:

“We appreciate the Committee’s efforts to streamline the reporting of cyber incidents by affected companies, an effort that financial institutions have been conducting in accordance with law and regulation for over 20 years. Banks entrust data on cyber incidents and potential threats to law enforcement, regulators and other government partners to help strengthen the financial system and fight financial crime. It is critical that this sensitive information should be covered by the same liability, disclosure and misuse protections whether it is reported directly to CISA or shared with CISA by regulators. We look forward to working with the Committee to include these protections which will further enhance cyber information sharing and enable banks to remain focused on protecting consumers. We value the Committee’s willingness to collaborate with stakeholders and ongoing commitment to address this issue and look forward to continuing to work together to ensure such protections are included before final passage.”

BPI strongly supports legislation sponsored by Chairman Gary Peters (D-MI) and Ranking Member Rob Portman (R-OH) to require critical infrastructure firms to report cyber incidents to CISA within 72 hours. The timeframe would allow firms to focus their early response on threat investigation and remediation rather than having to divert resources to compliance efforts. The bipartisan bill largely aligns with a proposal recently passed by the House as an amendment to the National Defense Authorization Act. Both bills recognize the need to harmonize new incident reporting requirements with existing laws and regulations. 

Coverage of the bill quoting BPI’s Heather Hogsett can be found in Bloomberg and Inside Cybersecurity.

Cleveland Fed Study: Bank Consolidation Doesn’t Hurt Branch Access

Bank consolidation does not impede consumers’ access to bank branches, according to a new Federal Reserve Bank of Cleveland study. Consolidation in recent years actually increased the total number of bank branches per institution, resulting in a larger number of branches to meet consumers’ needs, the study found. On average, urban consumers’ access to full-service bank branches was not significantly changed by consolidation, and rural consumers’ access increased.

Global Standard Setters Eye Stablecoin, Crypto Risks Ahead of U.S. Review

As the President’s Working Group on Financial Markets prepares to release a report on a possible approaches to a stablecoin regulatory framework, several global standard-setting groups recently issued their own guidelines about the digital assets, offering a view of how they may be supervised across financial markets.

  • CPMI/IOSCO: The Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions issued a paper this week outlining considerations to help authorities determine whether a stablecoin arrangement is systemically important. The considerations include size, nature and risk profile of stablecoin transactions, interconnectedness of the stablecoin with the real economy and the substitutability of the stablecoin. The paper also provides guidance on the application of the Principles for Financial Market Infrastructures (PFMI) to systemically important stablecoin arrangements, highlighting those principles that any systemically important stablecoin issuer should follow, such as appropriate governance arrangements and a comprehensive risk management framework.
  • IMF: The International Monetary Fund’s latest Global Financial Stability Report contains a chapter describing the risks posed by cryptocurrencies including stablecoins and offering policy options to navigate those risks. “Given the composition of their reserves, some stablecoins could be subject to runs, with knock-on effects to the financial system,” the IMF said in a blog post about the report. “The runs could be driven by investor concerns about the quality of their reserves or the speed at which reserves can be liquidated to meet potential redemptions.” The IMF recommends coordination among global regulators on crypto. Regulators should consider requiring enhanced stablecoin disclosure and independent auditing of stablecoin reserves, among other measures, the chapter says.
  • FSB: The Financial Stability Board issued a “progress report” on stablecoins this week evaluating progress in implementing several steps recommended last year to global financial authorities. The recommendations include regulatory coordination, ensuring stablecoin arrangements have a comprehensive governance framework and making sure stablecoin entities manage cybersecurity, AML/CFT and operational resilience risks. The process is still at an early stage, said the FSB, which warned that a “global stablecoin” entering the financial mainstream as a means of payment and/or store of value in multiple jurisdictions “would pose greater risks to financial stability than existing stablecoins and may challenge the comprehensiveness and effectiveness of existing regulatory, supervisory and oversight approaches.”

Quarles Warns on LIBOR’s Final Days

In anticipation of the House Financial Services Committee Subcommittee on Diversity and Inclusion’s hearing

Federal Reserve Vice Chair for Supervision Randal Quarles urged banks in a speech this week to accelerate their transition away from LIBOR. Some tenors of U.S. dollar LIBOR will continue to be published until mid-2023, but the post-2021 LIBOR quotes should only be used in legacy contracts, he said. “Use of these quotes for new contracts would create safety and soundness risks for counterparties and the financial system,” he said. “We will supervise firms accordingly.”

Quarles also clarified that a bank “may also use any reference rate for its loans that the bank determines to be appropriate for its funding model and customer needs,” he said. He reiterated banking agency guidance that the Federal Reserve, OCC and FDIC have not endorsed a specific LIBOR replacement rate for loans and that they have not changed that guidance.

DOJ Targets Ransomware on Crypto Exchanges

The Department of Justice is launching a new team targeting hackers using cryptocurrency exchanges to facilitate ransomware attacks, Deputy Attorney General Lisa Monaco said this week, according to Bloomberg. The move aims to dismantle the “criminal supply chain” hackers use to carry out such attacks, she said. DOJ will also levy “hefty fines” against government contractors that do not report hacks or that hide their cybersecurity vulnerabilities, Monaco said. DOJ’s actions follow recent Treasury Department ransomware actions, which included sanctioning cryptocurrency exchange SUEX – in line with recent BPI recommendations to address the threat of ransomware.

In Case You Missed It

Senate Reaches Deal on Debt Ceiling

The Senate punted on a longer-term agreement on the debt ceiling, with a U.S. debt default looming over financial markets when the agreement runs out in December. Democrats and Republicans agreed to a short-term extension of the debt limit this week, bringing a temporary resolution to weeks of gridlock. McConnell remains opposed to a longer-term increase in the debt limit, setting up the same partisan clash in December. Republicans have argued that Democrats should act alone using reconciliation – a budget measure requiring only a simple majority – if they want to extend the debt ceiling longer-term. Democrats contend that it should be a bipartisan process.

Republican Minority Leader Mitch McConnell has offered to consider a longer-term bipartisan debt limit increase if Democrats drop their social spending package – a deal Democrats consider a non-starter. The debt ceiling conundrum has bolstered some Senate Democrats’ argument for ending the legislative filibuster which while unlikely would lead to a precedent that would aid the party in control and undermine the cooling saucer of the Senate.

Treasury Weighs Imposing Bank-Like Rules on Stablecoins

The President’s Working Group on Financial Markets, led by the Treasury Department, is considering ways to impose bank-like regulation on the cryptocurrency companies that issue stablecoins, according to Bloomberg and the Wall Street Journal.  One way to achieve this result under consideration is a recommendation that Congress establish a limited banking charter allowing new crypto banks to manage stablecoins as deposits.  The group also is considering urging the Financial Stability Oversight Council to examine whether stablecoins pose a systemic risk to the financial system. Regulators are concerned that uncertainty over the reserves backing stablecoins may cause investor runs. The PWG is expected to issue a report soon offering recommendations for a stablecoin regulatory framework.

Stablecoin Issuer Circle Subpoenaed by SEC

Circle Internet Financial, backer of the USDC stablecoin, received an investigative subpoena in July from the Securities and Exchange Commission, according to Bloomberg. The subpoena was from the SEC’s Enforcement Division and requested documents and information regarding certain of Circle’s holdings, customer programs, and operations.  The firm disclosed the subpoena as part of a filing related to its plan to go public through a merger with Concord Acquisition Corp.

Brainard Previews Scenario Analysis as Climate Prudential Risk Tool

Federal Reserve Governor Lael Brainard this week said the central bank is developing scenario analysis to model financial risks associated with climate change and evaluate banks’ resilience to such risks. The tool, which differs from climate stress tests, allows bank supervisors to game out potential implications of physical and transition risks. Brainard said the Fed hopes to learn from foreign regulators’ use of scenario analysis. She also previewed that the Fed may provide supervisory guidance for large banks on climate risk management and measurement.

Hsu: OCC Exploring Approaches to Encourage Bank Board and Executive Diversity

Acting Comptroller Michael Hsu said in a speech this week at a WHF event that the OCC wants to improve transparency around bank board and executive diversity. Noting that diversity is important for a bank’s safety and soundness, Hsu explained that “we are also exploring and considering taking other steps, like encouraging banks to make it a practice to nominate or consider a diverse range of candidates or requiring institutions to either diversify their boards or explain why they have not.”

BMO Harris Raises U.S. Minimum Wage for Frontline Employees to $18/Hour

BMO Harris increased the minimum hourly wage for its U.S. branch and call center employees to $18, the bank announced this week. The change will take effect Oct. 17.

‘Top 25 Most Powerful Women in Banking’ Features BPI Member Executives

American Banker released its annual list of the Top 25 Most Powerful Women in Banking, which featured a large number of BPI member executives.

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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.