BPInsights: September 10, 2022

Stories Driving the Week

Capital, Climate, Crypto: Key Takeaways from the BPI/TCH Conference

The BPI/TCH Annual Conference this week explored a range of important topics in the bank policy landscape. Here are a few key takeaways from the event.

• Crypto and the regulatory perimeter: One theme in the conference: is crypto more dangerous inside or outside the regulated banking system? “The banking system should be used as the safe crypto distributor,” former OCC chief Eugene Ludwig said at a panel. Ludwig also emphasized the risks of regulated banks ceding market share of crucial financial products to nonbanks. Nonbanks are “getting away with murder” while banks are being pushed out of providing products like mortgages due to certain regulatory requirements, he said.
  
  Separately, Acting Comptroller Michael Hsu expressed concern that crypto is “very hype-driven”, and said the banking system weathered the crypto market meltdown unscathed partly because of the OCC’s “careful and cautious” approach. Hsu also said the banking agencies had more “breathing space” and time to collaborate on crypto now. Federal Reserve Vice Chair Lael Brainard separately noted the risks to consumers posed by crypto and said similar risks should have similar disclosures and regulatory outcomes. In some cases that would mean enforcing existing rules, while in others, policymakers should create “clear regulatory guardrails,” Brainard said. Stablecoins in particular would pose risks if not properly regulated, she said, such as with prudential guardrails and liquidity backstops.
  
  Bank-fintech partnerships were also a hot topic of discussion throughout the conference. Hsu highlighted the topic in his keynote remarks.
• Russian energy: Pressure is building in Europe as the continent faces a winter of high energy prices amid Russia’s war in Ukraine. The U.S. and allies are trying to strike a balance between inflicting pain on Russia and limiting constraints on European energy supply. Deputy Treasury Secretary Wally Adeyemo discussed the G7’s price cap coalition on Russian oil. Russia’s cutoff of the Nord Stream pipeline should make it clear to other countries that the nation is not a reliable supplier, Adeyemo said in a Q&A with BPI CEO Greg Baer.
• Supporting minority communities: Adeyemo also noted the benefits of the Economic Opportunity Coalition, an effort to invest in underserved communities that includes several BPI member banks. The coalition has committed tens of billions of dollars to support underserved communities, including billions in support for CDFIs and MDIs. Separately, industry, academic and government experts discussed challenges in financial inclusion. The discussion highlighted the Bank On program, which offers low-cost transaction accounts for underserved customers, and the fraud and consumer protection risks among some fintechs that tout their financial inclusion potential.  
• Addressing climate risk in banking: Participants also discussed climate in banking regulation. “Given the uncertain nature of climate-related risks today, probing for vulnerabilities under different scenarios will be more impactful to climate-related risk management than generating comparable, but overly stylized, loss estimates,” Hsu said in his keynote. “I am concerned that the muscle memory of capital stress testing is more likely to handicap climate scenario analysis than to help it. I believe a clean sheet of paper and an open mind to considering a wide range of risks and scenarios will yield richer and more actionable information than an approach that borrows heavily from capital stress testing.” Hsu previewed the upcoming announcement of a new Chief Climate Risk Officer at the OCC. Separately, industry and government experts discussed the challenging balance of financing the clean-energy transition amid state efforts to scrutinize banks transitioning their levels of fossil fuel financing.
• M&A: Bank merger review guidelines are “ripe for updating,” Hsu said in his remarks. Hsu recently suggested that large regional banks should face TLAC and SPOE resolution requirements in connection with M&A approvals. He reiterated concerns that a large regional bank would have to be sold to a GSIB if it failed. He clarified that he does not have a “set-in-stone view” on whether TLAC and SPOE would be the best way to enhance large regional banks’ resolvability. A separate panel discussed the regulatory approval process governing bank mergers and possible future directions in bank M&A policy.

The conference also included a roundtable of bank CEOs offering a big-picture view of the U.S. economy and post-pandemic workplace; a keynote speech by Brainard on the Fed’s inflation fight; and panels on tech in banking, real-time payments, access to the payments system and CBDC, among other relevant banking topics.

Gensler Draws Lines on Crypto Intermediaries

SEC Chair Gary Gensler called on crypto intermediaries — which often offer an “amalgam of services” including exchange functions, broker-dealer functions, custody, clearing or lending – to register with the SEC and, in some cases, split up their functions into separate legal entities. Gensler said in a speech this week that “given that many crypto tokens are securities, it follows that many crypto intermediaries are transacting in securities and have to register with the SEC in some capacity.” He added that “The commingling of the various functions within crypto intermediaries creates inherent conflicts of interest and risks for investors.” Gensler noted that stablecoins, depending on their attributes, may be considered shares of a money market fund or another kind of security, and may need to register and provide investor protections.

Coinbase Joins Effort of Crypto Mixer to Avoid AML/CFT Restrictions, Citing Privacy Rights

Coinbase is backing a federal lawsuit that claims the Treasury Department overreached by sanctioning crypto mixer Tornado Cash, which is accused of enabling North Korean hackers to launder money. Coinbase Chief Legal Officer Paul Grewal wrote that Treasury’s sanctions “have harmed innocent people seeking to legitimately protect their privacy and security using this technology, as the stories of these six individuals make clear.” Grewal was referring to the six individuals bringing the lawsuit who had used the mixer to anonymize their digital transactions. The move to fund the lawsuit comes as the SEC is eyeing crypto exchanges, and their panoply of different functions, for heightened oversight, and as Treasury is targeting crypto platforms that enable oppressive regimes and global criminals to evade sanctions.

Stress Tests, M&A, Stablecoins: Michael Barr’s Debut

The Fed’s new Vice Chair for Supervision, Michael Barr, made his first public speech on the job this week at a Brookings Institution event. Here are some highlights of his comments and a subsequent Q&A session.

• Capital: Barr outlined three principles to guide modifications to the Fed’s capital framework – evolving through a continuous process of incorporating emerging risks; tiered structure with firms facing higher costs and stringency levels as they grow in complexity, size and interconnectedness; and calibration to account for risks of specific activities. He also noted that “simpler, non-risk-based approaches can serve as important backstops” in light of the complexity of risk-based approaches. The Fed will seek to minimize “unintended consequences” and “limit opportunities for gaming” as it considers changes to its framework.
  • Coming soon: The Fed will undertake a “holistic review” of its regulatory capital tools this fall, Barr said – considering them as individual components and as a whole, combined framework. The central bank may weigh adjustments to the SLR, CCyB and stress testing. The review includes a commitment to implementing the “enhanced regulatory capital requirements that align with the final set of Basel III standards.”
  • Strong enough? Having questioned whether capital is “strong enough,” Barr indicated that, as part of its review, the Fed is looking at models of “what optimal capital levels look like in the literature” and “responses to past crises.” Will also consider “what might be a better level or more appropriate level [of capital] in the future,” and that a future rule will not necessarily be capital-neutral.
  • Together or separate? Barr said he is not certain whether any SLR changes would be proposed separately or together with a comprehensive package of capital rule modifications. He said the Fed intends to conduct its holistic review all at once, after which he plans to deliver public remarks in the fall outlining the direction he thinks the rulemaking on capital should go in.
  • Stay stressful: Barr noted that it is really critical that stress tests need to continue to evolve and that he wants to “make sure that the stress tests stay stressful.”
• Resolution: The Fed and FDIC will be looking at resolvability of the large non-GSIB banks as they grow and as their significance in the financial system increases, Barr said. The Fed will work with other banking agencies and seek public comment as they consider policy actions in this area, he said.
• M&A: Barr is working with Fed staff to evaluate how it analyzes bank mergers and where it could improve, he said. He did not specify what kind of output – formal updates to the Fed’s merger review guidance, for example — would come from that evaluation.
• Climate: The Fed plans to launch a scenario analysis exercise next year to evaluate long-term, climate-related financial risks among the largest banks, focused on a “handful” of GSIBs, Barr announced. The exercise will not have direct capital or supervisory implications; rather, it will be a learning exercise to help the Fed understand how banks are thinking about such risks. The Fed, FDIC and OCC will likely issue joint guidance to help banks develop their climate risk management systems, he said.
• Stablecoins: Barr expressed concern that stablecoins could pose financial stability risks. He urged Congress to pass legislation to bring them inside the prudential regulatory purview. The Fed will coordinate with the FDIC and OCC to ensure “that crypto activity inside banks is well regulated, based on the principle of same risk, same activity, same regulation, regardless of the technology used for the activity.” Barr said he plans to ensure that any crypto activity of Fed-supervised banks is subject to necessary safeguards. 
• CBDC: The Fed is “not in crisis mode” about the need to issue a CBDC, Barr said. He emphasized that the U.S. should explore the notion of a CBDC by “understanding policy tradeoffs” and privacy concerns. The Fed is focused on intermediated versions of CBDC rather than direct-to-consumer versions, he said, echoing statements by Lael Brainard at the BPI/TCH conference. Barr agreed with Fed Chair Powell’s view that the Fed should consult with Congress and the executive branch to ensure they coordinate. 

CRA: Innovation, Access, and Consumer Protection
Barr noted one of his major objectives as Vice Chair is to make the financial system fairer, noting the following three essential elements of fairness:  (1) financial capability, (2) financial access, and (3) consumer protection. He explained that financial capability requires transparency in the cost of services to help consumers make smart choices.  He also noted that the Federal Reserve should help promote access to low-cost and safe banking services for LMI consumers, such as through local Bank On initiatives and will use “supervision and regulation to fully implement laws to promote fair lending, consumer protection, and transparency in the consumer financial services marketplace.”

• Faster payments: Vice Chair Barr stated that the Fed needs to focus on access to fast, efficient digital payments as “a matter both of efficiency and of fairness,” as LMI consumers and small businesses “can ill afford to wait days for their income checks to clear” and “overdraft and insufficient funds fees hit LMI households hard.”  He pledged his support of the efforts underway at the Fed to move to instant payments, including “the launch of the FedNow Service” scheduled for spring of 2023. 
• CRA: Barr voiced his support of the interagency CRA proposal issued earlier this year “designed to strengthen and modernize CRA regulations” and the purpose of the CRA, which “sends the unequivocal message that there is no place for discrimination in the financial system, and that every community and every borrower deserve to be treated fairly.”

European Commission to Suggest Streamlined Energy Trading Rules Amid Volatility

The European Commission on Friday planned to present European finance ministers with modifications to EU trading rules under the European Market Infrastructure Regulation (EMIR) to ease pressures in the volatile energy market. The Commission will outline the plan at an informal meeting in Prague, where ministers will convene to discuss high energy prices as Russia limits its gas exports to Europe, according to POLITICO. The suggested changes, amid fears of energy supplier defaults and spillover into derivatives markets, face skepticism from the ECB as such rules are designed to protect the financial sector from stress. The Commission could ease requirements on providing cash as collateral at clearinghouses or introduce circuit breakers to halt trading during major market swings.

House GOP Asks Brainard to Clarify CBDC Testimony

Republicans on the House Financial Services Committee this week pressed Fed Vice Chair Lael Brainard in a letter to clarify statements she made in a May Congressional hearing on central bank digital currency. The lawmakers sought details on the Fed’s motivation for issuing a CBDC: “Is the Fed’s objective with a U.S. CBDC to curtail the use of digital assets and other private sector innovative payment methods?” They also asked her views on whether Congress would need to pass a law authorizing a CBDC; whether the Fed would limit its analysis to an intermediated form of CBDC; whether the Fed can establish an intermediated CBDC model without direct Congressional authorization; and what Brainard meant by the Fed needing “strong support from the executive branch.”

In Case You Missed It

The Crypto Ledger

Treasury is expected to call for strong crypto regulation in a series of forthcoming reports. The Administration issued a report on crypto’s climate impacts. Here’s what’s new in crypto this week.

• Another alleged Ponzi scheme: A Florida crypto trader, Joshua David Nicholas of crypto platform EmpiresX, pleaded guilty in an alleged Ponzi scheme that raised about $100 million, according to the Wall Street Journal.
• Did Celsius mislead investors? The Vermont Department of Financial Regulation accused bankrupt crypto lender Celsius Network of manipulating the market and misleading investors, according to Bloomberg. “During the course of the multistate investigation, it has become clear that Celsius, through its CEO Alex Mashinsky and otherwise, made false and misleading claims to investors about … the company’s financial health and its compliance with securities laws,” the filing said. “Both of which likely induced retail investors to invest in Celsius or to leave their investments in Celsius despite concerns about the volatility of the cryptocurrency market.”
• Senate hearing: The Senate Agriculture Committee scheduled a hearing for Sept. 14 to discuss a crypto bill, the Digital Commodities Consumer Protection Act. Witnesses will include CFTC Chair Rostin Behnam and attorneys from Coinbase and Citadel Securities.
• QT and crypto? The Axios Crypto newsletter this week featured an analysis of how the Fed’s quantitative tightening process might affect crypto assets.

The $2 Trillion Question: Will a Growing ON RRP Facility Force the Fed to Quit QT?

BPI Chief Economist Bill Nelson on Friday hosted a panel of expert analysts to discuss whether further growth of the ON RRP facility will lead to reserve balance scarcity and thereby force an early end to the Fed’s quantitative tightening process. Panelists expressed a range of views on the topic. The panel included Bank of America’s Mark Cabana, JPMorgan’s Teresa Ho, UBS’ Mike Cloherty and Barclays’ Joe Abate.

• The situation: Nelson set the stage – bank deposits ballooned during the pandemic, in part because deposit and money market rates were all basically zero. Deposits were an attractive place to keep cash. Now that the fed funds rate is rising, deposit rates may lag behind; funds could flow out of deposits into money funds; money funds could then invest in the ON RRP facility. The “$2 trillion question” is: Will the ON RRP facility remain high or get higher as extra deposits continue to leave banking system, forcing an early end to QT?
• Different perspectives: The panelists held various views on what would happen. Joseph Abate predicted that RRP balances would rise. In an environment where banks are “significantly over-deposited,” it would be expected that more money would move into money market funds, he said. Balances of government-only money market funds, however, have stayed relatively flat.
• Not sit idly: Mark Cabana said he expected RRP will “naturally drain over time” driven by bank competition. Institutional investor funds will likely leave banks in favor of higher-yielding securities or money funds, he said, but “we don’t expect banks to sit idly by and let that happen.” Banks want funds in order to make loans, he said, and money funds right now are avoiding having the Fed “out-hawk” them.
• Where is the floor? Mike Cloherty explored the various regulatory factors that could affect money market movements, such as the liquidity coverage ratio, leverage restrictions, capital requirements and forthcoming SEC money market reforms. He discussed uncertainty over where the “floor” of reserves in the system might be, and the precariousness of guessing that level.
• Confluence of constraints: Teresa Ho judged that the ON RRP facility would eventually decline, perhaps with a push from a wider IORB/ON RRP spread, but it will take time.  As a result, reserve scarcity and an elevated ON RRP may coincide.
• SRF stigma: The strategists also discussed the standing repo facility – “it’s about as useful as a bond strategist in a street fight,” Cloherty said. Cabana said that “when push comes to shove,” dealers will probably use the SRF, but it may not be stigma-free enough for a commercial bank to use it.

Court Rules Citi Can Recover $500M in Revlon Wire Transfer Case

The U.S. Court of Appeals for the Second Circuit ruled this week that Citibank can recover $500 million mistakenly wired to Revlon Inc. lenders, according to Law360. The court vacated a New York federal court decision that the lenders did not have to return the funds based on the legal doctrine of “discharge-for-value.” The Second Circuit panel disagreed. The Revlon debt was not yet due when the money was wired, and the transfer showed signs that it could have been made in error. The Second Circuit decision ends a two-year legal battle over the fund transfer. BPI filed a brief in the case.

CISA Prepares to Seek Public Input on Cyber Incident Reporting Requirement

The Cybersecurity and Infrastructure Security Agency announced its plans to seek public feedback on a cyber incident reporting requirement for critical infrastructure firms. The agency will publish a request for information on the topic as it moves toward a rulemaking, the agency announced Friday. Under the fiscal 2022 appropriations bill, Congress gave the agency two years to publish an interim rule, followed by 18 months to publish a final rule. CISA has indicated it will move more quickly and has announced a series of listening sessions around the country to gain private-sector feedback.

BofA to Invest $25M in Minority-Led CDFI Support

Bank of America is investing $25 million in two organizations to support minority-led CDFIs, according to an announcement this week. The organizations, National Alliance of Latino CDFI Executives and the African American Alliance of CDFI CEOs, represent over 130 CDFIs that serve Latino and African American communities.