BPInsights: September 16, 2023

Basel Proposal Violates the Law

The banking agencies’ Basel proposed rule violates the Administrative Procedure Act by relying on data and analyses that the agencies have not made available to the public, the Bank Policy Institute, the American Bankers Association, the Financial Services Forum, the Institute of International Bankers, the Securities Industry and Financial Markets Association and the U.S. Chamber of Commerce wrote in a letter this week. In addition to omitting necessary information from the proposed rule, the agencies have also announced that they plan to collect additional data which they will use to calibrate the final rule – a move that also fails to comply with the law because the public would be denied the ability to review the data used in the rulemaking. The trade associations called on the agencies to remedy these violations of the law by publicly disclosing any and all evidence and analyses the agencies relied on or plan to rely upon—and then re-proposing the rule with a new 120-day comment period.

What we are saying: “The agencies cannot fill in the blanks in the final rule. Instead, to the extent the agencies intend to collect and analyze further data on which to base some or all of their rulemaking in this area, they must suspend the current open rulemaking, complete any data collection and analysis necessary to support their crafting and calibration of the rule, re-propose the rule in light of the additional analyses and data, and make that information available to the public and then allow commenters an opportunity to respond.  Any other approach would violate the agencies’ duty to identify and make available for public review and comment the technical studies and data on which any rule is based,” the trade associations wrote in their letter.

Legal requirements: The proposed rule violates basic legal obligations of the APA. When proposing a rule, agencies must identify and make available all data and analysis the agencies used to develop the proposal so that the public has a meaningful opportunity to consider and respond to the agencies’ rationale through the public comment process. The agencies have not done so here.

To learn more, click here.

Five Key Things

1. The Fed’s Stress Testing Models Are Inaccurate. Something Has to Change.

The Federal Reserve’s stress tests measure how much money banks would lose in a hypothetical crisis scenario. These losses then feed into a capital charge for each bank. But there’s a problem: The Fed’s stress test models regularly produce results inconsistent with those of banks’ own models. Why? A recent Risk op-ed by BPI’s Greg Baer and Greg Hopper delves into this question.

  • Gaping hole: A recent real-world stress test raises alarm about the flaws in Fed models. The Fed’s 2020 stress test subjected banks to a hypothetical global market shock similar to the actual shock in March 2020, when pandemic panic roiled global financial markets. The Fed’s stress test projected that banks would suffer $83 billion in trading losses, but in reality, banks earned more than $43 billion in trading revenues in the first half of that year. This begs the question: Why were the results so different? And which models are more accurate – banks’ or the Fed’s?
  • Digging deeper: Banks invest heavily in their models and use them to plan their financial reporting and manage their risk. They have significant incentives to get them right. Bank models include more granular, comprehensive data than the Fed’s. And most importantly, they are back-tested to ensure they are high quality. Except in unusual circumstances like 2020, when a real black-swan event resembles the Fed’s stress test scenario, the Fed’s models will never get a reality check.
  • Multiple scenarios: Some have suggested that banks are trying to “game” the Fed’s stress tests by seeking transparency on its models. To address concerns of “gaming”, the Fed could employ multiple scenarios, then take an average of those results to set the capital charge; set the stress capital buffer at the average over the prior three years; or emulate Europe and the UK by making the stress test informative rather than a binding capital-charge input. But ultimately, the issue rests with the models, not scenarios – if models are inaccurate, they should be revised.
  • Show the work: The Fed should release its stress testing models for public notice and comment, as BPI and the American Bankers Association recently petitioned the central bank to do.

2. Basel Under Bipartisan Pressure

The banking agencies’ Basel capital proposal faces scrutiny on both sides of the aisle on Capitol Hill. Lawmakers expressed concern at a House hearing this week about potential consequences of the proposal. In addition to Republicans, Democrats expressed concerns about the proposal’s implications for the economy.

  • Perfect storm: Concern about the proposal’s impact is bipartisan. Sen. Mark Warner (D-VA) said higher capital requirements, high interest rates and a potential shock to the commercial real estate market could combine to create “the perfect storm,” according to POLITICO. In addition, Rep. Gregory Meeks (D-NY) asked at this week’s House hearing about the proposal’s implications for special purpose credit programs that boost homeownership, and about whether the U.S. implementation of Basel deviates from Europe’s.
  • Unintended consequences: Dodd-Frank aimed to strengthen the banking system, including with higher capital, Rep. David Scott (D-GA) said at the hearing. “Since then, our banking system has successfully navigated very difficult periods, including the recent 2020 COVID economic shock. But now, I’m very concerned with the unintended economic consequences of this proposed rule and its potential impact on our banking institutions as they engage in critical market activities.”  
  • Green energy: Another key issue for Democratic lawmakers is the proposal’s effects on capital requirements for renewable energy investments. “The immediate concern that I’ve got is what it might do to tax equity markets,” Rep. Sean Casten (D-IL) said in POLITICO’s Morning Money this week. Rep. Brad Sherman (D-CA) also flagged this concern at the hearing.
  • Small business impact: Rep. Roger Williams (R-TX) asked at the hearing how Basel would affect small businesses’ access to loans. “If you listen to earnings calls…you hear about banks—particularly regional banks—talking about risk-weighted asset optimization, which means basically shedding the assets that have the higher risk weights,” Greg Baer said in response. “There is already a credit crunch beginning in this country.”
  • Tailoring: Rep. Andy Barr (R-KY) said the proposal would result in a “barbell banking system” with only very large and very small banks and a hollowed-out regional banking sector. “Regional banks now are actually well-capitalized,” Baer said in response, noting that their current challenge is an “earnings challenge,” as deposit costs are rising and loan rates are not. “This would add a massive cost to them.” Baer said that regional banks could be subjected to a panoply of rules not fit for their business models.
  • CRA: Rep. Young Kim (R-CA) expressed concern about how Basel would affect forthcoming changes to the Community Reinvestment Act rules.
  • Letter: Republican members of the House Financial Services Committee urged the agencies to withdraw the proposal in a letter this week. The proposal’s goal appears to be to dismantle the bipartisan tailoring framework enacted in S. 2155, the lawmakers wrote. “The deficient proposal would massively raise capital requirements and has been appropriately met by opposition from members of the Federal Reserve Board and FDIC Board,” they said. “Even Governors at the Federal Reserve who supported releasing the proposal for comment expressed deep reservations about its impact.” The proposal “should be replaced with one based on sound, objective analysis supported by data, not one plagued by politics,” according to the letter.
  • BPI testimony: BPI CEO Greg Baer testified this week at the House Financial Services Subcommittee on Financial Institutions and Monetary Policy at a hearing titled “Implementing Basel III: What’s the Fed’s Endgame?” In his testimony, Baer detailed how substantial capital requirement increases resulting from the banking agencies’ Basel Endgame proposal will affect every person and every business in the United States if the proposal is implemented in its current form. “If adopted, the proposed rule would complete a sea change in capital regulation:  a move from the government ensuring safety and soundness of banks to the government allocating credit across the economy,” Baer said. “The proposed rule’s 1,000-plus pages assess and specify the risk of every loan made by a bank and every other type of product offered by a bank.  Of course, because the Basel agreement was drafted as a one-time, one-size-fits-all approach, it ignores unique features of borrowers and does nothing to accommodate nuance among products or differences in risk management among banks.  Rather, it groups loans together broadly by type.  But to be sure, your loan is in there somewhere.  And to an unprecedented extent in the history of this country, the decision of whether you get that loan and how it will be priced would be taken out of the hands of loan officers at banks and vested in the formula-writers in Basel and the stress testers at the Federal Reserve.”

3. BPI’s Paridon Testifies on CBDC Before House Subcommittee

Paige Pidano Paridon, senior vice president and senior associate general counsel of the Bank Policy Institute, testified this week before the House Subcommittee on Digital Assets, Financial Technology and Inclusion on the implications of central bank digital currency. Her testimony examined misconceptions about the purported benefits of a CBDC and highlights private sector innovations that could accomplish those same benefits without the risks a CBDC would present.

  • Key quote regarding retail CBDC: “We believe that — at this point — there is little evidence that a CBDC would bring measurable benefits to the U.S. economy, or that it is necessary to defend the dollar’s status as the world’s reserve currency. Furthermore, a CBDC comes with a series of difficult policy and operational issues and risks creating financial instability.”

 To learn more, click here.

4. Op-Ed: More Capital Isn’t Always the Answer

There are better ways to strengthen the financial system than increasing banks’ capital requirements, former Federal Reserve official Bill Dudley wrote in a recent Bloomberg op-ed. Higher capital requirements made sense after the global financial crisis, Dudley wrote, but “there’s a point of diminishing returns,” he said. “Capital is crucial, but more capital isn’t the right solution for every problem.”

  • Real costs of higher capital: Increased capital requirements make credit more expensive, Dudley wrote. “Equity costs more than deposits or subordinated debt, so banks and their securities units will pass that on in the form of higher lending rates, higher trading costs and reduced market liquidity,” he said. “It’s hard to see how the benefit of greater resilience will outweigh such costs.”
  • More fragility: Dudley also points out that “rising costs will inevitably make banks less competitive relative to non-bank institutions such as private credit firms and alternative mortgage lenders, which face much less regulatory scrutiny and often no capital requirements. “In trying to strengthen banks, the US could end up with a much more fragile financial system.”
  • Cost-effective solutions: Other options to bolster the banking system would come with fewer costs than higher capital requirements, Dudley suggested. Better supervision, corporate governance reforms, stress tests with more varied scenarios, and requiring banks to pre-pledge collateral with the Fed to cover runnable liabilities could all be more cost-effective steps, Dudley said.

5. The Lone Ranger in a Town Full of Sheriffs 

The SEC has proposed significant changes to its regulations governing capital markets and investor protection. As others have noted, the breadth, scope and speed of these regulatory proposals are virtually without precedent. Members of Congress of both parties have raised concerns with this ambitious and fast-paced regulatory agenda.

This phenomenon is not limited to SEC-registered market participants — the SEC’s ambitious agenda also threatens to overhaul how banks conduct their business. Specifically, several of the SEC’s swing-for-the-fences regulatory proposals would interfere with how banks conduct traditional banking activities, like accepting deposits and providing custody services, as well as how banks manage the risks of their activities. But these traditional banking activities and risk management functions are already subject to a comprehensive regulatory and supervisory regime that is dedicated to ensuring the safety and soundness of individual banks and the banking system as a whole. While the federal bank regulatory regime is imperfect, it is comparatively well-resourced, possesses a comprehensive rulebook and includes the unique authority of bank regulators to supervise virtually every aspect of a bank’s business. This means banks are subject to a preexisting constellation of requirements, from activity limitations to prudential requirements (like quantitative capital and liquidity requirements) to ongoing supervision and examination by dedicated agency personnel.

To learn more, read BPI’s recent blog post here.

In Case You Missed It

Why Banks May Go on a Loan ‘Diet’

One way to offset the pressure from higher deposit costs would be to make more loans, but U.S. banks are lending cautiously. Higher capital requirements from the banking agencies will likely put a damper on loan growth, according to a recent piece by Telis Demos of the Wall Street Journal. Other factors behind tepid loan growth include weakening demand due to rising rates and credit caution in sectors like commercial real estate. But ultimately, higher capital requirements cast a pall over future bank lending, particularly to customers with less pristine credit risk profiles.

Court Rules that CFPB Exam Policy Goes Too Far

A Texas federal judge late last week ruled that the CFPB exceeded its legal authority by instituting a broad new examination policy in March 2022, according to Law360. The judge upheld a legal challenge brought by the American Bankers Association, Consumer Bankers Association, U.S. Chamber of Commerce and other groups. The policy at issue in the case was an update to the CFPB exam manual classifying discrimination as a prohibited unfair practice under the Dodd-Frank Act ban on UDAAP – unfair, deceptive and abusive acts and practices. The decision vacates the policy and blocks the agency from using it in enforcement against firms that belong to the groups that challenged it.

The Crypto Ledger

A recent Bloomberg Businessweek feature explores how FTX founder Sam Bankman-Fried’s parents may have influenced the company. Here’s what else is new in crypto.

  • Liquidating assets: FTX received permission from a judge this week to sell crypto assets, which the bankrupt crypto exchange said would enable it to repay customers in U.S. dollars.
  • Judge tells SBF to stay put: A judge rejected Bankman-Fried’s request to be released from jail to prepare for his upcoming trial.
  • Binance turnover: Binance.US CEO Brian Shroder has left the firm, according to CoinDesk. The exchange, which faces an SEC lawsuit, has eliminated one-third of its workforce.

Financial Services Industry Opposes Effort by Senators Durbin & Marshall to Force Credit Card Routing Mandates into Military Construction, Veterans Affairs Funding Bill

On Friday, 11 trade associations representing virtually all banks and credit unions, including those primarily serving military-affiliated customers and members, released the following joint statement opposing the effort by Senators Dick Durbin (D-IL) and Roger Marshall (R-KS) to attach their proposed credit card routing legislation (S. 1838) to the Military Construction, Veterans Affairs, and Related Agencies Appropriations Act (H.R. 4366):

“The financial services industry stands united in opposition to the effort by Senators Durbin and Marshall to delay funding for veterans and our military in order to gift a massive government handout to Walmart, Target, and other big-box retailers. The Durbin-Marshall credit card routing legislation has no relevance to military or veteran spending whatsoever. We call on both Senators to promptly abandon their effort to use the Military Construction, Veterans Affairs, and Related Agencies Appropriations Act to secure government favors for big-box retailers at the expense of consumers, small businesses, and small financial institutions.”

To learn more, click here.

Limiting Medical Payment Options Won’t Deter Costs but Will Reduce Access to Services

BPI and the Consumer Bankers Association addressed misconceptions surrounding medical payment products in a letter this week to the Consumer Financial Protection Bureau, the Department of Health and Human Services and the U.S. Treasury Department. The agencies issued a request for information in July that wrongly asserts that “medical payment products” — a term the agencies do not define — are responsible for the high cost and disfavored practices of healthcare service providers, hospitals and insurance companies.

“Many consumers do not have access to sufficient funds to pay the full cost of a particular healthcare service using liquid funds,” the associations wrote. “Having different options to pay for medical care, each with different terms and features, provides consumers with the ability to select a payment product that best suits his or her individual needs and finances.”

The agencies only briefly acknowledge this benefit in the RFI, stating “[i]n some cases, medical payment products may allow patients to access care they would otherwise have to forgo,” but fail to further examine these benefits and instead attempt to blame the availability of payment options for the agencies’ broader criticisms of the U.S. healthcare system.

Bottom line: Limiting medical payment options will harm consumers, not help.

Bank Executives Express Concern on Higher Capital Requirements

Multiple bank leaders expressed concern about increased capital requirements under the Basel proposal. “I don’t think these rules make sense,” said Goldman Sachs CEO David Solomon at a recent Barclays conference. In addition, JPMorgan Chase CEO Jamie Dimon reiterated concerns about the significant costs of higher capital requirements. At the Barclays conference, the chief executive said regulators should have disclosed more details about the “cost-benefit to society” of higher capital. Central banks are “the ones that told the world rates aren’t going up,” he said. “So if I were them, I’d have a little bit more humility over stuff like this.” Dimon has previously warned that the proposed requirements will make it harder for banks to offer mortgage loans and other kinds of financing. Businesses in the U.S. are “the ones who ultimately are going to pay for this,” Bank of America CFO Alastair Borthwick said of the proposed capital increases at the same conference.

Survey: Small Business Owners Raise Alarm on Difficulty Accessing Capital

A large majority – 84% – of small business owners fear that new bank capital requirements will exacerbate difficulty accessing credit, according to new Goldman Sachs survey data. Seventy percent of small business owners who have applied for a new business loan over the last year reported difficulties accessing capital. Seventy-six percent say challenges accessing affordable capital have negatively affected their business. The Basel Endgame proposal to increase bank capital requirements could make these challenges even worse.


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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.