BPInsights: September 17, 2022

Stories Driving the Week

Banks Are Gradually Being Pushed Out of Business Lending. Here’s What That Means for the Economy

Mortgage lending has shifted away from the banking sector into nonbank firms, partly because of regulatory constraints. A similar phenomenon, albeit more gradually, is happening in business lending. Private capital markets – private equity, hedge funds, loan mutual funds and other nonbanks – have dramatically expanded their foothold in lending to businesses. These nonbank lenders are typically not public companies, so the lack of transparency into the size and scope of their operations make their role in lending to businesses difficult for the public and policymakers to observe. A new BPI blog post documents the decline in the bank share of business debt, explains how high bank capital requirements have driven it and explains why the trend is weakening financial stability.

Why? Reasons for the decline in bank lending to businesses include:

• Tighter regulatory constraints, such as capital requirements, applied only to banks.
• More stringent supervisory expectations with regard to leveraged lending standards.

Why it matters: Nonbank financial firms’ growing market share in business lending implies that financial stress will likely worsen in the next recessions as banks are the lender of first resort in a crisis. This heightened stress could make Federal Reserve intervention in financial markets – an extraordinary measure meant for the most extreme crises – into a regular, recurring phenomenon.

Takeaway: As regulators prepare to implement the Basel III Endgame framework in the U.S., they must consider that increasing bank capital requirements further would push bank lending, including business lending, into the less regulated nonbank sector. The rise in nonbank market share in business lending poses risks to financial stability through the role corporate leverage plays in propagating negative shocks throughout the economy, and by constraining the supply of liquidity by banks during a crisis.

Survey: U.S. Retail Banks Deliver Excellent Customer Service, Fraud Protection

In advance of a congressional hearing with the CEOs of the top seven U.S. retail banks, a new Morning Consult survey finds customers are highly satisfied with their bank’s service and fraud protections. The survey of customers of Bank of America, Citibank, JPMorgan Chase, PNC, Truist, U.S. Bank and Wells Fargo demonstrates the high degree of trust and customer satisfaction among large U.S. retail banks.

“This survey demonstrates that customers value and appreciate the products and services their banks provide, and understand banks keep their money safe and protect them from fraud,” said BPI President and CEO Greg Baer.

Key findings of the survey:

• 89% of customers rate their primary bank’s overall service as “excellent” or “good.”
• Almost 8 out of 10 customers say the fees associated with their bank account(s) are reasonable (79%).
• Almost 9 out of 10 adults who have been victims of fraud were satisfied with their bank’s response (89%).
• More than 4 in 5 customers agree they trust their bank to keep their money safe (88%).

To learn more, see our infographic here.

What’s Missing in the CFPB Analysis of Credit Card Interest Rates 

A recent CFPB blog post concludes that limited competition in the credit card market could be driving rising average credit card interest rates for revolving accounts and takes aim at credit card banks’ “outsized profits.” But the analysis failed to consider important factors such as the adoption of a new accounting standard and increased entry of fintech firms into the broader market for consumer loans, according to a new BPI post.

• Missing the big picture: The CFPB takes credit card bank profitability out of context – the profitability in 2021 that the Bureau cites was largely driven by the adoption of a new accounting standard combined with banks decreasing allowances for credit losses from their pandemic peak. Credit card bank profitability actually declined from 2011 to 2019. The emergence of fintech lenders in the consumer loan market is also relevant: fintech loans are more likely to be available to customers with higher credit scores. Fintech lenders drew some of the most creditworthy credit card borrowers away from banks by offering personal loans with attractive terms to pay off credit card debt. The increase in the average interest rate of revolving credit card balances likely reflects a skew toward households that did not obtain loans to pay off credit card balances and continued to carry credit card balances month to month.
• Next steps: As the CFPB considers potential changes to consumer regulations, it should conduct a deeper study of how recent trends in credit card usage, including cream-skimming by fintechs and the emergence of buy-now-pay-later firms, are affecting the average interest rates on credit card loans.

Future of Payments, Illicit Financing: Treasury’s New Digital Asset Reports

The U.S. Treasury Department on Friday issued three new reports under the Biden Administration’s executive order directing the federal government to formulate a strategy on digital assets. The reports cover “The Future of Money and Payments,” “Implications for Consumers, Investors, and Businesses,” and “Action Plan to Address Illicit Financing Risks for Digital Assets.” The future of money report explores the topics of CBDC and stablecoins and recommends that the U.S. advance its work on a potential CBDC, “in case one is determined to be in the national interest,” create a federal framework to regulate payments, and encourage the use of instant payments systems. The reports also encourage the CFPB and FTC to redouble efforts to monitor consumer complaints and enforce against unfair, deceptive or abusive practices.

Future of Money and Payments
Key recommendations:
The report makes recommendations for the U.S. government to:

1. Advance work on a possible U.S. CBDC, in case one is determined to be in the national interest.
2. Encourage use of instant payment systems to support a more competitive, efficient, and inclusive U.S. payment landscape.
3. Establish a federal framework for payments regulation to protect users and the financial system, while supporting responsible innovations in payments.
4. Prioritize efforts to improve cross-border payments, both to enhance payment system efficiency and protect national security.

Other key highlights:

• CBDC: The report acknowledges the risks of a potential CBDC, including flight to quality, and highlights that it is likely unnecessary to preserve the U.S dollar’s role as the reserve currency. Although the report said CBDC could potentially promote financial inclusion, it also recognized that CBDC could exacerbate barriers to inclusion for some individuals. The report also says that use of a new payment system, including a potential U.S. CBDC, should not be mandated.
  • The report encourages the Federal Reserve to: continue its research and technical experimentation on CBDCs, including its work on analyzing the possible choices of technology and other design elements of a CBDC; continue evaluating policy considerations; find mechanisms to provide the public with periodic updates; and consider how research and development on digital assets and other related innovations that is conducted or supported by other federal agencies could support a U.S. CBDC.
• Instant payments: The report recommends that U.S. government agencies should consider and support the use of instant payment systems, including in the distribution of disaster, emergency or other government-to-consumer payments.
• Federal payments regulation: The report notes that a federal framework for payments regulation could establish “appropriate federal oversight of nonbank companies that are involved in the issuance, custody, or transfer of money or money-like assets” that today are largely subject to state regulation, which “varies significantly, and is generally not designed to address run risk, payments risks, or other operational risks in a consistent and comprehensive manner.”
• Cross-border: The report emphasizes the importance of the U.S. taking a leadership role in the global effort to improve cross-border payments, that should prioritize:
  • Ensuring the safety and soundness of private and public sector innovations for cross-border payments, while protecting U.S. national security;
  • Considering the feasibility of new multilateral platforms and arrangements for cross-border payments, including utilizing instant payments;
  • Working across jurisdictions to align regulatory, supervisory, and oversight frameworks for cross-border payments; and
  • Harmonizing data and market practices for cross-border payments.

Implications for Consumers, Investors, and Businesses
Another report discusses topics such as the rampant levels of fraud and scams in the crypto markets and provides recommendations to address such issues. “Frauds, thefts, and scams have emerged as an especially grave area of concern in cryptoassets, with estimates of claimed losses reaching billions of dollars and causing material harm to U.S. consumers, investors, and businesses,” the report says. The recommendations encourage U.S. regulators and law enforcement agencies to “aggressively pursue” investigations of such illicit activity; issue supervisory guidance and rules to address crypto risks; and educate consumers on the risks of crypto.

Action Plan to Address Illicit Financing Risks for Digital Assets
Treasury also issued a report identifying steps to address illicit financing risks for crypto assets. Risks include sanctions evasion, money laundering, ransomware and terrorism financing. The report highlights examples of hostile actors such as North Korea and ISIS that have used digital assets to enable their activities. The report recommends taking actions such as monitoring risks, working with international partners to improve cooperation on and implementation of international AML/CFT standards, strengthening U.S. regulations and operational frameworks, and improving private sector compliance and information sharing, among others.

DOJ Releases Report, Announces Actions on Digital Assets

The Department of Justice on Friday unveiled its report on The Role of Law Enforcement in Detecting, Investigating, and Prosecuting Criminal Activity Related to Digital Assets. The report was issued pursuant to the President’s executive order on digital assets.

• The report: The DOJ report discusses the ways in which criminals exploit digital asset technologies, the challenges such technologies pose to law enforcement investigations and law enforcement efforts to combat crypto-related crimes. It also recommends several regulatory and legislative actions that could enhance prosecutors’ and investigators’ ability to target crypto crimes, such as: extending the existing prohibition against disclosing subpoenas applicable to traditional financial institutions to digital asset service providers that operate as money services businesses; strengthening the federal law prohibiting operation of an unlicensed money transmitting business; extending the statute of limitations for crimes involving digital assets from five years to 10; facilitating cryptocurrency forfeiture in appropriate cases and strengthening the Sentencing Guidelines applicable to certain BSA violations.
• New network: The DOJ’s Criminal Division launched the Digital Asset Coordinators Network, which will “serve as the department’s primary forum for prosecutors to obtain and disseminate specialized training, technical expertise, and guidance about the investigation and prosecution of digital asset crimes.”
• Worth noting: The DOJ’s press release contained a footnote noting that the Attorney General had separately transmitted to the White House an assessment of whether legislative changes would be necessary to issue a CBDC, which the DOJ had been tasked with under the Executive Order.  That assessment does not appear to have been made public, however.

CFPB Takes Aim at Buy Now Pay Later

The CFPB this week released a report highlighting risks presented by buy now pay later products. The report cited risks involving lack of standardized disclosures, the compulsory use of autopay, dispute resolution challenges, multiple payment re-presentments, late fees, data harvesting and overextension. The agency plans to regulate and supervise these products similar to credit cards. CFPB Director Rohit Chopra said changes might involve “some new rules, some new guidance.”

Separately, at a Public Citizen event this week, Chopra said he will continue moving forward with reviews of bank and credit card fees. In response to a recent Senate letter objecting to the CFPB’s actions and lack of accountability, Chopra said “we’re going to keep doing our work, regardless of the false accusations that are made about our staff.” He also said that “the regulators of the past really missed some of the major issues that [consumer lending] markets were facing because many of them were more concerned about ensuring banks were profitable.”

Regulatory Risks May Discourage Small-Dollar Lending by Banks

Regulatory uncertainty can preclude banks from offering short-term, small-dollar loans that help low-income consumers cover unexpected expenses, according to a recent BPI post.

• Why it matters: Inconsistent regulatory treatment of such small-dollar lending programs is creating missed opportunities for banks to expand safe, affordable credit that meets the needs of low-income customers.
• The barriers: Regulatory inconsistency implicitly discourages banks from maintaining small-dollar loan programs. Examples include:
• Arbitrary changes in supervisory treatment of small-dollar programs.
• Potential APR limits – APR is highly responsive to loan size and term, so smaller, shorter-term loans require relatively high APRs to cover the overhead and expenses associated with them.
• The solution: Clarifications, assurance and coordination among regulators could pave the way for banks to offer short-term, small-dollar loans. Such an approach would ultimately strengthen the financial wellbeing of low-income households.

In Case You Missed It

The Crypto Ledger

This week the Senate Agriculture Committee held a hearing to discuss a bill that would give the CFTC authority to oversee key parts of the crypto market. CFTC Chairman Rostin Behnam testified at the first part of the hearing, followed by a discussion panel. Democrats such as Sens. Cory Booker (D-NJ), Dick Durbin (D-IL) and Amy Klobuchar (D-MN) emphasized the need for crypto regulation to protect consumers from fraud, particularly low-income and minority consumers who may be particularly vulnerable. Republicans called for regulatory clarity to encourage crypto firms to stay in the U.S. and foster innovation rather than moving to foreign jurisdictions. Other key themes at the hearing included tension between the CFTC and SEC over who should regulate crypto, the CFTC’s limited budget and general lack of direct retail-investor oversight and the effectiveness of the CFTC as a “cop on the beat.”

• SEC view: SEC Chair Gary Gensler has taken a different approach — that most crypto assets are securities and therefore require SEC oversight. He has urged crypto intermediaries to “come in, talk to us” at the SEC to determine whether they should register with the agency. In recent Senate testimony, he urged lawmakers not to undermine investor protections when crafting crypto legislation. 
• Toomey on stablecoin bill: Toomey expressed optimism in a Bloomberg interview that Congress could pass a stablecoin regulation bill this year. Toomey said his preferred legislative approach would include disclosure rules, licensing for stablecoin issuers and “high-quality assets” backing stablecoins.
• Tornado: The Treasury Department said in guidance this week that crypto investors with unfinished transactions involving the Tornado Cash platform before it was sanctioned can request licenses to complete their transactions. Applicants for such approvals should be prepared to provide all relevant information to Treasury regarding the transactions, the department said.
• Terra fallout: The founder behind the collapsed Terra stablecoin, Do Kwon, faces an arrest warrant in South Korea.
• Celsius bankruptcy: A U.S. bankruptcy judge approved a request for an independent probe of bankrupt crypto platform Celsius’ digital asset holdings.
• Meanwhile, Voyager: Voyager customers whose crypto accounts are frozen are pinning their hopes on a bankruptcy auction as they seek access to their holdings.   
• SWIFT blockchain pilot: The SWIFT messaging system is piloting a project with fintech Symbiont, in collaboration with Citigroup, Vanguard and Northern Trust, aimed at increasing efficiency in communicating corporate actions like dividend payments and mergers, according to Bloomberg.

FDIC Quarterly Update Gives Window Into Deposit Trends

The FDIC’s Quarterly Banking Profile for the second quarter of 2022, released late last week, showed the first decline in bank deposits since the second quarter of 2018. The QBP offers noteworthy takeaways about the state of the industry and potential regulatory changes ahead.

• Deposits shrinking: The decline in deposits is not unexpected or alarming. Banks have been flush with deposits throughout the pandemic. “The quarterly reduction in deposits offset only a fraction of the unprecedented deposit growth reported during the pandemic,” the FDIC said. As noted in a recent BPI panel, the confluence of deposit shifts, an unusually hefty ON RRP facility and the quantitative tightening process could derail the Fed’s path to shrink its balance sheet.
• Assessment rates: The QBP noted the FDIC’s proposal to increase deposit insurance assessment rates by 2 basis points. Importantly, the FDIC said in the QBP that it “continues to incorporate recent data into its projections of the reserve ratio.” Notably, the QBP shows that insured deposits fell at about a 3 percent annual rate, which is inconsistent with the FDIC’s assumption that they would continue to grow at a 3 or 4 percent annual rate, which it used to justify the proposed assessment rate increase. BPI has urged the FDIC to reevaluate the need for any assessment increase after it incorporates relevant recent trends in deposit levels and interest rates into its analysis.

OCC Taps Chen as Chief Climate Risk Officer

Yue (Nina) Chen will serve as the new Chief Climate Risk Officer at the OCC, the agency announced this week. Chen will lead the OCC’s climate risk efforts related to supervision, policy and external engagement, according to the announcement, and will report directly to Acting Comptroller Michael Hsu. She has previously held roles at the New York State Department of Financial Services, the International Association of Insurance Supervisors and the Nature Conservancy. The announcement comes shortly after Hsu called for “a clean sheet of paper and an open mind” in climate risk analysis.

Appeals Court Holds National Banks are Not Subject to NY Law Setting Minimum Interest Rate on Mortgage Escrow Accounts

The U.S. Court of Appeals for the Second Circuit this week reversed a lower-court decision that New York state law setting minimum interest requirements for mortgage escrow accounts applies to national banks. The Second Circuit ruled that New York state law requiring a 2 percent minimum interest rate on mortgage escrow accounts is preempted by the National Bank Act. The minimum interest rate requirement would exert “control” over a banking power granted by the Act to establish escrow accounts and would thereby “significantly interfere” with national bank exercise of that ability.

The cases are Cantero v. Bank of America and Hymes v. Bank of America.

How Employees With Disabilities Are Transforming M&T

An American Banker article this week highlighted M&T Bank’s efforts to support staff and customers with disabilities, as well as caregivers of people with disabilities. The bank’s Disability Advocacy Network offers training programs, reviews facilities to ensure they are accessible and advocates for increased awareness of conditions such as autism.