BPInsights: September 3, 2022

Stories Driving the Week

Annual Conference Preview

BPI and The Clearing House will host their Annual Conference next week on Sept. 6-7. Here’s what’s on the agenda.

• Keynotes from decision makers: Keynote speakers will include Deputy Treasury Secretary Wally Adeyemo, Acting Comptroller Michael Hsu and Federal Reserve Vice Chair Lael Brainard.
• Across the C-suite: The conference will include perspectives from industry CEOs and CFOs, such as a CEO roundtable with Brian Moynihan, Bill Rogers, René Jones, Bruce Van Saun and Kelly Coffey.
• Hot topics: Panels will cover a range of hot topics in banking, such as financial inclusion, stablecoins, CBDC, fraud, climate, the industry’s tech transformation, real-time payments and fintech partnerships. There will also be a panel of top banking industry analysts to give an outside perspective on commercial banking.
• Regulatory perspectives: The conference will also include a range of regulatory discussions with industry leaders and regulators, such as panels on the CFPB in the Biden Administration, access to the payments system, bank mergers and enforcement.
• Global view: The program also includes a global perspective, with discussions on cross-border payments and post-Brexit regulatory developments and their implications for global banking.

What’s Coming at the Banking Agencies: Regulatory Preview

Here are major policy issues on the regulatory horizon this year.
Basel III Endgame 

• What is happening: The U.S. will soon propose its implementation of the latest revisions to the Basel framework, known as Basel III Endgame.
• Why it matters: The Basel framework is an internationally agreed set of standards for bank capital requirements that affects the cost of loans for households, and small and large businesses. It shapes bank capital requirements and directs banks to maintain designated amounts of capital based on the risk level of loans and other exposures, but those risk “weights” do not always reflect the true risk of the exposure. In addition, the Basel framework gets implemented differently across different countries and jurisdictions (for example, the U.S., U.K. and E.U.), and small differences in implementation can result in divergent lending rates for borrowers in each jurisdiction.
• What we expect: Basel III Endgame implementation will likely result in meaningful changes to U.S. banks’ capital requirements. First, the proposal will likely remove the ability of U.S. banks to use internal models for credit and operational risk. Second, it will add an explicit capital charge for operational risk and for credit valuation adjustment to the standardized approach, which does not currently exist in the U.S. In addition, the standardized approach for credit risk will be more risk-sensitive, with safer loans receiving a lower risk weight. Finally, the fundamental review of the trading book will result in a material increase in capital requirements for market risk. It will be interesting to see which types of adjustments will be proposed by U.S. regulators to avoid a sizable increase in the capital requirements of U.S. banks (as shown here, the capital requirements of U.S. banks are already 1.7x higher relative to the Basel Framework). The main levers at the disposal of regulators to prevent a further increase in capital requirements are: (i) adjusting the coefficients of the GSIB surcharge for economic growth; and (ii) making some changes to the stress tests (e.g., here). Finally, another important element is whether the U.S. banking agencies will also propose modifications to the supplementary leverage ratio.
• Road ahead: The U.S. proposal of Basel III Endgame rules will likely come out by early next year, or potentially at the end of 2022.

Community Reinvestment Act 

• What is happening: The U.S. banking agencies are working to quickly finalize a joint interagency overhaul of the Community Reinvestment Act (CRA) rules.
• Why it matters: The CRA’s purpose is to encourage banks to meet the credit needs of their communities, including low- and moderate-income neighborhoods, but overly complex CRA rules that stray beyond the statute’s contours would undermine that mission.
• What we expect: The final rule will likely resemble the proposal, which extends far beyond the agencies’ statutory authority and would undercut the law’s core goal of serving communities. 
• Road ahead: The final rule, if it hews closely to the proposal, would be vulnerable to legal challenges given features that exceed limitations of the CRA, the Administrative Procedure Act and the Constitution.

Digital Assets 

• What’s happening: Stablecoin legislation is at the forefront of policy discussions on how to regulate digital assets. Policymakers are debating key questions such as who should be allowed to issue stablecoins, what requirements they should be subject to, what regulators have the authority to oversee them and how they and other digital assets may affect financial inclusion.
• Why it matters: Stablecoins and other digital assets issued by nonbanks not subject to a federal regulatory framework pose risks to consumers and the financial system. However, the use of modernized technologies when used by highly regulated banking entities can help make finance more efficient.Indeed, distributed ledger technology is unrelated to cryptoassets in many cases and presents none of their typical volatility, fraud or cybersecurity risks – for example, tokenized or blockchain-based deposits on a permissioned ledger or use of DLT technology for recordkeeping purposes. Any digital asset regulatory framework should leave those opportunities open for banking organizations that are subject to comprehensive federal supervision and examination, while protecting consumers from the volatility and risks of stablecoins and other digital assets without adequate regulatory safeguards.
• What we expect: Regulators will continue to discuss where stablecoins fit in the federal regulatory framework. For the outlook on stablecoin legislation, see the Capitol Hill preview below. There are still many open questions on crypto, such as whether the CFPB will address consumer harm from crypto fraud, and how the Treasury Department will address sanctions evasion by crypto firms headquartered outside the U.S.
• Road ahead: There remains a lack of regulatory clarity on authority and risk management expectations for banks handling digital assets. Federal banking regulators have promised to improve clarity around this issue.

Other Issues 
Here’s what else is on the regulatory agenda this year.

• Credit cards: The CFPB is expected to release a proposal that eliminates or reduces the credit card late fees safe harbor.
• Data aggregators: The CFPB will also likely take the first step towards issuing a proposed rule under section 1033 of the Dodd-Frank Act regarding data aggregators and consumer financial data sharing.
• Bank M&A regulatory approvals: The bank merger regulatory review process is undergoing policy scrutiny at the FDIC, Department of Justice and other agencies with oversight over bank M&A. Bank merger review standards could become much less clear if the traditional Herfindahl-Hirschman Index used as a screen to identify transactions that could raise competitive concerns is replaced or supplemented with other standards that are more subjective or less well understood. The FDIC has also floated a new role for the CFPB in reviewing bank mergers and a presumption against mergers involving banks with greater than $100 billion in assets. The DOJ appears to be placing new weight on non-price impacts of bank mergers in addition to price impacts. Acting Comptroller Michael Hsu has also suggested requiring TLAC and single point of entry resolution for large regional banks seeking regulatory approval for mergers.

Stablecoin Legislation

• What is happening: Motivated by ongoing volatility in the crypto market, the House Financial Services Committee is working with the Administration on negotiating a stablecoin bill that would set new rules for issuers and order a study on the potential creation of a U.S. CBDC.
  • Chairwoman Waters and Ranking Member McHenry are working together and have had continued conversations throughout August recess in an effort to bring the legislation to markup by mid-September.
  • While official text has not yet been released, it’s expected that the bill would prohibit insured banks from issuing stablecoins directly (contrary to the PWG report’s core recommendation), specifically authorize nonbanks to issue stablecoins and subject those nonbank issuers to Federal Reserve oversight, and require the issuers to back each stablecoin issued 1:1 with so-called “reserves,” which would include “cash and cash-like instruments,” though precise definitions and details are still murky.
• Why it matters: Banks currently have the authority to issue both stablecoins and similar products like tokenized deposits.  Legislation could threaten this authority.
  • Additionally, a major concern is whether the legislation would grant nonbank stablecoin issuers access to Fed master accounts, which provides access to the nation’s payment rails and the Fed suite of services, including discount window access. The master accounts issue has also come up in court: Wyoming crypto bank Custodia has sued the Federal Reserve, accusing the central bank of impermissibly failing to act on  Custodia’s master account application.
• The road ahead: While the industry should not take the bipartisan effort lightly, even if the bill passes out of committee and momentum in the House allows for a vote, it is unlikely that there will be enough time to move legislation in the Senate for final passage before year’s end—especially with midterms in November.  

Cyber Legislation

• What is happening: Congress and the Administration are considering creating a new designation for critical infrastructure referred to as Systemically Important Entities (SIEs) – previously referred to as Systemically Important Critical Infrastructure (SICI).
  • The House has included language to create SIEs in the must-pass annual defense authorization bill. BPI opposes the language because it would create duplicative regulatory requirements for banks and interfere with security operations.
• Why it matters: In its current form, the SIE provision would add the Cybersecurity and Infrastructure Security Agency (CISA) as an additional regulator for banks and require they submit detailed reports on their security and third-party risk management efforts without providing enhanced collaboration with intelligence agencies.
• The road ahead: Congress is expected to begin the conference process in September with a final bill considered in November/early December.

Industrial Loan Company Legislation

• What is happening: Earlier this year in June, the House Financial Services Committee passed on a bipartisan basis HR 5912, the “Close the ILC Loophole Act,” introduced by Rep. Chuy Garcia (D-IL), which would eliminate the exemption from the Bank Holding Company Act that ILCs currently enjoy. 
• Why it matters: Use of the ILC has evolved beyond its original purpose.  Today, commercial firms and others use ILCs to avoid bank holding company regulation and supervision and evade restrictions on affiliations between banks and commercial firms.
  • Although current FDIC leadership is unlikely to approve additional ILC charters, the most recent FDIC Chair was more favorable and now is the time to address this issue.
• What we expect: BPI is working with a diverse coalition of small banks and consumer groups in support of this bill.  BPI has also led several Congressional letters by the coalition on this topic.
• The road ahead: Going forward, the House may consider this legislation on the floor, and there may be Senate companion legislation introduced as well. Both efforts could set up potential opportunities to attach language to must-pass legislation at the end of the year.

Section 19 Legislation

• What is happening: Bipartisan legislation to amend Section 19 of the Federal Deposit Insurance Act passed the House of Representatives earlier this year.
  • Section 19 governs banks’ ability to hire persons with criminal records for certain offenses, but oftentimes results in overly punitive treatment of such individuals.
  • While the FDIC recently modernized the relevant regulations, statutory limitations prevent additional needed changes.
• Why it matters: Many Americans, including persons of color, have been effectively barred from working in the banking sector because of past minor criminal convictions. 
  • Not only does this limit the available work pool for BPI members to hire from but it also impedes economic mobility and rehabilitation of affected individuals.
  • Bipartisan legislation would amend Section 19 of the Federal Deposit Insurance Act to open job opportunities in the banking sector to rehabilitated candidates that have criminal records for certain offenses.
• The road ahead: This legislation passed the House of Representatives earlier this year and now, BPI is currently working with multiple congressional and Senate offices on introduction in that chamber.