BPInsights: September 9, 2023 - Bank Policy Institute

BPI Launches New “Stop Basel Endgame” Campaign

BPI launched a major advertising campaign this week called “Stop Basel Endgame” warning about the costly consequences that higher capital requirements would have on small businesses and working families. The ads target Washington, D.C., and select national media markets and encourage Americans and their representatives to hold banking agencies accountable by demanding regulators revisit the Basel proposal.

In addition to addressing the costly consequences for businesses and consumers, the campaign highlights the following facts:

Large banks are well capitalized and highly resilient to economic downturns.
The proposal disadvantages U.S. businesses and raises costs for consumers by imposing measures that are more extreme than what was established under the original Basel agreement.
The new proposal undermines Congress and effectively repeals rules that tailored regulations to a bank’s size and business model.
The proposal was developed without transparency or accountability. Regulators have provided NO analysis to support the vast majority of these increases.
It benefits private equity and hedge funds at the expense of working Americans and broader financial stability.

The campaign features an educational website with an interactive form allowing visitors to contact their lawmakers to demand action. To learn more, please visit StopBaselEndgame.com.

Five Key Things

1. The Un-tailoring of Large Regional Bank Resolution Requirements

BPI President and CEO Greg Baer issued the following statement on the long-term debt and resolution proposals released on Aug. 29 by the FDIC:

These proposals attempt to fit regional and midsize banks into a regulatory mold designed for the largest globally active banks, a weakening of the bipartisan tailoring framework enacted by Congress. Regional banks have already developed credible resolution plans that reflect their structures, operations and risk profiles. Unlike GSIBs, which may have subsidiaries in multiple countries or other complex considerations, regional banks’ resolution framework is not based on a ‘capital refill’ standard because other resolution options are more appropriate for these banks.

Moreover, the proposals come on the heels of a proposed increase to capital requirements for the same banks. The agencies must consider the complete picture—and give a thorough accounting of the complete costs and benefits—of these proposals. Without careful consideration and calibration, there is a risk these proposals could damage the institutions they seek to strengthen and restrict vital financing to small businesses in the process.

Here’s the background: The long-term debt proposal, issued jointly with the Federal Reserve and OCC, would require banks with at least $100 billion in assets to issue long-term debt to absorb losses in a failure, a measure previously only applied to GSIBs. The FDIC also proposed a comprehensive revision to resolution requirements. The proposals reflect a larger effort by the banking agencies to make regulatory requirements for banks of this size resemble the framework for the very largest GSIBs in the wake of the spring bank failures – and to place blame for the failures on the tailoring framework.

Fed governor concerns: Federal Reserve Governor Michelle Bowman expressed concern about both the long-term debt proposal and a proposal on resolution guidance for Category II and III banks. The impact analysis on the long-term debt proposal “expressly ignores the effect of the proposed changes to capital rules, even though the outstanding Basel III proposal would materially increase capital requirements for these firms,” Bowman said in a statement. “In addition, these regulatory proposals would not operate independently of each other—increases in risk-based capital requirements would also increase long-term debt requirements.” Such a confluence could “significantly alter how banks are funded, the activities in which they engage, the products they offer, and the markets they serve, yet the proposal does not address these potential indirect costs.” On the resolution guidance, Bowman said any preference for a certain resolution strategy should be clarified: “Although the guidance suggests that it is not intended to favor either the ‘single point of entry’ or ‘multiple point of entry’ resolution strategy, ongoing regulatory reform efforts could effectively eliminate this optionality. If the agencies expect firms to adopt a particular resolution strategy, it would be preferable to make that clear in the guidance.” On the long-term debt proposal, Governor Christopher Waller expressed concern “that our regulatory framework for large banks is moving in a direction that does not tailor requirements in a manner consistent with the spirit of the Dodd-Frank Act, as amended by Congress in 2018.”
OCC view: Acting Comptroller Michael Hsu wrote in a recent Bloomberg op-ed that the spring bank failures revealed a gap in resolvability requirements for large regional banks. Such banks need to be separable – able to identify business lines or portfolios that can be sold in a failure – for the system to be safe, he said. “Making a bank separable is like hard-wiring a self-deconstruct button,” Hsu wrote. “It creates realistic options for making bailouts avoidable and mitigating instability when stress and crises hit.”
Chopra’s take: Meanwhile, CFPB Director Rohit Chopra suggested at the FDIC’s Board meeting that the agencies should consider extending the long-term debt requirements even further to some banks with less than $100B in assets.

2. Capital Increases, Court Uncertainty and Could Complicate Banks’ CRA Programs

Two recent policy developments could fundamentally alter banks’ Community Reinvestment Act programs, and policymakers should avoid finalizing proposed changes to the CRA rules until these issues are resolved, BPI and the American Bankers Association told regulators in a recent letter. The recent Basel capital proposal would dramatically raise capital requirements for large and midsize banks, directly undermining bank lending efforts related to CRA, particularly mortgages. In addition, a federal court recently halted the CFPB’s enforcement of a key small-business lending data rule while the regulator awaits a Supreme Court ruling on its funding structure’s constitutionality. The agencies should not finalize the CRA rules until the Supreme Court determines the constitutionality of the CFPB’s funding structure and the implications of that decision on the implementation of a new CRA rule are understood, BPI and ABA assert in the letter.

What we are saying: “We do not believe that the agencies or the public fully understand the impacts that the proposed capital changes would have on banks’ CRA programs, which must be considered, both by the agencies and the public, before any new CRA rules are finalized. The agencies should consider whether changes to the CRA proposal are warranted in light of the proposed changes to the capital rules, and, if so, the agencies must seek comment on any such changes. Should the agencies finalize the CRA rules before the capital rules are finalized, the agencies will not have provided the public with a meaningful opportunity to comment on the proposed CRA amendments in light of the changes banks are likely to make to their CRA programs due to revisions to the capital rules.” – BPI and ABA
Mortgage impact: Increases in Basel capital requirements will not only further reduce banks’ participation in the mortgage market, but it could also lead to higher borrowing costs for homeowners through higher capital requirements for mortgage servicing assets, American Banker recently reported.

3. Tightening of Bank Regulation May Cause Recession, Early End to Quantitative Tightening

There is widespread agreement that recent bank failures demonstrated shortcomings in Fed and FDIC bank supervision, and that supervision needs to be more tightly focused on issues that pose real risks to bank safety and soundness, wrote BPI’s Bill Nelson in a blog post this week. However, examiners may not legally impose a de facto tightening of bank regulation without notice-and-comment rulemaking. Moreover, such a tightening risks upending the Fed’s soft-landing and tipping the economy into recession, just as the implementation of Basel I led to a recession in the early 1990s. Furthermore, a tightening of liquidity requirements could prevent the Fed from continuing its efforts to get smaller and less entangled with the financial system, just as happened in 2019.

4. Mayo: Basel Proposal is ‘Game-Changing’

Longtime bank analyst Mike Mayo broke down the implications of proposed Basel requirements in recent CNBC and Bloomberg TV interviews. “I don’t think the market appreciates the game-changing nature of the proposed regulations,” said Mayo, head of U.S. large-cap banks at Wells Fargo Securities.

Overkill: Banks have demonstrated resilience in recent years, including their support of the economy during the pandemic, Mayo said. He noted that in the last decade, large banks have doubled their capital, boosted liquidity and weathered stress tests. “I thought, mission accomplished,” he said on Bloomberg TV.
Head-scratcher: The Basel proposal targets credit risk, market risk and operational risk, and changes to the latter two categories – which include vastly higher capital charges – raise questions, Mayo suggested. “The market risk and operational risk – some of those changes are really a head-scratcher,” Mayo said in the Bloomberg interview.
Punch in the stomach: Mayo said he is eagerly anticipating when large banks parse the effects of Basel regulations on their balance sheets, with new analysis potentially coming in mid-September during the banking conference circuit. “Get ready for a punch in the stomach when it comes to some of the reveals of what the Basel III Endgame does to the largest banks,” Mayo said.
Marginalized: The new regulations will push financing out of the banking system, Mayo said on CNBC.

5. A Tiny Bank, Big Crypto Interest … and Eventually, a Fed Crackdown

The Federal Reserve ordered Farmington State Bank, a small Washington state bank with strong ties to defunct crypto firm FTX, to wind down in a recent enforcement action. The bank, which did business as Moonstone Bank, engaged in crypto-related activities without the Fed’s signoff, according to the enforcement action.

The journey: Farmington State started as a small community bank with one branch, three employees and less than $10 million in deposits. In 2020, it was acquired by Jean Chalopin, chairman of a Bahamas-based bank known for ties to FTX and Tether. The acquisition was approved in just five months by the Federal Reserve Bank of San Francisco, acting under delegated authority from the Federal Reserve Board, in September 2020. In early 2022, Farmington announced a new investment by Alameda Research Ventures, an affiliate of FTX, of $11.5 million. In connection with the investment, the bank rebranded itself as “Moonstone Bank” and announced a “digital transformation of the organization into a top provider of innovative financial services to fast-growing industries such as blockchain, cryptocurrencies and cannabis.” No U.S. banking regulatory application was filed or approved in connection with the investment. However, depending on the exact details of the investment, two regulatory approval requirements could have been implicated.
Oversight: The Federal Reserve Bank of San Francisco is the same institution under whose oversight massive problems at Silicon Valley Bank went undetected.
Questions unanswered: The Fed allowed the bank to undergo an orderly liquidation rather than to fail, and therefore, there will be no Fed inspector general report about the collapse. This leaves questions about the bank’s crypto ties and potential supervisory mistakes of the San Francisco Fed unfortunately unanswered in the public record. Two key questions: Did the Fed miss any risks to the financial system posed by Chalopin’s original acquisition and Alameda’s investment? And are there other community banks with crypto ties that could pose such risks now?

In Case You Missed It

Big Tech Faces CFPB Scrutiny for Restricting Consumer Payment Options

The CFPB issued an “issue spotlight” on Thursday highlighting the dominant positions of Apple and Google in the mobile operating system market and accusing Apple of restricting consumers’ ability to choose how they pay via point of sale using Apple mobile devices and warning that Google could similarly restrict consumers’ options in the future. In remarks delivered alongside the Issue Spotlight, CFPB Director Rohit Chopra pointed to restrictions imposed by Apple that limit competitor access to proprietary payment platforms like Apple Pay. The Bureau indicated that these restrictions likely violate the open banking and data portability goals outlined in the forthcoming Section 1033 rulemaking. The Bureau stated that it would continue to assess any roadblocks that would reduce competition, innovation and choice; while the Bureau did not specify how it would address such roadblocks, one response could come in the form of a larger participant rulemaking, which would enable the CFPB to exercise its supervisory authority over Big Tech companies in the payment space.

Op-Ed: The Fed’s Bank Stress Test Proposal Would Only Heighten Uncertainty

In proposed changes to bank capital requirements, the Federal Reserve assumes banks’ internal models should not be used to estimate credit risk because they are impossible to verify. But this logic contradicts the lack of transparency around the Fed’s own internal models, which are used in stress tests to determine banks’ stress capital buffers, American Enterprise Institute Senior Fellow Paul Kupiec wrote in a recent op-ed. “If adopting a standardized approach is necessary to set an accurate transparent floor under internal model credit risk capital requirements because internal model estimates are not to be trusted, then common sense suggests that it is inappropriate to deputize the Federal Reserve Board with the power to increase the stress capital buffers of the largest banks using stress scenario loss estimates from secret and unverifiable internal models,” Kupiec wrote.

U.S. Fails to Follow International Peers in Making Rational Departures from Basel Agreement

U.S. and European financial regulators are working to finalize prudential banking rules established under Basel III Endgame. However, while European regulators have appropriately proposed certain deviations from the international standard that will likely lessen the burden on European banks, according to POLITICO, U.S. regulators have taken the opposite approach and plan to impose rules that exceed the core requirements set by Basel. The proposal would lead to significant capital hikes for American banks and would result in the U.S. deviating from common international standards – one of the core objectives of this effort. BPI President and CEO is quoted in the article stating: “The U.S. is in a pretty radical departure from the whole Basel approach and its implementation in other countries. … It’s happening because an adoption of the Basel proposal in adherence to its principles would result in lower capital requirements.”

IMF and FSB Address Crypto Regulation in New Policy Paper

The International Monetary Fund and the Financial Stability Board published new policy recommendations on Thursday to address the economic and regulatory challenges posed by cryptocurrency. While the paper cautions against blanket bans, which are “costly and demanding to enforce,” it does argue that crypto-assets are becoming more complex and have the potential to become a source of systemic risk if they continue to gain traction. The paper is intended to serve as a consolidated set of recommendations that global regulators can reference as they work to identify, assess and mitigate macro-economic and financial stability risks associated with crypto-assets.

Senate Votes to Confirm Federal Reserve Governor Appointments

The U.S. Senate voted this week to confirm the appointments of Federal Reserve Governors Phillip Jefferson, Lisa Cook and Adriana Kugler. Jefferson was confirmed as Vice Chair of the Federal Reserve Board by a vote of 88-10, a role previously held by Lael Brainard who departed the Board in February to become Director of the National Economic Council. Cook’s confirmation marks the start of a new 14-year term as she was previously appointed to fill an unexpired term. Kugler’s confirmation fills the final vacancy on the seven-member Board and makes her the first Latina in the Central Bank’s history to serve as a governor.

House Homeland Security Leaders Criticize Cyber Disclosure Rule, Calls for Implementation Delay

U.S. House Homeland Security Committee leaders, including Committee Chair Mark Green (R-TN) and Cyber Subcommittee Chair Andrew Garbarino (R-NY), criticized the SEC’s recent cyber disclosure rule in a joint letter sent late last week. The letter warns that the rule will only increase cybersecurity risk, harm investors and conflicts with other existing cyber reporting requirements, such as the Cyber Incident Reporting for Critical Infrastructure Act of 2022. The rule, which requires publicly-traded companies to notify investors when a cybersecurity incident has occurred — even if that incident is ongoing and could expose ongoing vulnerabilities — was finalized in late July. The lawmakers call for the SEC to delay implementation of the rule until the SEC can work with other regulators to harmonize these new requirements with other existing cyber reporting requirements.

Tarullo: Should the Fed Go Back to Point-in-Time Capital Requirements?

Former Federal Reserve Governor Daniel Tarullo, who led the central bank’s supervision and regulation efforts, discussed several regulatory and supervisory topics in a recent Brookings Institution interview. He expressed skepticism about some aspects of stress testing, suggesting the Fed’s stress tests have become too predictable to be useful in determining capital requirements. (Tarullo referred to ABA and BPI’s petition for rulemaking on the Fed’s stress testing and supervisory models.) He also discussed supervision “whipsawing” in regulation during changes of Administration and potential changes to deposit insurance.

Key quote: “[T]here’s an increasingly compelling case for shifting back to using point-in-time capital requirements as the binding constraints upon banks and using stress testing more to provide information to supervisors about the resilience of banks under a variety of possible stresses, without automatically tying the results to minimum capital requirements,” Tarullo said. “If that’s the route the Fed eventually takes, then there’s a good argument for raising the point-in-time capital requirements higher than at present, since those requirements will no longer be more or less regularly augmented by stress test results, which up until a few years ago were adding a couple of percentage points to the capital requirements of most big banks.”
Liquidity: Policymakers should adjust either the liquidity coverage ratio or “some other part of the current regulatory structure” to account for a higher risk of uninsured deposit runs than previously assumed, Tarullo said. Regulators would need to consider the extent to which uninsured deposits are funding lending, he suggested. “[I]f a more extensive inquiry concludes that a significant portion of highly runnable uninsured deposits do fund productive lending to businesses and households, then policymakers will have to make a more difficult judgment on how much to disfavor them through regulatory measures,” he said.
How far to go? Regulators have proposed significant new requirements for banks $100 billion and over, making the framework for larger midsize banks resemble that of GSIBs. Tarullo cautioned that “the agencies need to be especially careful here not to overreact to the events of this spring,” particularly “whether some ideas for increased regulation would just exacerbate the competitive problems of these banks while not efficiently containing those vulnerabilities.”

Higher Bank Capital: A Boon for Private Credit

The private credit industry was already encroaching on types of business once dominated by banks. Now, the proposed Basel capital increases could fuel even bigger market share by private nonbank lenders, Axios reported recently. Apollo Management’s Marc Rowan called the current era a “great time” for private credit, and Blackstone’s Jon Gray said it’s a “golden moment.”

Everywhere: Private nonbank lenders are popping up in all corners of the financial markets, from commercial real estate to mortgages to student loans.
Downside: Not only is a private credit market of this size (tripled in size since 2015) “untested in a downturn,” according to Axios – it’s also outside the oversight of regulators.

Higher Bank Capital: A Boon for Private Credit

Everywhere: Private nonbank lenders are popping up in all corners of the financial markets, from commercial real estate to mortgages to student loans.
Downside: Not only is a private credit market of this size (tripled in size since 2015) “untested in a downturn,” according to Axios – it’s also outside the oversight of regulators.

The Middle Course: What Fed History Teaches Us About Liquidity Requirements

A recent BPI note explains how lessons from early in the Fed’s history prove relevant to current challenges. In the wake of spring bank failures, the time is ripe to re-examine the design of the liquidity framework with these lessons in mind.

Iron rations: Bank liquidity regulation has shifted from an emphasis on diversified, reliable contingency funding to stockpiles of high-quality liquid assets – useless unless banks are willing to use them. Liquidity requirements in the 1800s, before the Fed’s founding, looked very similar to today’s requirements, such as the liquidity coverage ratio. Just like today, a critical problem was that banks were unwilling to use the emergency “iron ration” of reserves to meet outflows for fear of falling below requirements.
Less lending: Another problem, both then and now: large reserve stockpiles make less room for lending and economic activity.
Into the shadows: Yet another concern with parallels to present-day banking: Reserve requirements contributed to the movement of financing out of the banking system.
Discount window: To address these issues, Congress created the Fed to enable banks to convert their loans to cash in order to meet liquidity needs and continue financing businesses and the economy. The discount window, which is meant to provide liquidity to commercial banks if needed, could play a similar role today, but it suffers from lingering stigma. Preparation to borrow from the window could have made the SVB failure less disorderly.

The middle course: The Fed could address significant costs of current liquidity requirements by returning to its roots: allowing banks to address any needed increase in liquidity with improved ability to convert their loans to businesses and households into reliable contingent sources of funding by offering each bank a committed line of credit, a CLF, for a fee. Doing so would make banks more liquid, more willing to use their HQLA, encourage more banks to be ready to use the discount window when under stress and promote appropriate incentives for managing their liquidity risk. As a result, the financial system would be made more resilient without sacrificing economic growth or employment.

CFPB Takes Aim at Credit Repair Companies Accused of Illegal Practices

The CFPB recently announced a proposed settlement with a group of companies accused of illegally telemarketing credit repair services. The companies operate brands, including Lexington Law and CreditRepair.com. A court has ruled that the firms collected illegal advance fees for credit repair services through telemarketing. The proposed settlement would impose a $2.7 billion judgment against the companies and ban them from telemarketing credit repair services for 10 years.

The Truth About Small Banks and Office Loans

Commercial real estate, pressured by hybrid work and higher interest rates, has been garnering some attention as a potential risk in banking. But despite media reports about small banks and commercial real estate lending, most U.S. commercial real estate debt is owed to lenders other than domestically chartered commercial banks, according to Bloomberg. Small banks hold 69% of commercial real estate loans on the balance sheets of domestically chartered commercial banks. However, as of the end of March, domestic depository institutions held 47% of CRE debt, with smaller banks holding about 32% of the total.

The Crypto Ledger

Asset manager Grayscale won a court victory against the SEC on Aug. 29. The federal court ruling that the SEC must review its rejection of Grayscale’s bitcoin ETF follows a favorable ruling toward crypto firm Ripple in July. The decision could pave the way for more bitcoin ETFs on the market. Here’s what else is new in crypto.

Expert witnesses: Sam Bankman-Fried could pay seven expert witnesses up to $1,200 an hour to testify on his behalf at his upcoming trial.
Russia retreat: Crypto firm Binance is considering fully withdrawing from business in Russia, according to the Wall Street Journal, which recently reported that the exchange has helped Russians move money abroad. The country faces a litany of sanctions from Western authorities over the war in Ukraine.
Tornado: Federal prosecutors charged Tornado Cash founders Roman Storm and Roman Semenov with conspiracy to launder money and violate U.S. sanctions. The crypto “mixer” founders are accused of helping launder more than $1 billion for clients that included a North Korean cybercrime organization.

Goldman Sachs Announces $100 Million Investment to Support Rural Small Businesses

Goldman Sachs announced plans on Friday to invest $100 million in rural communities in the form of support to community development financial institutions, educational programs and capacity-building grants. Initial investments will begin in North Dakota and Arkansas and will expand to reach 20 states over the next five years.

Wells Fargo’s Bill Daley Announces Departure

Axios broke the news on Thursday that Bill Daley, Wells Fargo vice chairman and head of public affairs, will step down at the end of the year. Daley was Chief of Staff under President Barack Obama from 2011 to 2012 and also served as U.S. Secretary of Commerce under President Bill Clinton from 1997 to 2000.