BPInsights: Top 10 Most Read Posts in First Half of 2021

1. The Time Is Now: 30 Best Bank Practices to Help Improve Outcomes In Black Communities

The Bank Policy Institute published a report offering best practices for banks as they intensify their efforts to support racial equity. The report, “The Time Is Now: 30 Best Bank Practices to Help Improve Outcomes in Black Communities,” was the result of a year-long effort to work with banks to identify, study and share innovative steps banks are taking to deepen their engagement, broaden access to affordable financial services and credit, diversify their workforces and serve as engines of shared prosperity. Many BPI members are already showcasing their efforts in this space, and this report allows banks to share successful experiences on how to best meet the needs of their customers, employees, and the communities they serve. The profiled practices are intended to provide a menu of innovative options for banks to select from as they develop, enhance and tailor their engagement efforts to address inequity. Read More >>

2. Actions the Fed Could Take inCentral Bank Digital Currencies: Costs, Benefits and Major Implications for the U.S. Economic System

Central bank digital currencies are under consideration at central banks around the world, and active technical development at some. Yet their profound policy implications have undergone little public debate, and little analysis outside the realm of the central banks themselves. Such debate is overdue because a central bank digital currency is not simply paper currency in digital form: its adoption would have profound consequences for the financial system and economic growth. It could transform the place of the central bank, and the government more generally, in our society.

A working paper by BPI President and CEO Gregory Baer presents a comprehensive analysis of the costs and benefits of a CBDC for the United States. Such an analysis must include a review of how a CBDC would function and how it would compare to existing payments systems. Importantly, this analysis reviews in detail how steps to mitigate some of the costs of CBDC issuance — in particular, efforts to mitigate significant risks to financial stability and economic growth — necessarily reduce some of its potential benefits, most notably financial inclusion. Read More >>

3. Fed Account Access for Nonbanks

The International Consortium of Investigative Journalists and BuzzFeed reported on more than two thousand illegally leaked SusOn May 5, 2021, the Federal Reserve issued for public comment a set of proposed guidelines intended to govern how Federal Reserve Banks would review and assess account applications by firms with novel charters. 
 
The proposed guidelines are in part a reflection of the ongoing efforts by Big Tech and FinTech firms to engage in banking activities without being subject to bank regulation and supervision. Federal and state authorities have begun creating novel types of charters that permit various forms of lending, deposit-taking and payments activities, while avoiding most federal bank regulation and supervision (notably, the BHC Act). Once armed with novel charters, these firms could seek accounts at Federal Reserve Banks in order to, among other things, gain direct access to the Fed’s payment systems (i.e., without the requirement to partner with a regulated bank). 
 
The key elements of the proposal are outlined here; however, serious policy questions remain unaddressed. BPI developed the following series of posts and analyses in an effort to address some of the complexities and implications that would be introduced by allowing nonbanks Fed account access. Read More >>

4. When the Fed Buys a Treasury Security, the Debt Does Not Go Away 

When the Fed buys a Treasury security, the debt does not go away, according to a BPI analysis by Chief Economist Bill Nelson and AVP and Research Analyst Robert Lindgren. The Treasury security is a borrowing by the Treasury from an investor in exchange for a promise to repay the funds, plus interest, as scheduled. When the Fed buys the Treasury security, it is transformed into deposits of a depository institution at the Federal Reserve, also known as “reserve balances.”  A deposit at the Federal Reserve, in turn, is a borrowing by the Fed from a depository institution (commercial bank, thrift or credit union) in exchange for a promise to repay the funds, plus interest, on demand. The Fed’s assets go up by the amount of the purchased security and its liabilities go up by the increase in reserve balances.  The consolidated borrowing of the U.S. government, including the Fed, is unchanged. Read More >>

5. The Overnight Reverse Repurchase Agreement Facility

In an April blog post, BPI Chief Economist Bill Nelson predicted that the overnight reverse repurchase agreement (ON RRP) facility would top $1 trillion by mid-summer. The ON RRP facility accepts overnight cash investments from banks, GSEs and money market mutual funds and provides Treasuries as collateral.  The facility essentially expanded the central bank’s authority to pay interest on reserve balances to a broader set of counterparties such as money market funds. Nelson predicted that as reserve balances continued to balloon — and after the exclusion of Treasuries and reserves from banks’ supplementary leverage ratios expired, making it more expensive for banks to hold reserves – the use of the facility would likely rise sharply.  What was meant to be a temporary measure to ensure the Fed could raise rates when it wanted to do so in 2015 ended up becoming a massive and permanent government vehicle for private-sector savings.  In the event, use of the facility hit $1 trillion on June 30, topped $1 trillion on July 30, and then moved persistently above $1 trillion in early August. Read More >>

6. Credit-Sensitive Benchmarks in a Post-LIBOR World

As no new contracts for LIBOR will be written after 2021, markets are preparing for what comes next.  For derivatives markets, SOFR appears to be the predominant replacement rate, but for wholesale lending markets both lenders and borrowers are demanding a credit-sensitive benchmark.  In response, the free market is producing options like Bloomberg’s Short-Term Bank Yield Index (BSBY), ICE’s Bank Yield Index and American Financial Exchange’s Ameribor. The federal banking agencies have made clear that in their view lenders are free to choose a credit-sensitive benchmark for use in commercial loans, but the FHFA has issued regulatory guidance stating that credit-sensitive benchmarks come with the same risks as LIBOR and require examiner review and approval.  This note by BPI CEO Greg Baer focuses on one of those benchmarks, BSBY, and examines whether it raises manipulation or financial stability concerns. Read More >>

7. The FSOC’s Looming Challenge: Un-Ringing a Very Large Bell

The Financial Stability Oversight Council faces a daunting challenge: a large and growing shortage of fixed-income capital market liquidity that has led to unprecedented government intervention and threatens to undermine those markets’ vitality, BPI President and CEO Greg Baer wrote in a blog. This situation, where investors expect the Federal Reserve to rescue bond markets in times of volatility or mass selloffs, causes extreme moral hazard.  Regulators faced, and met, a similar challenge when they took steps to end a “Too Big to Fail” perception in the wake of the Global Financial Crisis. But the stakes now are much higher and the challenge far greater.  In sum, private sector markets are becoming accustomed to central bank support; those markets are likely growing inorganically large on the assumption of that support; private sector market making continues to be discouraged by regulation; and thus the need for future central bank support continues to grow.  If for any reason that support were ever withheld, the results would be devastating.  And, so, on our present course, it never will be withheld. To change course, policymakers have three basic options: (1) reduce private sector demand for market liquidity, either directly through new curbs on money market funds, hedge funds and mutual funds, or indirectly through major monetary and fiscal policy changes; (2) increase the private sector supply of market liquidity by rationalizing rules to allow bank-affiliated broker-dealers to provide more market-maker services; or (3) further nationalize U.S. markets by establishing a permanent role for the central bank in supporting U.S. capital markets. Read More >>

8. The Importance of Moving to the Stress Capital Buffer

The Federal Reserve finalized the stress capital buffer framework in March 2020, just days before the worst of the COVID-19 shock ignited global financial turbulence and economic uncertainty. Implementation of the SCB was delayed before it took effect in October, and that delay remained in place as of March 2021, when a BPI blog post argued that it was time to move forward with implementation. The move to the SCB to determine capital distributions was finally implemented after the publication of the 2021 stress test results at the end of June.

The SCB enables capital requirements to be more dynamic because it integrates both the results of stress tests with banks’ point-in-time capital requirements. While banks weathered one of the worst crises in modern history through 2020 and demonstrated their ability to withstand a severe economic shock, ongoing uncertainty and concerns over a second COVID-19 wave influenced the Fed’s decision to delay the implementation of the SCB. Now that conditions are improving and the veil of uncertainty is lifting, any further delay could undermine the credibility of the new framework by sending a message to market participants that banks require more capital than is demonstrated under the framework. This would effectively raise capital requirements, tighten credit availability, and would generate uncertainty among shareholders that results in a permanent increase in banks’ cost of capital. Read More >>

9. DFAST 2021 Stress Tests: Banks Remain Highly Resilient but Bank-Specific Results are Hard to Predict

This post analyzed what the effect would be on bank capital levels if there were a second wave of virus and prolonged economic downturn, using the most severe stress scenario published by Moody’s Analytics. The resIn June, the Federal Reserve Board released the highly anticipated 2021 DFAST stress test results. The results proved again that large banks are extremely well capitalized. The aggregate common equity tier 1 (CET1) capital ratio declined from 13 percent in the fourth quarter of 2020 to a minimum of 10.6 percent, or a 2.4-percent maximum decline in the ratio. As the Federal Reserve observes in its summary, “the average minimum CET1 capital ratio is more than double the banks’ minimum requirement of 4½ percent.” While the average peak decline in the CET1 ratio was little changed across the December 2020 and June 2021 stress tests, we observe material moves in the peak-to-trough decline of CET1 capital ratios of individual banks. The large variability in firm performance in the tests shows that stress test results of individual firms are not easy to predict. In addition, the large variability in results leads to significant volatility in capital requirements and may induce banks to increase their own capital buffers for precautionary reasons, according to BPI’s analysis of the stress test results authored by Head of Research Francisco Covas and Vice President of Research Gonzalo Fernandez Dionis. Read More >>

10. Regulators Need To Revisit the Calibration of Leverage Ratios

The Fed adopted the enhanced supplementary leverage ratio in 2014 despite concerns expressed by several board members that the eSLR would reduce demand for safe assets and disincentivize banks from providing liquidity to U.S. Treasury markets. Fed staff indicated that these unintended consequences would be offset by a decline in reserve balances to $25 billion, which subsequently did not occur. Instead, and in response to the Federal Reserve’s asset purchases spurred by the COVID-19 pandemic, reserve balances ballooned to $4 trillion this summer, and will likely remain elevated for the foreseeable future.

Consequently, the Fed must recalibrate the eSLR so that it is more of a backstop for risk-based capital requirements and less of the binding capital constraint, Francisco Covas and Anna Harrington wrote in a BPI blog. If the eSLR is not recalibrated, there’s an increased risk of a repeat of the recent Treasury market disruption and an additional incentive for banks to reduce low-risk, balance-sheet-intensive activities. Read More >>

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Disclaimer:

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.