BPInsights: Top 10 Research and Blog Posts of 2020

1. Beware the Kraken

The business model of Payward Inc.’s Kraken Financial, part of a U.S.-based cryptocurrency exchange that Wyoming bank authorities approved for a special-purpose bank charter, shows that treating payment tech companies like full-fledged banks can endanger customer deposits, argues BPI in a blog post published on Oct. 21. Banks maintain multiple layers of protection, further bolstered since the financial crisis, that Kraken lacks – yet it wants to enjoy the regulatory status and Federal Reserve access of a bank. Overlooking Kraken’s rickety structure – uninsured deposit funding and reliance on potentially volatile bond investments to help it weather mass withdrawals – could have dangerous consequences for depositors, including a bank run. Relevant bond market disasters aren’t just theoretical – one need only look to the Treasury market’s March meltdown this year.
The blog concludes that the Fed should weigh Kraken’s risk profile carefully, perhaps by evaluating its capital ratios like it weighs those of new banks – or requiring even more capital, given Kraken’s added risk compared to regular banks. With sensible regulatory policies the banking system can advance innovation while protecting customer deposits. Read More >>

2. Actions the Fed Could Take in Response to COVID-19

BPI projected that the COVID-19 epidemic would reduce economic activity, reduce market liquidity and could generate an increase in federally insured deposits at banks as investors looked to get rid of riskier assets. This blog post suggested steps that the Fed could take to mitigate these risks, many of which were later implemented. Read More >>

3. The Truth About Suspicious Activity Reports

The International Consortium of Investigative Journalists and BuzzFeed reported on more than two thousand illegally leaked Suspicious Activity Reports in a release termed “FinCEN Files” in September. FinCEN Files is based on limited information and lacks a full understanding of the anti-money laundering framework, which in turn provides a skewed and misleading perception of AML enforcement efforts.
Since the report completely misses the purpose of SARs and demonstrates an uninformed view of how they are generated by banks and used by law enforcement, BPI published a blog which provides questions and answers about how banks file SARs to help provide leads to law enforcement. Read More >>

4. Don’t Keep Your Powder Dry

BPI Chief Economist Bill Nelson predicted on March 1 that the Fed would make a large inter-meeting interest rate cut in response to the weakening economic outlook and the associated decline in the stock market. These predictions resulted in a surge of coverage by numerous major media outlets, including CNBC’s Squawk Box. As predicted, the Fed cut rates by 50 basis points just a few hours later. Read More >>

5. Why a Wyoming Charter is No Hail Mary for the Anti-Fractional Banking Team

Avanti Financial, a cryptocurrency firm, received Wyoming’s approval to take deposits like a bank, but its boasts of being “100 percent backed by reserves” belie its real risks to customer deposits, BPI wrote in a blog post Nov. 9. 

Wyoming regulators approved the FinTech company for a special-purpose depository institution charter, a license recently granted to fellow FinTech Kraken Financial, whose structure is similarly risky. Avanti will take deposits, but instead of making loans with them, it will buy corporate bonds, munis, Treasuries and other assets. The problem comes when customers demand a withdrawal. Those assets can rapidly drop in value and might not be worth the $100 or $10,000 the customer originally deposited. Such discrepancies between deposits and what backs them can lead to disaster scenarios like bank runs, especially when the deposits are uninsured by the FDIC like Avanti’s.   

Avanti’s whole concept appeals to many critics of the way banks work. Avanti boasts that its deposits are 100 percent reserve-backed, but they’re really talking about assets rather than reserves.  Reserves don’t go up and down in value in the same way other assets can. The average U.S. bank’s assets exceed its deposits by more than 25 percent, as of late October. Critiques that banks shouldn’t create money by taking deposits and lending to other customers also fall flat – Avanti is just taking deposits and making loans in a different way by buying bonds, which is just another way to lend a firm funds that the firm pays back later with interest.  Read More >>

6. Reserve Requirements Should – and Must – Be Set to Zero

In a blog post published Feb.18, BPI CEO Greg Baer and Chief Economist Bill Nelson highlighted a conclusion by the Fed more than a decade ago that nonzero reserve requirements serve no monetary policy purpose in the policy implementation framework that the Fed currently uses. Therefore, the Fed should – and legally must — set reserve requirements to zero. The two explained that by setting reserve requirements to zero, the Fed could come into compliance with two laws, reduce the risk of money market turmoil witnessed in September 2019, reduce the amount it needs to blow up its balance sheet, increase the supply of credit to Main Street and eliminate the incentive it is creating for banks to engage in inefficient behavior that edges up liquidity risk.Read More >>

7. Alleged PPP Scammers Steered Clear of Large Banks: An Analysis of the DOJ’s Reported Cases to Date

Alleged Paycheck Protection Program scammers mostly bypassed large banks, according to an Oct. 29 BPI blog post by Paul Calem. In the bulk of the fraud cases analyzed, the allegedly fraudulent loan came from an internet bank or FinTech. The analysis, which corroborates reports from Bloomberg and the Project on Government Oversight, looked at alleged PPP fraud cases with one or more loans larger than $150,000 that had received approval and been distributed.  Findings include: 

  • The 14 large banks on the SBA’s list of top 15 PPP lenders (which additionally includes one FinTech-related lender) originated approximately 75,000 loans of at least $350,000 in size, of which just 10 are allegedly fraudulent.  
  • The percentage of allegedly fraudulent loans among the PPP loans of the major internet banks and FinTech lenders is nearly 48 times the percentage among the PPP loans of these 14 large banks. 

The analysis also strongly suggests that most allegedly fraudulent loans at community and midsize banks involved borrowers with no prior relationship with those banks, including loans from FinTech-related marketplace platforms. A key takeaway: Relationships between banks and borrowers matter in preventing online small-business lending fraud. Read More >>

8. BPI Sanctions Report: Modern Sanctions Threats Deserve Modern Detection Methods

The Treasury Department and U.S. bank regulators should modernize their approach to bank sanctions compliance in order to more effectively target activities in the financial system that truly threaten U.S. national security and foreign policy interests, a Dec. 9 BPI report says. Inefficiency in the current sanctions compliance framework – such as a patchwork of sanctions intelligence that differs between banks, or low- to no-yield transactions screening expectations against OFAC lists – could expose the U.S. financial system to terrorists, human traffickers or other foreign adversaries. Sanctions evaders use innovative techniques like blockchain technology to infiltrate the financial system, so sanctions enforcers and banks should use equally innovative methods to stop them, the report argues.

The Treasury Department’s Office of Foreign Assets Control should officially endorse a risk-based approach to sanctions compliance, rather than one that compels banks to increasingly devote resources to efforts to improbable detection scenarios, BPI recommends in the report. A re-alignment of expectations would encourage banks to devote more resources to the risks that pose the highest threats and use innovative methods, like artificial intelligence, to improve detection efforts. Bank regulators should acknowledge this direction, so that examiners don’t contradict Treasury’s expectations, the report recommends. Read More >>

9. Would a Serious Second Wave of COVID-19 Require Banks to Reduce Their Dividends?

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 results demonstrated that even in this scenario, banks retain sufficient capital to remain well above minimum capital requirements and maintain most of their capital buffers; as a result, none of the major banks would face dividend restrictions. The post also highlighted that the resulting increase in the stress capital buffer would decrease banks’ lending capacity. Read More >>

10. Some Thoughts on the Bank Regulatory Picture: Dividends, CECL, Buffers and the Rest

This post featured arguments for why it would be bad public policy for the Federal Reserve Board to mandate a blanket halt to dividends by U.S. banks. In short, a governmental ban on bank dividends would:

  • Not produce additional lending;
  • Undermine the credibility of a regulatory regime that thus far has worked well; and
  • Do permanent damage to the banking industry by driving its already low market values still lower, with adverse consequences for its ability to support economic growth.

The post concludes that those advocating for government-mandated dividend halts for banks (and only banks) appear to have adopted an “if it ain’t broke, let’s break it” approach to bank regulation. While perhaps politically appealing, such an approach is bad policy and a repudiation of the good work that both regulators and banks have done since the last financial crisis. Read More >>

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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.