BPInsights: February 8, 2019

BPInsights: February 8, 2019

TOP OF THE AGENDA

Federal Reserve’s Stress Scenario is Much More Severe Than the 2007-2009 Financial Crisis

On February 5, the Federal Reserve published the macroeconomic scenarios that it will use in its 2019 stress tests. The Fed’s stress tests have become an important driver of the capital levels for banks subject to the exercise, and its choice of macroeconomic scenarios plays a crucial role in determining the overall stringency of the stress tests. The severely adverse scenario of this year’s stress tests features a downturn in the U.S. economy that is significantly more severe than the 2007-2009 financial crisis and any other post-war recession. It is therefore inconsistent with the Fed’s own guidance for how it constructs the stress tests. And, once again, it was issued without prior notice and the opportunity for public comment, including analyses like this one from BPI.
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Fed’s Quarles Touts Need for Stress Test Changes

Federal Reserve Vice Chairman of Supervision Randal Quarles said in a speech on February 6 that he sees the Federal Reserve’s stress test as evolving and improving based on input from outsiders, including other central banks, academics, and industry. “The question of how best to consolidate the gains from the first 10 years of stress testing deserves the attention and effort of the country’s best minds,” Quarles said in the speech to the Council for Economic Education in New York. “We should welcome changes and novel ideas, even when they explore stress testing in a new and unfamiliar light,” Quarles said, highlighting the agency’s upcoming July stress testing conference as “a forum for such ideas.”
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INDUSTRY NEWS

CFPB Proposes to Rescind Portions of Payday Lending Rule

On February 6, the Consumer Financial Protection Bureau issued a proposal to amend its 2017 payday lending rule by rescinding the rule’s “mandatory underwriting” requirements for certain covered short-term and longer-term balloon payment loans, including payday and vehicle title loans. The Bureau said in a press release that the evidence underlying the unfair or abusive practices in mandatory underwriting requirements was insufficient and that rescinding these provisions of the final rule would “increase consumer access to credit.” In addition, in a separate proposal, the Bureau proposed to delay the August 2019 compliance date for the mandatory underwriting provisions to November 19, 2020. Both proposals are open for comment 90 days after publication in the Federal Register.

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FSB Report Finds Growth in Shadow Banking

The Financial Stability Board published a report February 4 on the growth of shadow banks. The report found non-bank financial intermediation grew by 8.5 % to $51.6 trillion in 2017 – 14% of total global financial assets. “Non-banks play a growing role in the financial system, and their share of the financial system is the largest on record,” Klaas Knot, Chair of the FSB Standing Committee on Assessment of Vulnerabilities, said in the press release. “They are becoming important players in areas where banks traditionally have played dominant roles.”

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Trump’s Attorney General Nominee Clears Committee Vote

On February 7, the Senate Judiciary Committee voted 12-10 along party lines to endorse the nomination of William Barr to be Attorney General. Senate Majority Leader Mitch McConnell (R-KY) has previously said he intends to hold a full Senate vote on the nomination this month, according to Politico.

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Trump Nominates Treasury’s Malpass to Lead World Bank

President Donald Trump nominated David Malpass of the Treasury Department to lead the World Bank. Malpass currently serves as Treasury Under Secretary for International Affairs.

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BPI Submits Comment on Interagency Proposal to Raise Residential Real Estate Appraisal Requirement Threshold Under FIRREA

In a February 5 comment letter to the Office of the Comptroller of the Currency, Federal Reserve Board of Governors, and Federal Deposit Insurance Corporation, BPI argued that the appraisal requirement threshold for residential real estate-related transactions under Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) of 1989 should be raised from its current level of $250,000 to $500,000, rather than the agencies’ proposed increase to $400,000. The letter contends this change is supported by the data cited in the agencies’ proposal and would appropriately reflect appreciation in housing prices since the current threshold was established in 1994. The letter also encourages periodic review and, if appropriate, adjustment of the threshold to account for future property value changes.

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Federal Reserve Chairman Powell Meets with Trump

Federal Reserve Chairman Jerome Powell had dinner with President Trump on February 4. In a statement, Powell said he did not discuss expectations for monetary policy, “except to stress that the path of policy will depend entirely on incoming economic information and what that means for the outlook.” He also said in the statement that the Federal Reserve’s decisions will continue to be “based solely on careful, objective and non-political analysis.”

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EVENTS

February 11: Federal Reserve Governor Bowman Speech
Federal Reserve Governor Michelle Bowman will deliver remarks on February 11 at 11:15 am at the 2019 American Bankers Association Conference for Community Bankers in San Diego.
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February 12: Federal Reserve Chairman Powell Speech
Federal Reserve Board Chairman Jerome Powell will deliver remarks on “Economic Development in High Poverty Rural Communities” on February 12 at 12:45 pm at the Hope Enterprise Corporation Rural Policy Forum in Bena, Miss.
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February 12: Capital Markets Year Ahead
The Bipartisan Policy Center will host an event on February 12 at 10 am entitled, “The Year Ahead for Capital Markets.” Securities and Exchange Commissioner Hester Peirce and Commodity Futures Trading Commissioner Brian Quintenz are among the speakers. Bipartisan Policy Center, 1225 Eye Street NW, Suite 1000, Washington, D.C
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February 13: Cannabis Banking
The House Financial Services Consumer Protection and Financial Institutions Subcommittee will hold a hearing on February 13 at 2 pm on banking for cannabis-related businesses.
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February 14: Nominations Hearing
The Senate Banking, Housing and Urban Affairs Committee will hold a hearing on February 14 at 10 am on nominations, including Mark Calabria for Federal Housing Finance Agency Director and Bimal Patel to be Assistant Secretary of the Treasury.

February 14: Affordable Housing
The House Financial Services Housing, Community Development and Insurance Subcommittee will convene a hearing on February 14 at 10 am entitled, “The Affordable Housing Crisis in Rural America: Assessing the Federal Response.”
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February 20: FDIC Chairwoman McWIlliams Speech
Federal Deposit Insurance Corporation Chairman Jelena McWilliams will deliver a speech to the Exchequer Club on February 20 at 12:30 pm at the Mayflower Hotel in Washington, DC.

February 26: Senate Federal Reserve Hearing
The Senate Banking, Housing and Urban Affairs Committee will hold the semiannual Humphrey-Hawkins hearing with Federal Reserve Board Chairman Jerome Powell on February 26 at 10 am.
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February 26: Credit Bureaus Hearing
The House Financial Services Committee will hold a hearing on February 26 at 10 am on credit bureaus.
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February 27: House Federal Reserve Hearing
The House Financial Services Committee will convene the semiannual Humphrey-Hawkins hearing with Federal Reserve Chairman Jerome Powell at 10 am on February 27.
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February 27: Diversity in Financial Services Hearing
The House Financial Services Diversity and Inclusion Subcommittee will hold a hearing on diversity trends in the financial services industry on February 27 at 2 pm.
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May 1: Columbia/BPI 2019 Research Conference – Bank Regulation, Lending and Growth
The Bank Policy Institute and Columbia University’s School of International and Public Affairs invite submission of papers for a conference on Bank Regulation, Lending and Growth. The conference brings together academics, market participants, and policymakers to discuss the latest research on how regulation affects credit formation and economic activity.

March 1, 2019, Columbia University, NYC
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November 19-21: The Clearing House + BPI 2019 Annual Conference
The Annual Conference provides a forum for the industry’s leaders to examine the changing dynamics of the bank regulatory and payments landscapes with two and half days of high-level keynote speakers, in-depth expert panels, and networking. Register today.
The Pierre, New York
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RESEARCH RUNDOWN

From Incurred Loss to Current Expected Credit Loss (CECL): Forensic Analysis of the Allowance for Loan Losses in Unconditionally Cancelable Credit Card Portfolios<>

This working paper investigates the effects of two different credit card payment allocation assumptions on allowances for loan and lease losses (ALLL) under CECL. Under one assumption, all future monthly payments, net finance charges, are allocated to the initial balance. Under the other assumption, all future monthly payments, net finance charges and incurred expenses, are allocated to the initial balance. The choice of payment allocation rule plays an important role in the definition of loan default and the authors find that differing rules give diverging cumulative default curves.

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When Losses Turn into Loans: The Cost of Undercapitalized Banks

This paper provides evidence that a weak banking sector contributed to low productivity following the European sovereign debt crisis. To establish this result, the paper exploits a regulatory intervention by the European Banking Authority in 2011 that induced exogenous variation in banks’ capital adequacy, enabling comparison of the changes in credit from exposed and non-exposed banks. Using Portuguese data, the authors find that banks exposed to the higher capital requirements not only reduced lending but also reallocated credit toward keeping distressed corporate customers afloat to forestall having to take losses. The authors then trace how such credit misallocation distorts firm-level use of production factors and, in turn, significantly reduces aggregate productivity. Based on partial equilibrium estimates, the EBA intervention accounts for over 50% of the decline in aggregate productivity in 2012.

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Eliminating Latent Discrimination: Train Then Mask

Machine learning algorithms are used in a variety of decision-making tasks, including lending, credit scoring, and investment. This paper investigates how latent discrimination can be removed from these predictive models. First, the authors propose an operational definition of fairness that both excludes explicit discrimination on the basis of sensitive features such as race or gender while providing a means for detecting latent discrimination. They show that eliminating latent discrimination requires that the sensitive features be included when the algorithm is trained but then excluded when the algorithm is used.

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When the Dollar Appreciates, Credit Tightens for US Corporates

This post analyzes the relationship between dollar appreciation and domestic corporate lending by U.S. banks. U.S. banks hold fewer loans than they once did, selling 80% on the secondary market within 30 days of origination, and the secondary market is increasingly composed of institutional investors rather than other US banks. These institutional investors hold global portfolios and lose their appetite for risk when the dollar increases in value, which reduces demand for US bank loans in the secondary market. The authors find that this, in turn, reduces domestic corporate lending by US banks.

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