BPInsights: January 24, 2020

Top of the Agenda

Banking Regulation, Monetary Policy and the Role of the Central Bank

During the financial crisis, the Federal Reserve and other government agencies took extraordinary actions to support the financial sector. Those actions were an appropriate response to unprecedented events, but vastly increased government’s role in financial markets.  Ten years post-crisis, however, the Federal Reserve’s role in financial markets has not returned to its pre-crisis norm and only continues to grow.

The Fed’s expanding role owes much to a feedback loop between its regulatory and monetary policies. Several new regulations and examination mandates encourage banks to prefer the Fed (or other government entities) as counterparties rather than other banks or financial institutions, and more generally to retreat from financial market intermediation critical for monetary transmission. Meanwhile, the Fed has been conducting monetary policy with a massive balance sheet and an expanded set of counterparties—actions that not only respond to but also further encourage the regulatory-induced retreat from intermediation by the private sector.

In BPI’s latest blog, our CEO Greg Baer and Chief Economist Bill Nelson argue that the Fed should consider returning to conduct monetary policy as it did pre-crisis, when it engaged in small and comparably unimportant repo transactions with primary dealers to adjust the size of its balance sheet. Given the tight linkages between financial markets, changes in the fed funds rate were well transmitted to other interest rates. As a result, the Fed once had a small footprint and good monetary control. In the current environment, the Fed’s footprint is huge and growing, and its monetary control questionable.

If the Fed continues on its current course, when the next crisis occurs, we worry that its independence will be at risk.


5 Stories Driving the Week

1. Agencies to Release Volcker Covered Funds Proposal January 30

An interagency proposal on the “covered funds” portion of the Volcker Rule will be released January 30, according to bank agency and CFTC officials. The upcoming proposal was announced in remarks by CFTC Chairman Heath Tarbert at the American Bar Association Banking Law Committee Meeting on January 17, and further addressed on January 22 by Comptroller of the Currency Joseph Otting, who emphasized that all five agencies are in agreement on the coming proposal. While details on the proposal have yet to be disclosed, there have been previous indications that the agencies are looking to simplify the rule. On January 23, both the Fed and the FDIC noted the proposed rulemaking in their upcoming agendas for January 30.

2. European Banking Authority Proposes Changes to Stress Test Framework, Effective in 2022

On January 22, Politico reported that the European Banking Authority (EBA) released a discussion paper proposing alterations to the current European stress test framework with the intended goal of “balanc[ing] the need to preserve comparability and conservatism, while allowing for more flexibility in order to identify banks’ idiosyncratic risks.” The proposal would establish two components to the framework based on the same scenarios: a supervisory stress test based on a common EU methodology that relies on the current constrained bottom-up approach, and a bank-own methodology based on their own risk assessments. Banks would have to explain and disclose the rationale and impact of deviations from the EU common methodology. The EBA plans to host a public hearing on February 21 and comments are due by April 30. The new framework would not go into effect until 2022.


3. Fed Vice Chair for Supervision Randal Quarles Reiterates Importance of Flexibility and Due Process in Supervision at ABA Banking Law Committee Conference

As previewed in last week’s edition of BPInsights, on January 17 Federal Reserve Vice Chair for Supervision Randal Quarles gave a speech at the ABA Banking Law Committee Meeting, largely focused on the importance of both flexibility and fairness and due process in supervision. The Vice Chair’s speech highlighted many issues and concerns raised by BPI over the past few years and provides a path to reforms that would greatly reduce variability and promote transparency in the examination process.

The speech highlighted several proposed changes to large bank supervision, including LISCC to be limited to US BHC Category 1 firms, along with the publishing of an internal Fed LISCC manual, LFI not determined by lowest rating, increased CCAR transparency, longer bank review periods for stress test results and capital requirements, and the reduction of stress test volatility through the use of averaging results with previous years. He continued to propose further transparency improvements, including a searchable database of Fed interpretations, opening significant supervisory guidance to public comment, and submitting significant supervisory guidance to Congress for approval. Finally, he addressed overall proposals in supervisory process improvements, including a modernization of the Fed’s CSI regime, rulemaking on the use of agency guidance, heightening the standards for MRAs to violations of law, violations of regulation, and material safety and soundness issues, the improvement of bank and examiner communications, increased after-the-fact reviews on supervisory communications, along with avoidance of bright lines and mandatory language in guidance documents. To view complete remarks, please click here.


4. Data Privacy is Greatest Challenge as Banks Assess Moving to the Cloud
On January 21, the American Banker published a report identifying a new survey conducted by Refinitiv, which seeks to determine the challenges banks assess when electing to move critical data services to a cloud provider, such as Amazon Web Services or Microsoft Azure. The survey of 300 financial institution chief technology officers, chief information officers and chief data officers found that over half of respondents perceive data privacy to be the biggest challenge to cloud service adoption. The report goes on to identify compliance expectations that financial institutions are expected to meet in order to responsibly innovate, while prioritizing customers and their data privacy, such as state-wide regulations like the California Consumer Privacy Act and global considerations such as Europe’s General Data Protection Regulation and the transnational movement and storage of customer data. As policymakers consider additional privacy legislation, BPI has highlighted the existing privacy and security requirements financial firms already adhere to and has suggested these be used as a model for other industries.


5. Alternative Reference Rate Committee Requests Feedback on Potential Static Spread Adjustment Methodologies for LIBOR/SOFR Shift
On Tuesday, the Alternative Reference Rates Committee (ARRC) released a consultation requesting feedback on static spread adjustment methodologies for cash products referencing LIBOR as part of the transition away from LIBOR to the Secured Overnight Financing Rate (SOFR). The methodologies proposed are similar to those adopted for derivative contracts. The ARRC noted that it “is not considering” dynamic spread adjustments because these would need to be based on the same wholesale unsecured funding markets that underpin LIBOR and that have now grown to be so thin. The ARRC also reiterated its reasons for not recommending term unsecured lending rates, which it considered previously as it sought alternatives to LIBOR.  On Wednesday, however, Comptroller of the Currency Joseph Otting announced the anticipated launch of an interagency consideration with banks of other credit-sensitive alternatives to LIBOR.


In Case You Missed It

CFPB May Use Enforcement Policy Statement to Clarify Abusiveness Standard
In comments at the American Bar Association’s Consumer Financial Services Committee Meeting last Saturday, recently departed CFPB officials suggested that the agency may consider issuing an enforcement policy statement as one method of adding clarity to the “abusiveness” prong within the prohibition on “unfair, deceptive, or abusive acts or practices” (“UDAAP”) under the Dodd-Frank Act. CFPB Director Kathleen Kraninger has alluded to such a potential step in the past, as in remarks last November at the TCH/BPI Annual Conference, where she said that she expected a “concrete step in the near future around this issue” that the CFPB would be “taking soon.”

Senator Warren Sends Letter to GSIBs Regarding Climate Change

On Tuesday, Senator Warren (D-MA) wrote a letter to the CEOs of the eight global systemically important banks (G-SIBs) requesting information regarding their plans to mitigate risks that climate change poses to their banks. Senator Warren’s letter follows the introduction of the Climate Change Financial Risk Act by Senator Brian Schatz (D-HI) in the Senate and Representative Sean Casten (D-IL) in the House late last year.  The bill would require the Federal Reserve “to conduct stress tests on large financial institutions to measure their resilience to climate-related financial risks.”

BPI Geeks Out on Game Theory in New Research Note Analyzing Ringfencing versus Cooperation

On January 22, BPI published a new research note, “Ringfencing versus Cooperation: A Game-theoretic Perspective,” analyzing the growing focus over the last decade by regulatory bodies toward the resilience of international bank subsidiaries operating within their jurisdictions. To protect local creditors from losses when a subsidiary of an international bank fails, local regulators have implemented ringfencing measures that have made it harder for the international bank to diversify losses. As a result, these measures—designed to enhance prudential safety and protect local creditors—can hinder the global organization’s ability to deploy resources when needed, leading to a greater risk that the international bank will fail and leave creditors ultimately worse off.

Through the lens of game theory, the note models how regulators respond and react to ringfencing and evaluates the cooperation between U.S. and European authorities pre- and post-crisis.

Otting Makes News in Briefing with Reporters: CRA Comment Period Unlikely to be Extended, and Possible Impending Action on Small-dollar Lending

At a press roundtable on January 22, Comptroller of the Currency Joseph Otting signaled that the OCC was unlikely to extend the comment period for the agency’s Community Reinvestment Act (CRA) proposal following calls from stakeholders to extend the comment period to 120 days—from the standard 60-day comment period—to allow time for additional comments and analysis. The CRA proposal under consideration is one of Otting’s proposed seminal achievements during his time as Comptroller and would be the first substantial revision to the law in over 40 years. 
As reported by Politico, Otting also hinted at an impending OCC rulemaking or guidance on small-dollar lending aimed at making it easier for banks to offer small-dollar loan products—typically valued between $300 and $5,000—to consumers. Banks currently occupy a small share of the small-dollar loan market due to regulatory uncertainty created following the 2013 guidance issued by the OCC and FDIC that imposed significant compliance risks on banks offering small-dollar loan products, including deposit advances and installment loans. This decision by the agencies discouraged many institutions from offering these products and resulted in greater consumer reliance on payday lenders and check cashers to cover emergency expenses, whose products are often accompanied by exorbitant rates, limited regulatory oversight and fewer consumer protections than traditional banks. This indication by Otting follows a 2018 bulletin published by the agency intended to alleviate some of the regulatory uncertainty in the space for national banks; Otting did not provide a concrete timeline for the announcement.

Treasury Seeks Financial-Infrastructure Cyber Data
On January 22, The Treasury Department’s Office of Cybersecurity and Critical Infrastructure Protection (OCCIP) announced it is seeking comments on a proposed survey of financial sector cybersecurity risks. The survey will go to 75 firms. OCCIP says the responses will help it to enhance the security and resilience of the financial services sector critical infrastructure and reduce operational risk.

IBM CEO Ginni Rometty Calls on Global Regulators to Establish AI Regulatory Standards At a Davos World Economic Forum panel on the topic of AI, Bloomberg reported that IBM Chief Executive Officer Ginni Rometty called for international regulators to collaborate with the private sector to establish new standards for AI algorithms to minimize the risk of disparate impact. Rometty also called on companies to appoint chief AI ethics officials responsible for documenting and providing internal feedback on AI models. Rometty’s comments follow recent government initiatives, including a January 7 memo from the White House proposing guidance to executive branch departments and agencies on the regulation of AI, and the European Union’s High-Level Expert Group on Artificial Intelligence—established in June 2018—is currently considering a second draft of Ethics Guidelines for Trustworthy Artificial Intelligence.

The application of AI and machine learning is a significant consideration across all industries. In banking, AI offers the potential to expand access to credit to underserved communities and enhance the effectiveness of anti-money laundering programs. In September 2019, BPI published a discussion draft in coordination with Covington & Burling LLP soliciting input from stakeholders and intends to publish a final set of recommendations in the coming weeks.

European Parliament Panel Rejects European Banking Authority Nominee Gerry Cross

Irish banking regulator Gerry Cross’s bid to become executive director of the European Banking Authority (EBA) was rejected by the European Parliament’s economic committee on Thursday, following questioning about his links to industry group Association for Financial Markets in Europe (AFME). Cross had been expected to succeed former EBA executive director Adam Farkas, but drew scrutiny from committee members over his vote as a member of the EBA board of supervisors to allow Farkas to join AFME. No successor candidate has yet to be put forward, but it is reasonable to speculate that any further candidates may come from more traditional public sector backgrounds.

BPI, SFA Back OCC’s Proposal for “Valid-When-Made” Rule
In a comment letter submitted Tuesday, BPI and the Structured Finance Association (SFA) offered comments to the OCC on its proposal to amend portions of the regulations implementing the National Bank Act and Home Owners’ Loan Act, rectifying a 2015 appeals court ruling in Madden v. Midland Funding that challenged the longstanding “valid-when-made” doctrine governing interest rates on loans sold to nonbanks. BPI and the SFA expressed their support for the proposal, which would “reestablish the correct legal interpretation—well understood for over 150 years—that a loan validly originated does not become usurious if the originator subsequently sells, assigns, or securitizes the loan,” and emphasized the importance of the proposal in limiting the threat of disruption to the lending and securitization markets posed by the Madden decision. The letter encouraged the OCC to finalize the proposed rule as soon as possible to address uncertainty in the market and to harmonize the final rule with the parallel proposal from the FDIC.

BPI Submits Supplemental Comment Letter to Fed on Changes to CCAR Reporting Requirements
On January 23, BPI submitted an unsolicited supplemental comment letter to the Fed regarding its recently finalized changes to the Comprehensive Capital Analysis and Review (CCAR) stress test reports (FR Y-14A/Q/M). The letter requests that CCAR 2020 instructions be released as early as possible and invites further discussion with the Fed if the industry interpretation of certain of the final FR Y-14A reporting changes (i.e., firms are now permitted to reflect global market shock adjustments to capital deduction calculations, balance sheet, leverage and risk-weighted asset calculations) does not comport with the intent of the Fed in including these Y-14A changes in the final notice. The letter also encourages the Fed to add optional data fields for securitization exposures, allowing the agency to more accurately calculate stress losses on these items for electing firms.


  • 01/29/2020 – The House Committee on Financial Services will hold a hearing entitled “The Community Reinvestment Act: Is the OCC Undermining the Law’s Purpose and Intent?”
  • 01/29/2020 – News Conference: Federal Reserve Board Chairman Jerome Powell
  • 01/30/2020 – Federal Reserve Board of Governors Meeting to Vote on Volcker Covered Funds NPR and Final Rule on Control Under the Bank Holding Company Act
  • 01/31/2020 – The House Committee on Financial Services will hold a hearing entitled “Is Cash Still King? Reviewing the Rise of Mobile Payments”
  • 02/14/2020 – Columbia University/Bank Policy Institute 2020 Bank Regulation Research Conference
  • 02/04/2020 – The Bipartisan Policy Center holds an event, “A Conversation with Janet Yellen and David Malpass”

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