BPInsights: July 18, 2020

BPInsights: July 18, 2020

Top of the Agenda

The Fed’s Sensitivity Analysis was Extremely Tough and Still, Banks Remain Well-Capitalized

The Federal Reserve (Fed) released the results of its 2020 supervisory stress tests on June 25, which included projections of the stressed aggregate common equity tier (CET1) capital ratio and aggregate loan loss rates under the Fed’s alternative downside scenarios (a/k/a sensitivity analysis). The test combined severe macroeconomic outlook with other “targeted adjustments” to arrive at the projected loan loss rates.

In a new blog post published July 14 by BPI Senior Vice President and Head of Research Francisco Covas, titled “How Tough Was the Fed’s Sensitivity Analysis,” Covas measures the severity of the sensitivity analysis by estimating the peak in the unemployment rate that would be consistent with the reported loan loss rates. The conclusion: the Fed’s sensitivity analysis was extremely tough and still, banks remain well-capitalized. Learn More >>

Stories Driving the Week

If We Take the LEI-Derived Optimal Capital Levels Seriously, Capital Levels Are a Bit Too High

In a new blog post, “Should we take estimates of the optimal level of bank capital ratios seriously or not?”, BPI Chief Economist Bill Nelson looks at an influential Basel Committee for Banking Supervision (BCBS) study titled “An assessment of the long-term economic impact of stronger capital and liquidity requirements,” generally referred to as “the LEI study,” and the many other studies that used the same approach.

Nelson explains in the post that we at BPI have long struggled to take studies using the LEI approach seriously. The estimate of the optimal level of capital depends critically on many assumptions that the researchers for each paper have to make, and even then, they are imprecisely estimated. As a result, the results of the studies vary widely, reflecting in part differences in the specific assumptions made by the authors. Moreover, when we have pointed out the implications of the studies to the banking agencies, the agencies have informally told us that no one takes the studies seriously.

Nevertheless, because the studies are influential, Nelson fixes two material errors that shift up the estimate of optimal capital requirements, on net. The resulting estimate of optimal capital, however, is below U.S. bank holding companies’ current average capital ratio. He points out that if we should take the estimates seriously, capital levels are a bit too high. Learn More >>

Quarles Underlines Shadow Bank Risk in Letter to G20 Finance Ministers, Bloomberg Reports

Federal Reserve Vice Chair for Supervision and Chairman of the Financial Stability Board (FSB) penned a letter to G20 finance ministers on Tuesday warning of the growing risk nonbank financial intermediaries — often referred to as shadow banks due to their ability to offer credit and many other commercial bank services without being subjected to the same regulatory oversight — pose to the financial market, and citing shadow banks as a key reason for the Fed’s “extraordinary” intervention to calm capital markets. In his letter, Quarles cited “excessive leverage, interconnectedness and instances of assets freezing up that investors assumed were akin to cash” as just some of the potential weaknesses of these nonbank firms that have resulted in “significant pricing disconnects between the market and economic fundamentals,” reported Bloomberg.

The group of G20 finance ministers will virtually meet on July 18, and the FSB is expected to release a review of the March turbulence in November; this report will serve as a basis to determine the need for additional reform. Learn More >>


Congress and Stakeholders Continue Debate Over Cyberspace Solarium Commission’s Recommendations

House debate over the National Defense Authorization Act (NDAA) is expected to begin early next week, which will include numerous amendments implementing cybersecurity proposals from the Cyberspace Solarium Commission. Most notably, Congressman James Langevin (D-RI), a member of the Commission, plans to offer amendments that would support public-private partnerships as well as a recommendation supported by BPI to establish a national Cybersecurity Director in the White House. Also next week, the House Intelligence Committee will markup its Intelligence Authorization Act, which is expected to include provisions BPI supports to strengthen intelligence sharing and collaboration between critical infrastructure and the intelligence agencies.

The House Committee on Oversight and Reform held a hearing on July 15 to debate the merits of installing a Cybersecurity Director in the White House, during which Congressman Langevin and Congressman Michael Gallagher (R-WI) argued that the position is important to provide the necessary prominence and coordination to establish a national cyber strategy and that making the position Senate-confirmed would institute stronger congressional oversight.

Two additional events were held this week in advance of next week’s proceedings, including one that took place on July 16 and was co-hosted by BPI and the Intelligence and National Security Alliance (INSA) evaluating the benefits of intelligence sharing and operational collaboration between the financial sector and the intelligence community, and an event that took place on July 17 hosted by the Committee on Homeland Security.

As these events highlighted, banks and other financial institutions are facing increasingly sophisticated attacks from nation-states and multinational criminal organizations. Financial firms have made substantial investments in strengthening cybersecurity and fostering information sharing between firms, with government partners and other critical infrastructure sectors, but codifying a stronger relationship with intelligence agencies would close an existing gap in public-private efforts and help safeguard the vital infrastructure making up the backbone of the economy. Learn More >>

CFTC Issues Statement of Support for Cyber Risk Institute’s Cybersecurity Profile

In an official statement this week, the Commodity Futures Trading Commission (CFTC) listed the Cybersecurity Profile — previously maintained by the Financial Services Sector Coordinating Council (FSSCC) and now developed and maintained by the Cyber Risk Institute (CRI) — as an effective tool used to assess a financial entity’s cybersecurity preparedness, recognizing its standardized approach to risk assessment and alignment with industry standards and best practices.

The CFTC joins a growing list of U.S. and global regulators that have recognized the benefits of the Profile. The Profile offers a common-language approach to cybersecurity and provides a comprehensive cyber threat assessment unique to each financial institution through the issuance of 277 diagnostic statements. The Securities and Exchange Commission (SEC), the Federal Deposit Insurance Corporation (FDIC), the National Institute of Standards and Technology (NIST), and other regulatory bodies have released similar statements applauding the Profile’s focus and efficiency in identifying risk while reducing paperwork. Learn More >>

In Case You Missed It

WSJ Editorial Board Defends ‘Valid-When-Made’ Doctrine

The Wall Street Journal Editorial Board mounted a defense of the valid-when-made legal doctrine in an editorial published on July 12. As indicated in the editorial, valid-when-made is a legal principle established by the Supreme Court over 200 years ago and affirmed by the Eighth Circuit in 2000. The principle establishes that a loan agreement remains valid under the interest rate and terms that it was issued, even if the loan is later transferred to a third-party; this remains true if a loan acquired by a third-party would otherwise violate individual state usury laws, thus benefitting the availability of credit.

The editorial details a contentious and regularly cited Second Circuit Court of Appeals Madden decision that carved out debt buyers as distinct from agents or subsidiary of a national bank. President Obama’s Solicitor General stated that the ruling was a misinterpretation of federal law and, according to the editorial, the effects of the decision resulted in a 52% reduction in loan volumes for borrowers with FICO scores below 625 in New York and Connecticut.

Capital Requirements Must Be Based on Financial Risk. Address Climate Change Through Fiscal Policy.

POLITICO quoted BPI President and CEO Greg Baer earlier this week in an article on the topic of climate change and whether banks should be subject to additional capital requirements or stress testing to account for global warming or more frequent natural disasters. While acknowledging the merit in identifying solutions to climate change, Baer stated:

Capital requirements, including risk-weighted requirements and stress tests, should be based on actual financial risk and not co-opted as a subsidy or penalty to serve other public policy goals, however worthy. Climate change policy should be effectuated through fiscal policy and direct regulation, while financial regulation should remain focused on protecting taxpayers and reducing systemic risk.

Banks are already active contributors to green finance initiatives and global efforts to accurately measure and disclose climate-related financial risk. On July 9, several of BPI member banks — Bank of America, Goldman Sachs, JPMorgan and Wells Fargo — announced a collaboration with the Rocky Mountain Institute to launch the Center for Climate-Aligned Finance. The Center represents a collaboration between industry, policymakers and the general public to identify solutions to address rising emissions and the many challenges contributing to climate change.

BPI Comments on OCC IFR Codifying National Bank Authorization to Hold Board and Shareholder Meetings by Phone or Internet-Based Conferencing

BPI submitted a comment letter on July 13th in response to a recently released Office of the Comptroller of the Currency (OCC) interim final rule (IFR) authorizing remote national bank board and shareholder meetings. BPI’s comments, which focused on board of directors meetings, commended the agency for permitting national banks to provide for telephonic or electronic participation at board of directors meetings, noting that remote communications tools provide national banks with more flexibility in planning and holding director meetings; could permit greater director participation at these meetings for those participants not able to attend in person; and may reduce the costs, logistical constraints, and other burdens — as well as, in the current environment, health risks — associated with conducting in-person meetings. In response to a question posed for public comment, BPI, however, cautioned the agency against the issuance of any new OCC risk management standards to govern this telephonic or virtual participation. While BPI and its members recognize the critical importance of the continued integrity of board communications, national banks have extensive experience with risk-reduction tools that predate the current COVID-19 crisis.

BPI Comments on Joint Agency IFR on Supplementary Leverage Ratio

On July 14, BPI filed a comment letter with the Fed, the OCC and the FDIC in response to the joint agency IFR regarding the supplementary leverage ratio (SLR) for depository institutions. The IFR permits a depository institution to elect to temporarily exclude U.S. Treasuries and deposits at Federal Reserve Banks from calculations of their SLR, however, any depository institution that makes this election must receive approval from its primary Federal banking regulator before paying dividends or making certain other capital distributions so long as the exclusion is in effect.

BPI expressed support for the agencies’ modifications to the SLR to allow banks to better serve their vital function as financial market intermediaries and support lending to U.S. households and businesses, especially during this critical time. However, we believe that the consequence of the dividend prior approval condition is that few banks will “opt-in” because of the resultant unpredictability of dividend capacity and the inability of the banks to plan and anticipate how opting in would affect their ability to pay dividends. The ultimate result will be largely to moot the IFR by failing to encourage bank lending and provide support for the broader economy that the agencies intended to produce.

Accordingly, BPI recommends the agencies should:

  • Follow the unconditional approach of the Federal Reserve interim final rule and adopt the SLR modifications without the dividend prior approval condition;
  • Consider other adjustments that would support the ability of banks to provide credit to the economy and function as financial market intermediaries, and revisit the calibration of all leverage ratios in the longer-term so that leverage ratios appropriately function as a backstop and not as a binding constraint; and
  • Exclude repo-style transactions backed by Treasuries from the final rule to further support Treasury market functioning and banks’ roles as intermediaries to support the broader economy.

BPI Comments on FinCEN Proposal to Renew Information Collection Requirements

On July 13, BPI submitted a comment letter to the Financial Crimes Enforcement Network (FinCEN) in response to the agency’s proposal to renew, without change, currently approved information collections requiring certain financial institutions to file Currency Transaction Reports (CTRs). BPI appreciates the agency’s efforts to further enhance its assessments of the burden imposed on financial instructions by these requirements but believes that renewing these requirements without change would forgo an important and constructive opportunity to improve the effectiveness and efficiency of the reporting framework.

BPI suggests that the agency should revise its burden assessment to include the full scope of resources invested in pre-filing reviews, identification, technology, training, testing and quality assurance. Additionally, CTR requirements should be streamlined and modernized to facilitate automated filings of currency transactions at a certain dollar threshold. Finally, a holistic review of the U.S. AML/CFT regime is needed to prioritize reporting of a high degree of usefulness to law enforcement.

Upcoming Events

  • 07/21/2020 – Senate Banking Committee Markup of the Nominations of Judy Shelton and Christopher Waller to be members of the Federal Reserve System Board of Governors
  • 07/29/2020 – Brookings Institution hosts “Fixing America’s Payment System: The Role of Banks and Fintech”
  • 07/29/2020 – FOMC Meeting
  • 07/29/2020 – Senate Banking Committee hosts a hearing titled “The Consumer Financial Protection Bureau’s Semi-Annual Report to Congress”
  • 07/30/2020 – House Financial Services Committee hosts hearing titled “Protecting Consumers During the Pandemic? An Examination of the Consumer Financial Protection Bureau”
  • 08/27/2020 – 08/28/2020 – Kansas City Fed 2020 Economic Policy Symposium “Navigating the Decade Ahead: Implications for Monetary Policy”
  • 10/16/2020 – 10th Annual FDIC Consumer Research Symposium

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