Top of the Agenda

Federal Reserve’s Quarles Outlines Needed Adjustments to Stress Testing Framework

• In a speech at the Brookings Institution this morning, Federal Reserve Vice Chairman Randal Quarles provided a comprehensive look at the Federal Reserve’s stress testing policy:
• The general framework of the Federal Reserve’s proposed stress capital buffer will be finalized shortly.
• Consistent with the tailoring of enhanced prudential standards required under recent legislation (s. 2155), Vice Chairman Quarles suggested that banks with between $100 and $250 billion in assets would not be subject to CCAR in 2019, and presumably recommence in 2020.
• Reducing the year-to-year volatility of CCAR and the SCB will likely be the subject of a forthcoming proposal.
• Under the Fed’s forthcoming capital framework, firms will soon know their stress losses (which become their Stress Capital Buffer) prior to having to submit their capital plan.
• The Fed is re-thinking the inclusion of four quarters of dividends in a firm’s SCB, but it remains unclear what the eventual result will be.
• The Fed’s new capital framework is not likely to include a leverage-based measure, recognizing the conceptual incoherence of calibrating a leverage measure using a risk-based stress test methodology.
• The Fed is likely to propose soon (via a policy statement) further transparency measures for CCAR, to begin in 2019.
• The Fed will shortly propose to begin subjecting its annual CCAR scenarios to public notice and comment.
• The CCAR qualitative objection, already eliminated for most banks in favor of standard supervisory processes, will likely be discontinued for all firms.

In addition, we highlight the following from the Q&A:

• Vice Chairman Quarles indicated his opposition to imposing a countercyclical capital buffer, noting that its purpose was financial stability and not macroeconomic management and thus only rising financial stability risks would argue for its use.
• Vice Chairman Quarles acknowledged that the Volcker Rule was having effects on market liquidity.
• The Vice Chairman downplayed the notion that increased transparency was akin to “giving the banks the exam questions,” rather it was more akin to giving them “the textbook.”
• Asked about CECL, Vice Chairman Quarles referenced a forthcoming statement and indicated that there would be a study of the interrelationship of the accounting standard and regulatory capital.

BPI and ABA Ask Regulators to Issue Regulation Codifying Guidance is Nonbinding

To address any potential legal uncertainty resulting from examiners’ reliance on guidance, policy statements, and similar communications as the basis for supervisory mandates, the Bank Policy Institute and American Bankers Association submitted a letter Monday petitioning the banking agencies and the Bureau of Consumer Financial Protection for a formal rulemaking regarding the use of supervisory guidance. Recently, and in response to growing concerns about regulators’ overreliance on guidance, bank regulators and the BCFP importantly issued an Interagency Statement confirming that supervisory guidance does not have the force of law, and that bank examiners should not take enforcement actions based on supervisory guidance.

To institutionalize this recognition, and particularly to promote its prompt and consistent observance by examiners and other agency personnel, the BPI and ABA are asking for regulators to formalize the Interagency Statement in the form of a binding regulation, to ensure it endures over time and is followed consistently across the country.

Midterm Election Results in Split Congress with Limited Opportunities

Republicans have held the Senate and the Democrats now control the House. It will be a fundamentally different environment next Congress, comprised of new members who are coming to banking issues for the first time, and doing so in a divided and polarized Congress. Oversight is likely to dominate the next Congress. We expect the House Financial Services Committee to conduct vigorous oversight and investigations into agencies, industry practices and potentially individual firm’s activities and practices. Going forward, the financial services industry will need to effectively tell its story to illustrate the positive impact on people and communities as well as how banks drive economic growth and create jobs.
Note: BPI members provide 72% of bank loans in America and 44% of small business loans.

Generally, legislation is unlikely with the cameral divisions and the 2020 Presidential election, but nominations will continue to be a focus for the Senate. We also expect continued focus on consumer privacy and data protection, driven in no small part at the macro level by tech industry headlines; but enactment remains unlikely. However, there is legislative opportunity with BSA/AML reform, as there is a bipartisan commitment to achieving improvements in this space. BPI members will continue to find ways to work with lawmakers and regulators to create a financial system that works for economic growth and consumers.

Federal Reserve Updates Rating System for Large Financial Institutions

BPI welcomed the Federal Reserve’s final rule, issued on November 2, on supervisory rating system for large financial institutions, including bank holding companies and non-insurance, non-commercial savings and loan companies with total consolidated assets of $100 billion or more and U.S. intermediate holding companies of foreign banking organizations with total consolidated assets of $50 billion or more. The final rating system, which follows BPI’s urging in a March 2018 comment letter, introduces a new rating scale with component ratings for (i) capital planning and positions, (ii) liquidity risk management and positions, and (iii) governance and controls. The final rule delays applicability of the ratings system from what was proposed; the Federal Reserve will begin to apply the new ratings system to BHCs and IHCs subject to the Large Institution Supervision Coordinating Committee (LISCC) framework in 2019 and to other large financial institutions in 2020.

BPI, SIFMA Submit Comment on Bank Recovery Planning Size Threshold

On Monday, BPI and SIFMA submitted a comment letter to the OCC on its proposal to raise the asset threshold for its national bank recovery planning requirements from $50 billion to $250 billion. The letter offers support for the OCC’s proposal to release banks with less than $250 billion in total assets from the requirements and outlines the four following recommendations to ensure that formal recovery planning is more aligned with the differing risk profiles of the remaining banks that would be subject to the requirements: (1) the OCC should consider a tailored approach to the application of the requirements to banks with $250 billion or more in total assets; (2) the OCC should consider moving from an annual to a biennial recovery plan cycle with targeted updates for material changes or events; (3) recovery planning standards and feedback should be more transparent in the future, and supervisory horizontal reviews of recovery plans may be inappropriate; and (4) the OCC should immediately clarify that no recovery plans are expected of banks on or after January 1, 2019 if they do not meet the $250 billion total assets threshold.

BITS, SIFMA Submit Comment Letter on Privacy Framework

BITS on Thursday submitted a comment letter in conjunction with the American Bankers Association and Securities Industry and Financial Markets Association regarding the National Telecommunications and Information Administration’s (NTIA) proposed voluntary privacy framework. The letter affirms the financial services industry’s support for the framework and points out that the principles articulated by the NTIA are already cornerstones in the current legal mandates on financial firms. The letter NTIA to ensure that the proposed framework will ultimately provide a national standard that preempts the current patchwork of state laws.

BPI Events

BITS Hosts Board Governance Meeting on Cybersecurity Preparedness

On Tuesday, BITS hosted seven CEOs and 16 Board Directors from member firms for a cybersecurity discussion on crisis preparedness, cyber risk at the board level and innovation. The day-long meeting included a conversation with Treasury Secretary Steven Mnuchin who commented that the current anti-money laundering (AML) regulatory regime needs reform.

BPI & TCH ANNUAL CONFERENCE 2018

Join us this November 26-28 for the 2018 BPI & TCH Annual Conference. Registration is now open for the premier gathering for senior financial services executives, regulators, policymakers, and academics focused on the changing regulatory landscape and the future of payments.
Space is limited! Register today.
November 26-28, 2018, The Pierre, NYC

NYU Stern-BPI Gallatin Lecture Series on Banking

The New York University Stern Business School and BPI host a lecture entitled, “A Crisis of Beliefs: Investor Psychology and Financial Fragility,” with Andrei Shleifer, John L. Loeb Professor of Economics, Harvard University, on Dec. 4 at 5 pm.
Henry Kaufman Management Center
44 West Fourth Street (corner of Greene Street), NYC

Industry News and Events

Hearings on Competition and Consumer Protection in the 21st Century

Over the course of three days this week, the FTC held the sixth session of its series “Hearings on Competition and Consumer Protection in the 21st Century”. Representatives from academia, law and industry discussed the inherent tension between innovation and privacy regulations. Major themes in the discussion included the dampening effect of GDPR on technology venture investment, the disproportionate compliance costs borne by young or small firms after data privacy regulations are enforced, and how this reduces incentives for entrepreneurship. Panelists highlighted the fact that simpler and more practical codes of conduct lead to lower barriers to entry. Further sessions focusing on artificial intelligence, data security and privacy will be held November 13-14, December 11-12 and February 12-13. Public comment can be made online until January 7, 2019.

HOUSE FINANCIAL SERVICES AND SENATE BANKING COMMITTEES TO HOLD HEARINGS

AML: The Senate Committee on Banking, Housing, and Urban Affairs will hold a hearing on November 29 at 10 am on “Combating Money Laundering and Other Forms of Illicit Finance: Regulator and Law Enforcement Perspectives on Reform.” Financial Crimes Enforcement Network Director Kenneth A. Blanco is among the witnesses.

Federal Reserve: The House Financial Services Committee is expected to hold a hearing entitled “Semi-Annual Testimony on the Federal Reserve’s Supervision and Regulation of the Financial System” with Federal Reserve Vice Chairman of Supervision Randal Quarles on November 14 at 10am. Vice Chairman Quarles will also testify in a hearing on the same subject on November 15 at 10am before the Senate Banking Committee.

GSE Pilots: The Senate Banking, Housing, and Urban Affairs will hold a hearing on December 5 at 10 am on Pilot Programs at Fannie Mae and Freddie Mac. Witnesses include Sandra Thompson, deputy director of the Federal Housing Finance Agency, Fannie Mae Interim Chief Executive Officer Hugh Frater and Freddie Mac Chief Executive Officer Donald Layton. This hearing was rescheduled from November 14.

Conference on Fintech and the New Financial Landscape

Fintech has been playing an increasing role in shaping financial and banking landscapes. The Federal Reserve Bank of Philadelphia hosts a conference to provide a platform for industry practitioners, regulators, policymakers, business leaders, and researchers to share their thoughts on the new financial landscape.
November 13-14, Renaissance Philadelphia Downtown, Philadelphia

Research Rundown

U.S. Treasury Market Action on Election Night 2016 (Fleming)

This post explores the reaction of the U.S. Treasury market to the 2016 federal elections. As election results came in and projected outcome changed, Treasury yields dropped. Market commentary indicates that this was driven by uncertainty around both the election outcome and Trump’s economic positions. As the election results solidified and Trump gave a victory speech more conciliatory than expected, yields rebounded.

Contagion in the European CoCos Market (Bologna et al)

This post analyzes the dynamics of the contingent convertible bond market to determine whether these bonds are effective instruments for bank recapitalization or if they are destabilizing. Examining the period between January 2014 and November 2016 when the CoCos market experienced two moments of turbulence, the authors find support for the existence of a CoCo-specific contagion channel on top of a “fundamental” contagion channel. They recommend that regulators continue to monitor the development of CoCo markets.

Why Does Credit Growth Crowd Out Real Economic Growth? (Cecchetti and Kharroubi)

This paper studies the relationship between credit growth and productivity across 20 countries over 25 years. The authors find a robust negative correlation, with higher credit growth accompanied by lower productivity. R&D intensive industries and those with less tangible assets are disproportionately affected. They build a model assuming that risky investments lead to higher returns and find a possible mechanism: within the model, entrepreneurs take on safer, lower return projects as their borrowing increases.

The Big Con – Reassessing the “Great” Recession and its “Fix” (Kotlikoff)

This paper analyzes possible causes of the Great Recession, finding that the crisis was essentially a run. The author dismisses more common explanations, such as sub-prime lending, unsustainable housing prices, and insufficient regulatory capital. They argue instead that opaque assets, panic, and false rumors drove a shift from one market equilibrium to another.