BPInsights: September 12, 2020

BPInsights: September 12, 2020

Top of the Agenda

Putting Too Big to Fail to Rest: Evidence from Market Behavior in the COVID-19 Pandemic

In a new blog post out on September 9, BPI Senior Vice President and Head of Research Francisco Covas and Gonzalo Fernandez-Dionis use the repricing of financial assets during the pandemic’s early stages to evaluate the efficacy of TBTF reforms. As noted in a recent FSB report, the pandemic represents an excellent opportunity to test the post-2010 crisis framework. The note uses the period before the Federal Reserve and the government’s massive intervention to assess the impact of the rapid and severe deterioration in economic conditions on the funding costs of banks. Results strongly indicate that the spreads of GSIBs showed a significantly more pronounced response to changes in the economic outlook relative to the spreads of non-GSIBs during the early stages of the COVID-19 pandemic. As a result, the funding cost advantages of systemically important banks have disappeared. In addition, consistent with the preliminary findings of the FSB report, the blog also finds that funding costs are lower for banks other than the GSIBs in the period before the start of the pandemic. The blog concludes that TBTF reforms have worked. Learn More >>

Stories Driving the Week

Jane Fraser Appointed First Female CEO of Citigroup Following Announcement of Corbat’s Retirement

Citigroup appointed Jane Fraser as the company’s next chief executive officer — the first female CEO in the company’s history and the first female to serve as CEO of a major U.S. bank — starting in February 2021 following an announcement that current CEO Michael Corbat will be retiring. Fraser joined Citigroup in 2004 and currently serves as the chief executive of global consumer banking, a role she assumed after leading the company’s operations in Latin America. BPI President & CEO Greg Baer was quoted in a Reuters article on Fraser’s appointment stating that she has the “knowledge and perspicacity to be a policy leader for the industry.” Ms. Fraser will also replace Mr. Corbat on BPI’s Board of Directors. Learn More >>

Federal Reserve Board Versus Minneapolis Fed: Whose Stress Test Should We Believe?

The Federal Reserve Bank of Minneapolis recently published a COVID-19 stress test tool on its website that allows the public to simulate a stress test for domestic banks to determine how those banks would fair under several COVID-19 recession scenarios. When a user stresses the banks against the same “severely adverse” scenario the Federal Reserve Board (FRB) used in the 2020 stress test, there’s a large discrepancy between the results from the tool and those published by the FRB.

BPI SVP and Head of Research Francisco Covas analyzed the findings and published a blog post on August 31 titled, “Federal Reserve Board Versus Minneapolis Fed:  Whose Stress Test Should We Believe?” explaining some of the discrepancies and concluding that all the Minneapolis tool has produced so far is confusion about the resiliency of the U.S. banking sector. Learn More >>

CFTC Advisory Committee Issues Recommendations to Address Climate Change

An advisory committee for the U.S. Commodity Futures Trading Commission (CFTC) published a set of recommendations titled “Managing Climate Risk in the U.S. Financial System” on September 9, addressing some of the policy considerations relating to climate change, and cautioning that a climate-related event could simultaneously affect multiple sectors, geographies and assets in the U.S.

The report recommends that U.S. financial regulators take action under existing legislative authority to address financial risks related to climate change. The report makes several broad recommendations covering both prudential and market regulation, as well as specific recommendations in the fiscal space, while importantly acknowledging some of the limitations that authorities face in evaluating climate-related financial risks—specifically citing limitations related to data and scenario analysis.

In response to the report, BPI President & CEO Greg Baer issued the following statement:

Climate change is one of the most pressing issues of our time and it is encouraging that leading financial institutions are working with the regulatory community to bring about meaningful change. Specifically, banks are considering how climate change affects the risk of numerous types of lending and exploring how stress scenario analysis could assist their analysis. Stress testing for long-term climate change, however, is an extraordinarily complex and difficult endeavor given a lack of data, established modeling techniques and the need to forecast over longer time horizons than economic stress testing has ever contemplated. Such stress testing will also need to consider how both customer and bank practices might change over time – for example, how currently carbon-intensive businesses might diversify; how banks might change their client mix if they do not; and how banks might also diversify and hedge their risks.

Learn More >>

Senate Banking Committee Hosts Hearing on Status of Fed Emergency Lending Facilities

On Wednesday, the Senate Banking Committee held a hearing titled “Status of the Federal Reserve Emergency Lending Facilities,” which featured a discussion of the Main Street Lending Program (MSLP) and its uptake to date, as well as potential recommendations to improve access to the program. Approximately $1.2 billion of Main Street loans have been disbursed out of the $600 billion that was authorized for the program. Senators and witnesses discussed potentially expanding the MSLP to include the commercial real estate industry and changes to the term sheets to offer more favorable terms for potential borrowers. BPI Senior Vice President and Associate General Counsel Lauren Anderson testified in August before the Congressional Oversight Commission regarding the MSLP and ways it could be improved for banks to be able to offer loans to a wider range of borrowers. Learn More >>

Negotiations Continue on Proposed Coronavirus Relief Package Despite Bleak Outlook

Senate Republicans introduced a limited coronavirus relief package earlier this week. However, a vote on the legislation Thursday failed to meet the 60-vote threshold to advance the bill. Negotiations appear to have reached an impasse due to ongoing disagreements regarding the total amount to allocate in relief funding, generating uncertainty about whether a final package can be agreed to and passed before Congress recesses ahead of the November election. Separately, Secretary Mnuchin and Speaker Pelosi have agreed to avoid a government shutdown by passing a continuing resolution at the end of September. Learn More >>

In Case You Missed It

The U.S. GSIB Surcharge is Overstated in Light of Basel III Changes

As part of the Basel III post-crisis reforms, the eight U.S. GSIBs are required to meet higher capital requirements than their non-GSIB counterparts as a result of additional “GSIB surcharges” that vary between 1 and 3.5 percent. To calibrate the surcharges, the Fed, by necessity, used data from before Basel III was implemented. In a blog post released on August 13, BPI’s Chief Economist, Bill Nelson, points out that using pre-Basel III data results in an overestimation of the probability banks will make large losses, a bias that the Fed also recognized but did not correct. In the post, Nelson corrects for the bias using data from the GSIBs’ quarterly and annual reports and finds that the GSIB surcharges are 29 percent too high.

Past BPI notes cited by Nelson have identified other corrections necessary for the calibration of the GSIB surcharges. Cumulating these corrections, current surcharges for the U.S. GSIBs should range from 0 at the low end to about 1.2 percent at the high end.


Medieval Money Changers, FinTechs, and the Risk of Unbundling

In a recent blog post — Medieval Money Changers, FinTechs, and the Risk of Unbundling— BPI Chief Economist Bill Nelson raises concerns about FinTechs being granted national bank charters based on the belief that they will unbundle payment services from deposit taking and loan making. He notes that banking was born when medieval money changers expanded from providing payment services to also taking deposits and making loans and argues that such a process is inevitable. Payments services require deposits (or things like deposits), which in turn have a way of becoming invested in loans or things like loans as the deposit receiver seeks higher returns. The FinTechs with narrow charters would end up as entities that look like banks but do not have deposit insurance or a lender of last resort, are subject to lighter supervision and are a material source of financial instability.

To preserve financial stability, FinTechs that provide banking services must be regulated from the start like any other bank so that they don’t become the weakest link in the intermediation chain: they must be subject to the same set of prudential regulatory and supervisory requirements as ordinary banks, including exactly the same capital and liquidity requirements; their retail deposits must be insured; they must be subject to the same know-your-customer and anti-money-laundering requirements as ordinary banks; their holding companies must be classified as bank holding companies, just like with ordinary banks, and they must not be allowed to combine banking and commerce.


How to Design a Fed Credit Facility to Help Support LMI Communities

In a blog post published August 5 titled “How to Design a Fed Credit Facility to Help Support LMI Communities,” BPI Chief Economist Bill Nelson explains how the Federal Reserve could design a credit facility specifically for Community Development Financial Institutions (CDFIs) under its existing, non-emergency, lending authority. This program could be modeled on the seasonal credit program and could be narrowly designed to fund and subsidize lending to low- and moderate-income areas and households.

Such a program would be extremely safe because loans would be collateralized by the same assets that collateralize seasonal credits and other discount window loans, and would establish a reliable and ongoing source of funding that CDFI-depository institutions could use to support their mission of community development.


BPI Joins Joint Coalition Comment Letter Responding to CFPB NPR on General Qualified Mortgage Definition

On September 8, BPI joined a joint coalition comment letter responding to the CFPB’s NPR regarding changes to the General Qualified Mortgage (QM) definition. These definitions help to ensure consumer access to affordable and sustainable mortgage credit, which BPI along with the eleven other signatories firmly support. The letter supports the agency’s decision to remove from the QM definition the fixed debt-to-income ratio requirement for prime and near-prime loans, which will help avoid disruptions resulting from the expiration of the temporary Government Sponsored Enterprise (GSE) Patch. The coalition further encouraged the agency to consider including no presumption or inferences relating to fair housing/fair lending, an increase in the Safe Harbor rate spread threshold, an increase to the overall QM cap, and an alternative treatment for short-reset adjustable-rate mortgages (“ARMs”).


Pew Charitable Trusts Examines CFPB Action on Small-Dollar Loans and Highlights BPI’s No-Action Letter Template

On August 12, Pew Charitable Trusts published an article summarizing recent actions taken by the Consumer Financial Protection Bureau (CFPB) to modify the agency’s payday lending rules. The article describes the role banks can play in providing an alternative to borrowers traditionally reliant on these high-cost credit products and expresses support for a No-Action Letter Template (NALT) submitted by BPI and recently approved by the CFPB. The NALT establishes the underlying criteria and operating guardrails for a bank to offer small-dollar loan products for amounts of up to $2,500 in the form of an installment loan or line of credit product. It allows banks the flexibility to design their own product, but also provide further information regarding the specific product they intend to offer.

Upcoming Events

  • 09/15/2020 – Women in Housing & Finance hosts “Access to Credit: How Inclusive is the U.S. Financial System?”
  • 09/16/2020 – FOMC Meeting
  • 09/17/2020 – Congressional Oversight Commission hosts hearing to examine the Municipal Liquidity Facility
  • 09/18/2020 – BPI hosts virtual symposium on the current status of efforts to create a credit-sensitive benchmark as a replacement for Libor for bank loan pricing
  • 09/22/2020 – House Financial Services Committee hosts hearing titled “Oversight of the Treasury Department’s and Federal Reserve’s Pandemic Response
  • 09/29/2020 – House Financial Services Committee hosts hearing titled “License to Bank: Examining the Legal Framework Governing Who Can Lender and Process Payments in the Fintech Age”
  • 10/16/2020 – 10th Annual FDIC Consumer Research Symposium
  • 12/11/2020 – Fed Research Conference on Bank Supervision

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