BPInsights: September 21, 2018

BPInsights: September 21, 2018

Top of the Agenda

What a Recent Fed Paper Gets Wrong on European Stress Tests

In a blog on Thursday, BPI’s Francisco Covas provides a critical assessment of a recent Federal Reserve paper “Modelling your Stress Away.” The paper presents data suggesting that some European banks may have “gamed” the European Banking Authority’s (EBA) stress tests by adjusting their models to offset an increase in the severity of the 2016 adverse scenario. Covas writes that the paper’s findings are likely driven by (i) a misspecification of the relationship between macroeconomic variables and banks’ credit losses and (ii) not explicitly controlling for differences in loss rates at the start of the stress tests and changes in macroeconomic scenarios. As a result, it is highly unlikely that the paper’s findings are driven by systematic changes to banks’ own models.

Covas explains why the lower estimated model coefficients based on EBA’s stress test 2016 results reported by the authors are likely driven by several factors that are unrelated to the estimation of banks’ own models and, therefore, why the lower estimated coefficients do not reflect that banks “gamed” the stress tests by making adjustments to their own models. Covas’ analysis “suggests that lower historical loss rates at the start of the 2016 stress tests and differences in supervisory scenarios – not model changes by banks – were likely the main driver of [the author’s] findings,” he concludes.

Of Note

Post-Crisis Regulation Has Spurred Economic Inequality, Karen Shaw Petrou Argues

You may have missed this interesting article when you were on vacation. In an August interview with Bloomberg’s Joe Nocera, Karen Shaw Petrou lays out her view – articulated in a series of blog posts and a March speech to the New York Fed, as well as in a book set to be published next spring – that regulations put in place after the 2008 crisis, including the Federal Reserve’s monetary policy, have served to exacerbate economic inequality in the last decade. “Banking regulations make [the unprofitability of middle class bank products] worse because the capital requirements imposed after the banking crisis make it a lot more expensive for banks to do a startup small-business loan than go into wealth management. Startup loans are riskier than wealth management, of course, but the capital costs have become prohibitive,” she explains. Shaw Petrou, emphasizing that these consequences are unintended, presents a two-pronged solution, involving a more rapid tapering of the Fed’s portfolio coupled with a normalization of interest rates.

Richard Clarida Sworn In as Fed Vice Chair

Richard Clairda has been sworn in as Vice Chairman of the Federal Reserve and a member of its Board of Governors, a Monday press release announced. Clarida, a former economics professor and Bush-era Treasury official, was confirmed to a four-year term as Vice Chairman last month in the Senate by a 69-26 vote, and to the remainder of a 14-year term as board governor that expires in 2022.

Nellie Liang Nominated as Federal Reserve Board Governor

President Trump will nominate former Federal Reserve economist Dr. Nellie Liang to the agency’s Board of Governors, the Wall Street Journal reports. Liang is President Trump’s sixth nomination to the Federal Reserve Board.

European Union Leaders Reject Prime Minister May’s Brexit Proposal

European Union Leaders rejected Prime Minister Teresa May’s Brexit proposal at an informal summit in Salzburg, Austria. May had hoped to use the gathering to garner support for the plan. “Instead Donald Tusk, European Council president, threw out the centrepiece of Mrs. May’s proposal — an EU-UK free trade area covering goods and agriculture — leaving her fighting to save her Brexit strategy,” the Financial Times reports.

White House Unveils National Cyber Strategy

The White House on Thursday released its national cyber strategy. The 40-page document outlines efforts to strengthen federal cybersecurity and deter hostile actors. The strategy broadly seeks to improve national security, boost the digital economy, combat cyberthreats and advocate for internet freedom. Most notably, the strategy promotes offensive cyber operations against adversaries. This follows a recent decision by the Trump administration to reverse the Obama-era directive PPD-20, which established a lengthy approval process for the military to launch offensive cyber operations. The Trump administration believes greater use of these offensive operations will deter adversaries from launching cyber-attacks against the United States.

Also of note in the cybersecurity realm, last week the House Homeland Security Committee approved a bill establishing a “bug-bounty” program for the Department of Homeland Security. The program would pay cyber security researchers for identifying weaknesses in DHS systems.

BPI News

Bank Policy Institute and SIFMA Respond to Banking Agencies’ Proposed Guidance on the Living Will Process

On September 14, BPI submitted a comment letter in conjunction with SIFMA, on the proposed guidance issued by the Federal Reserve and FDIC that would apply to the living wills prepared by the eight U.S. banks designated as G-SIBs. The letter strongly endorses the living will process for these banks and offers suggestions for improvements based on experience to date, including:
• The agencies should explicitly acknowledge in the guidance what they have already indicated in practice–that an effective version of a single-point-of-entry (SPOE) resolution strategy is a credible means of resolving a G-SIB in an orderly manner.
• The separate resolution plan requirement for large insured depository institution subsidiaries (the IDI plan) should be eliminated for filers that have adopted SPOE as their preferred resolution strategy in their resolution plan for their U.S. bank holding company, as it is at odds with SPOE.
• Reflecting what has become current practice, the agencies should formalize the two-year submission and review cycle (including for the separate IDI plan, should it be retained)

BPI Files Amici Brief on Significant Supreme Court Preemption Case

On Monday, BPI along with the ABA, CBA, Chamber of Commerce and MBA, submitted an amici brief in support of Bank of America’s petition for U.S. Supreme Court review of a Ninth Circuit Court of Appeals case (Bank of America v. Lusnak) regarding the applicability of National Bank Act (NBA) preemption to a California state law mandating payment of at least a 2% interest rate on mortgage escrow accounts. The brief argues that a Ninth Circuit panel misinterpreted and misapplied longstanding case law precedent as well as provisions of the Dodd-Frank Act in holding that the NBA does not preempt the California law BPI and its trade association partners noted that if the Ninth Circuit’s decision is not reversed it could (i) upset important bank risk management practices and/or shift the economic model of some bank mortgage products making them more costly especially for borrowers with weaker credit and more modest means, and (ii) set a dangerous precedent allowing states to regulate other terms and prices of national bank products.

Underwritings: The BPI Blog

BPI Responds to Washington Post Unsubstantiated TBTF Claim

In a BPI blog, BPI’s Greg Baer responded to a September 10 Washington Post article by Renae Merle that stated as fact that large banks remain “too big to fail.” Baer wrote that “Ms. Merle provides no analysis other than to note the current size of U.S. banks. In fact, four significant post-crisis reforms now ensure banks can be safely resolved without putting the taxpayer at risk,” including living wills, significantly restructured balance sheets, contractual changes to derivatives contracts that provide for temporary restrictions on early termination rights for counterparties, and new “orderly resolution” powers that regulators can use in extreme instances, Baer wrote.

Six questions about the Net Stable Funding Ratio (NSFR) requirement

Today, in a BPI blog, Bill Nelson offers policymakers a list of six questions that they should be asking their staff about the Net Stable Funding Ratio (NSFR) after the Basel Committee on Banking Supervision (BCBS) “reiterated their expectation of full, timely and consistent” implementation of the Basel III standards for internationally active banks,” yesterday. The NSFR was the last of the major post-crisis regulatory reforms released by the Basel Committee and, because it was developed and completed on a rushed basis, the final version features several significant and serious flaws. Thus, Nelson details why policymakers should be asking the following questions about the NSFR:
• How, exactly, were the ASF and RSF factors determined and calibrated?
• Why are the ASF and RSF factors that define the NSFR inconsistent with the LCR?
• How was the proposed requirement that banks with between $50 billion and $250 billion in assets maintain an NSFR of at least 70 percent derived?
• Is the NSFR necessary?
• Does the NSFR pass a cost-benefit test?
• Does the U.S. have to implement the NSFR just because the Basel Committee adopted it?


Fintech Policy Series

The FinTech Policy Series explores the changes in technology through the lens of public policy, including the shifting regulatory landscape for fintech, the customer experience, innovation, and the future of data and identity. The event includes panels with technologists, innovators, financial services executives, and policymakers. Register and learn more here.
October 10, 2018
Washington, D.C., The Showroom


Jelena McWillams, chairman of the FDIC, will deliver her keynote remarks on Wednesday, November 28 to 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. Register today!
November 26-28, 2018, The Pierre, NYC


The Bank Policy Institute and Columbia University’s School of International and Public Affairs invite the submission of papers for a conference on Bank Regulation, Lending and Growth. The purpose of the conference is to bring together academics, market participants, and policymakers to discuss the latest research on how regulation affects credit formation and economic activity. Paper submission deadline is November 1, 2018.
March 1, 2019, Columbia University, NYC

Industry News

Banking Agencies

OCC Proposes Raising Recovery Planning Application Threshold

On Wednesday, the OCC proposed revising its existing recovery planning guidelines for large banks, raising the application threshold to $250 billion. The proposed regulation, which the OCC believes would reduce the number of covered institutions from 25 to eight, conforms to the threshold established in May under the Economic Growth, Regulatory Relief, and Consumer Protection Act (S. 2155). The proposal would be effective October 19, preceding its November 5 comment deadline.

Banking Agencies Propose Revisions to Treatment of HVCRE

On Tuesday, the U.S. Banking Agencies issued a proposed rule that would modify the regulatory capital rules for high volatility commercial real estate (HVCRE) exposures, by modifying the underlying definition of HVCRE. The proposed rule is intended to meet the Agencies’ requirements under the Economic Growth, Regulatory Relief and Consumer Protection Act (S.2155). Notably, the proposed rule does not make any changes to the calculation of RWAs other than the definitional change, and would apply to RWA calculations under both the Standardized Approach and the Advanced Approaches. Comments on the proposal will be due 60 days after publication in the Federal Register.

International Developments

BCBS Discusses GSIB Assessment, Revisions to Market Risk Framework, More During September Meeting

The Basel Committee on Banking Supervision (BCBS) met earlier this week to discuss policy and supervisory issues. Of note, the BCBS discussed (i) the annual results of GSIB assessment, which will be published later this year by the FSB, (ii) revisions to the market risk framework, which are expected to be finalized near year-end, (iii) banks’ responses to a changing regulatory environment, which are reflected in FAQs issued to clarify the treatment of “settled-to-market” derivatives under the LCR and NSFR, as well as an upcoming newsletter on leverage ratio window-dressing behavior, and (iv) the results of their review of the impact of the leverage ratio on client clearing. Additionally, the BCBS disclosed that they will be publishing next month a revised version of their Principles on Stress Testing, which were proposed in December 2017 (see BPI’s comments on that proposal here).

Capitol Hill

Senate Hearing Focuses on Protecting Consumer Data

On Tuesday, the Senate Banking Committee held a hearing on Fintech: Examining Digitization, Data, and Technology. The Senators focused on the issues of protecting consumer data and ensuring consumers have control of their data. There was bipartisan support for a federal data breach notification law. Determining where the liability lies when a breach occurs continues to be a primary concern among companies. Many Senators noted the benefits of FinTech companies for consumers. Some Democrats expressed concern that FinTech companies may pose a risk to the financial system, drawing comparisons to developments preceding the 2008 financial crisis. While the overall threat to the financial sector remains relatively low from a legislative perspective, this hearing reinforced the belief that regulatory efforts like the OCC’s Fintech Charter and the potential approval of new ILC applications by the FDIC will become increasingly partisan and contentious issues in the months ahead.

Senate Commerce, Science and Transportation Hearing: Examining Safeguards for Consumer Data Privacy

On September 26, the Senate Commerce, Science and Transportation will hold a hearing entitled “Examining Safeguards for Consumer Data Privacy.” Witnesses include: Len Cali, SVP-Global Public Policy, AT&T; Andrew DeVore, VP and Associate General Counsel, Amazon.com; Keith Enright, Chief Privacy Officer, Google; Damien Kieran, Global Data Protection Officer and Associate Legal Director, Twitter; Guy (Bud) Tribble, VP for Software Technology, Apple; and Rachel Welch, SVP, Policy & External Affairs, Charter Communications.

  • Both the House and Senate both are in session next week, and most likely the Senate will remain in session during much of October.

Industry Events

Conference on Fintech and the New Financial Landscape

Fintech has been playing an increasing role in shaping financial and banking landscapes. The conference, hosted by the Federal Reserve Bank of Philadelphia, intends 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

A Wealthless Recovery? Asset Ownership and the Uneven Recovery from the Great Recession (FEDS Note)

The note shows that wealth inequality widened between the top 10 and bottom 90 percent of the income distribution over 2007-2016. In particular, the bottom 90 percent of the income distribution experienced little to no wealth gains during the Great Recession and recovery period whereas the top 10 percent experienced significant gains. The main driver of the lack of recovery in wealth for the bottom 90 percent is the reduction in homeownership rates, especially for first-time home buyers. The tightness in mortgage credit for borrowers with less than perfect credit scores is likely the main culprit.

Eight Lessons for Fighting the Next Financial Crisis

In this blog, Nellie Lang of the Brookings Institute (formerly of the Federal Reserve Board staff and recently nominated to the central bank’s board of governors) describes eight lessons learned from the response to the recent financial crisis. These lessons address regulatory and supervisory structure, crisis management capabilities, navigating uncertainty, and the timing of interventions.

The Procyclicality of Expected Credit Loss Provisions (CEPR discussion paper)

This paper assesses the impact of different approaches to loan loss provisioning on the cyclicality of bank profits and regulatory capital using a recursive ratings-migration model. The model is used to analyze the effectiveness of potential policy responses to the procyclicality problem.

The Increasing Faith in Macroprudential Policies

This column examines the use of macroprudential measures from 2000 to 2017 across 119 countries. The authors find that the use of these policies—such as countercyclical capital requirements, caps on loan-to-value ratios, and limits on foreign currency exposures—has increased over the sample period, with accelerated adoption after the financial crisis. This accelerated adoption is especially notable in advanced economies, which now rely on macroprudential policies more than emerging economies.