The Office of the Comptroller of the Currency Wednesday issued a consent order against Los Angeles-based City National Bank, fining the bank $65 million over risk management issues related to third-party vendors, operational risk and other concerns.
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WASHINGTON — The Office of the Comptroller of the Currency Wednesday fined the Los Angeles-based City National Bank $65 million after it found that the firm had systemic deficiencies in its risk management practices and engaged in unsafe or unsound practices.
The OCC — the primary supervisor for nationally chartered banks — issued a consent order Wednesday against the $93 billion-of-assets bank over concerns about its management of third-party risks, lack of robust internal controls, deficiencies in operational risk event reporting, and shortcomings in fraud risk management. While the bank did not confirm or deny the allegations, CNB agreed to take remedial actions to avoid further enforcement actions from its regulator.
“The OCC expressly reserves its right to assess civil money penalties or take other enforcement actions if the OCC determines that the Bank has continued, or failed to correct, the practices and/or violations,” the consent order states. “These actions could include additional requirements and restrictions, such as: (a) requirements that the Bank make or increase investments, acquire or hold additional capital or liquidity, or simplify or reduce its operations; or (b) restrictions on the Bank’s growth, business activities, or payment of dividends.”
The OCC notice announcing the penalty notes CNB’s Board of Directors consented to the issuance of the consent order and has undertaken corrective actions and committed to addressing the identified deficiencies “in the interest of cooperation and to avoid additional costs associated with administrative and judicial proceedings.”
Diana Rodriguez, Chief Communications Officer at City National Bank reiterated in an email the firm’s ongoing work to strengthen the bank’s financial and regulatory standing.
“City National, and our new executive management team, are committed to resolving the matters identified in the OCC’s order as quickly as possible,” she wrote. “Our focus will continue to be on both strengthening our infrastructure and systems to reflect a bank of our size and business model, while at the same time providing our clients with consistently outstanding banking products and services.”
City National, renowned for its focus on wealth management and boasting high profile clientele in the city of angels, is a subsidiary of the Royal Bank of Canada since RBC bought it in 2015 for $5.4 Billion.
The order also comes on the heels of a challenging 2023 for CNB. In January 2023, City National entered into a consent order with the Justice Department that included a fine of $31 million over allegations that it failed to offer home loans to Black and Hispanic borrowers in Los Angeles County from 2017 to 2020. The order marked the largest redlining settlement in DOJ history.
CNB also reported a $38 million loss — driven by rising deposit costs — in the second quarter, a steep decline compared to its profitable $102 million net income in the same period in 2022. The turmoil resulted in RBC replacing CNB’s top leadership, installing Greg Carmichael as the banks’ executive chair.
The bank also reportedly had one of the highest levels of average unrealized securities losses among U.S. banks of comparable size. RBC later took steps to address unrealized losses at CNB and injected capital into City National to fortify its financial position and repay higher-cost borrowings. Despite the efforts to right the ship, CNB recorded a whopping $247 million loss during the fourth quarter 2023 that ultimately led to more turnover in senior leadership. Industry veteran Howard Hammond replaced Kelly Coffey as CEO in November.
Experts are criticizing a proposal from the Consumer Financial Protection Bureau to cut overdraft fees for the largest banks but not smaller banks as ignoring the firms that rely disproportionately on overdraft fee income.
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A plan by the Consumer Financial Protection Bureau to slash overdraft fees comes with a major omission: Small banks, which are more reliant on overdraft revenue as a profit center than larger banks. Several dozen small institutions are among the worst offenders in targeting consumers for overdraft charges, experts say.
The CFPB’s proposal released last week would allow large financial institutions with more than $10 billion in assets to charge a breakeven fee or a maximum overdraft fee of between $3 to $14, under a rubric to be set by the bureau. If banks charge a higher amount than their costs, the CFPB will consider an overdraft charge to be a line of credit subject to the Truth in Lending Act, which requires disclosures of annual interest rates.
“Exempting banks and credit unions that have under $10 billion in assets is a mistake because the bureau’s rule doesn’t touch some of the biggest offenders,” said Aaron Klein, a senior fellow at the Brookings Institution and a former deputy assistant secretary for economic policy in the Treasury Department. “If overdraft is a profit center, then it’s an extension of credit — and credit is regulated.”
Some small banks continue to reorder transactions from high to low amounts, which can maximize fees, said Klein, citing his own research that found small banks and credit unions “are some of the biggest overdraft predators.”
The 211-page proposed rule would apply only to 175 large banks and credit unions. The CFPB also said it plans “to monitor the market’s response” and determine whether “to alter the regulatory framework,” for smaller institutions with less than $10 billion in assets.
“I see no way for small banks not to be affected by this,” said Kristen Larson, an attorney at Ballard Spahr. “They’re regulating the larger banks, but the smaller ones lose leverage because of the regulation.”
The CFPB may have exempted small banks in an effort to avoid convening a small business review panel, which is required for rules impacting small businesses, but would have delayed the proposal’s release. Community banks and credit unions also could exert their political muscle in opposing a final rule if they were not exempted.
“This is very much a part of the Biden administration’s campaign, and they needed to get this out so they can say they are trying to tackle prices, however misguided that might be,” said Nicholas Anthony, a policy analyst at the Cato Institute.
The flip side is that the CFPB may have to persuade a court that a final overdraft rule is not “arbitrary and capricious,” which may be a harder lift if the bureau treats overdraft fees as finance charges when assessed by larger financial institutions but not by smaller ones.
Rob Nichols, president and CEO of the American Bankers Association, said the CFPB has no legal authority to impose what he called a “price cap” on overdraft charges. Lindsay Johnson, president and CEO of the Consumer Bankers Association, called the CFPB’s proposal “price setting” and claimed changes to overdraft services would impact whether banks could offer free checking accounts.
The CFPB delved into the history of overdraft fees that began as a courtesy service to cover bounced checks in the 1980s. When financial institutions began extending overdraft services to debit card transactions, the volume of overdraft fees skyrocketed and the fee revenue began to influence banks’ business models.
Overdraft fees accounted for $10 billion in revenue in 2004, but skyrocketed to an estimated $25 billion by 2009, according to research by the Center for Responsible Lending. By 2019, under pressure from the CFPB, overdraft fee revenue had dropped to an estimated $12.6 billion.
CFPB Director Rohit Chopra has repeatedly complained that the Federal Reserve Board used its authority — and did not rely on an interpretation of statute — to carve out an exception for overdraft charges from Regulation Z, which implements the Truth in Lending Act.
“The question now is, if you’re under $10 billion, why does any bank get an exemption from TILA?” asked Joe Lynyak, a partner at Dorsey & Whitney.
The CFPB’s past research found that overdraft presents a serious risk to low-income consumers with roughly 9% of consumer accounts paying 10 or more overdrafts a year, accounting for close to 80% of all overdraft revenue.
“Overdraft disproportionately targets lower-income minorities, stripping wealth — and it has been tremendously profitable for banks,” said Klein, who cited some small banks that specifically target military personnel for overdraft charges and suggested regulators need to discourage such abuse. “Little banks and credit unions punch far above their weight in overdraft.”
Another wrinkle is that not all of the 175 large banks and credit unions that would be covered by the proposed rule have reduced overdraft fees. When Bank of America cut overdraft fees from $35 to $10 in 2022, other large and mid-sized banks followed. But many did not.
“There may be an interesting industry split between banks that have already eliminated overdraft and those that are still reliant or using it as part of their business model,” said Anthony at Cato.
JPMorgan Chase and Wells Fargo accounted for roughly one-third of overdraft revenue reported by banks over $1 billion, according to the CFPB. Still, larger banks may have more leeway to replace overdraft fees with monthly fees, or by scaling back free checking account offerings.
Larson said the CFPB has left the door open for future expansion of the rule to smaller institutions.
“The fees will be really transparent, and then smaller institutions are going to be forced to make modifications or risk losing customers over this,” she said. “In a competitive landscape, why would a consumer pay $24 or $35 for the same service? If smaller banks don’t start following what these larger providers are doing, they’re going to lose customers.”
Larson is urging small banks to submit comments on the proposal by the April 1, 2024 deadline because of “the downstream impact to competition in the marketplace,” she said.
A final rule on overdraft fees is expected to go into effect in October 2025.
Rohit Chopra, director of the Consumer Financial Protection Bureau, said that the agency’s overdraft proposal “would establish clear, bright lines and ensure customers know what they are getting when it comes to overdraft,” adding that overdraft lending “is one of the only types of consumer loans where consumers are not told an APR or given lending disclosures.”
Bloomberg News
The Consumer Financial Protection Bureau plans to dramatically slash overdraft fees at the largest banks by classifying overdraft services as extensions of credit and allowing financial institutions to recoup their costs or agree to charge a maximum fee of $14 under a benchmark set by the government.
Under a proposal to be released Wednesday, the CFPB plans to radically change how overdraft fees are calculated and charged by financial institutions that have more than $10 billion in assets. Banks and credit unions with less than $10 billion in assets would be exempt from the proposed rule.
Two years after many large banks eliminated or dropped overdraft and nonsufficient fund fees, the CFPB wants overdraft services to be classified as an extension of credit, subject to the same consumer protections as credit cards under the Truth in Lending Act that requires disclosures of annual percentage rates.
CFPB Director Rohit Chopra said that what began more than a half-century ago with banks offering overdraft services as a convenience to customers when bills were paid with paper checks has morphed into what he called “a junk fee harvesting machine.” The advent of debit cards changed the calculus with banks collecting $12.6 billion in overdraft fee revenue in 2019. The CFPB has estimated that recent policy changes by some banks have lowered overdraft revenue to about $9 billion a year.
“We’re proposing a rule that would establish clear, bright lines and ensure customers know what they are getting when it comes to overdraft,” Chopra said Tuesday on a conference call with reporters. “Right now, overdraft lending is one of the only types of consumer loans where consumers are not told an APR or given lending disclosures.”
A key aspect of the proposal is that the CFPB would set a benchmark fee of either $3, $6, $7 or $14 that would not require the financial institution to calculate their own costs and losses for providing overdraft services. The bureau calculated how much it would cost to cover costs and losses based on data collected from various financial institutions, and proposed those four benchmark amounts. The CFPB is seeking comment on which of those benchmarks is appropriate, senior CFPB officials said on the call with reporters.
Under the proposal, large financial institutions would have the choice of either offering customers overdraft services as a courtesy and charging the benchmark amount set by the bureau, or charging a fee in line with their costs. Alternatively, banks could also provide overdraft as a line of credit to customers, though doing so would require compliance with TILA, including disclosing an applicable interest rate for overdraft services. The pricing for overdraft services translates to an annual percentage rate of roughly 16,000%, Chopra said.
Because the largest financial institutions cover roughly 80% of consumers, the bureau exempted smaller banks and credit unions. As a result, it did not have to convene a small business review panel, which is typically required for major rules that would impact small institutions.
The CFPB is seeking public comment by April 1. A final rule is expected in October, though an overdraft rule would not go into effect until Oct. 1, 2025, due to TILA requirements.
Chopra has repeatedly blamed the Federal Reserve Board for giving banks an exemption from the Truth in Lending Act’s disclosure requirements that allowed overdraft to become what he called a “profit driver.” Technically, the CFPB plans to propose eliminating an exemption for overdraft services from complying with the Truth in Lending Act.
Chopra said consumers have paid an estimated $280 billion in overdraft fees in the past two decades. In 2022 alone, Wells Fargo and JPMorgan Chase accounted for one- third of all overdraft revenue, the CFPB said.
Lael Brainard, director of the National Economic Council and a former vice chair of the Federal Reserve, joined Chopra from the White House on a call with reporters and said the CFPB’s overdraft proposal was part of President Biden’s efforts to eliminate hidden fees generally for all Americans.
“We’re calling on all corporations that are benefitting from yields and supply chains and lower input costs, to pass those savings along to consumers,” Brainard said.
Under Chopra, the CFPB has announced a slew of enforcement actions and settlements with banks. Wells Fargo had to return $205 million, Regions Bank $141 million, and Atlantic Union $5 million in fees to consumers that the CFPB said were unlawful. Chopra cited on the call with reporters the deceptive overdraft practices of TCF Financial, which was acquired by Huntington Bancshares in 2020.
The Trump administration opened the door to rewriting overdraft rules in 2019. Chopra first announced a crackdown in 2021, then issued guidance in late 2022 that found practices that the agency considered unfair to consumers. Last year, the Office of the Comptroller of the Currencyand Federal Deposit Insurance Corp. also took aim at certain practices such as “authorized positive, settle negative,” that may be deceptive because transactions get approved when a consumer’s account balance is positive, but later post to the account when the available balance is negative, incurring fees.
Authority for regulating overdraft fees was transferred from the Fed to the CFPB in the 2010 Dodd-Frank Act.
Rep. Blaine Luetkemeyer, R-Mo., announced Wednesday that he will be retiring from Congress after his current term. Luetkemeyer had been seen as a frontrunner to serve as top Republican on the House Financial Services Committee after committee chairman Patrick McHenry, R-N.C., announced his retirement last month.
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WASHINGTON — Rep. Blaine Luetkemeyer, the longtime Republican from Missouri and senior member of the House Financial Services Committee, will not seek reelection in 2024, his office said.
Luetkemeyer had established himself as one of the committee’s most influential voices. He currently chairs the panel’s subcommittee on national security, and before his time in Washington, worked as a state banking examiner and community banker. He was first elected in 2009, and will retire when his term ends in January 2025.
“It has been an honor to serve the great people of the Third Congressional District and State of Missouri these past several years,” Luetkemeyer said in a statement. “However, after a lot of thoughtful discussion with my family, I have decided to not file for re-election and retire at the end of my term in December. Over the coming months, as I finish up my last term, I look forward to continuing to work with all my constituents on their myriad of issues as well as work on the many difficult and serious problems confronting our great country. There is still a lot to do.”
Luetkemeyer is the second senior Republican on the House Financial Services Committee to announce that he will not seek reelection in the upcoming races.
The panel’s current chairman, Rep. Patrick McHenry of North Carolina, has also said he will retire from Congress at the end of the year, leaving open the top Republican spots on the committee. Before announcing his departure, Luetkemeyer was considered a frontrunner to take over for McHenry as the top Republican on the committee, and had previously expressed interest in the position.
His departure leaves Reps. Andy Barr of Kentucky, French Hill of Arkansas and Bill Huizenga of Michigan as the most likely frontrunners to serve as the top Republican on the committee in the next Congress. Of those candidates, Hill is the most senior member and led the committee on an interim basis when McHenry was interim speaker last year.
Luetkemeyer had staked out severalsignaturebanking issues in his time on the committee, but none more so than a crusade against the Financial Accounting Standards Board’s CECL, or “current expected credit loss” standard. Prior to Congress’ most recent recess, Luetkemeyer introduced a bill that would increase rulemaking guidelines for FASB and require it to report annually to Congress.
Luetkemeyer was also one of the loudest voices criticizing “Operation Chokepoint,” and in hearings, has frequently complained that Biden administration banking officials have inserted politics into the industry.
His departure is not likely to lose Republicans a seat. His district, representing central Missouri and some St. Louis suburbs, is considered safely Republican.
James Gorman, chairman and chief executive of Morgan Stanley, said during a Senate Banking Committee hearing this week that the proposed operational risk provision in the Basel III endgame capital rules “makes no sense,” echoing critiques from Federal Reserve Gov. Christopher Waller and banking trade groups.
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What had for months been a broad debate around the wisdom and process of the Basel III capital proposal has narrowed in recent weeks to center on a particular aspect of that proposal: capital retention for banks’ operational risks.
The so-called Basel III endgame package put forth by the Federal Reserve, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency would also adjust capital requirements banks would face for risk exposures related to credit, trading and derivative contracts — also referred to as credit valuation adjustment risk. But the operational component has drawn the most ire from banks.
“It makes no sense. I mean, that’s the bottom line,” said James Gorman, chairman and CEO of Morgan Stanley, while testifying in front of the Senate Banking Committee on Wednesday. “I’ve been at this a long time, I was on the New York Fed board for years, I’ve seen a lot of rules, some that make sense and it’s a question of how far you turn the dial. This doesn’t make sense.”
Gorman went on to say the proposal would “punish” banks for creating “fee-based businesses,” echoing criticisms put forth by banks, their lobbying groups and even regulatory officials in recent weeks.
Last week, Fed Gov. Christopher Waller questioned the need for a standalone operational risk charge, arguing that the capital set aside to deal with market and credit risks could be tapped for idiosyncratic events — such as litigation, cyber attacks or fraud.
“Those are things that don’t typically occur at the same time as a financial meltdown due to a macroeconomic shock. So, they’re not correlated with market risk, trading risk, all the other things that might bring a bank down,” Waller said during an event hosted by the American Enterprise Institute. “I just argue that because it’s not really a threat to this, we don’t need a separate bucket for this. You can use operational risk, paid for out of your standard capital bucket.”
Currently, most banks are not subject to a set standard for maintaining capital to address operational risks. Only banks with at least $700 billion of total assets or $75 billion of cross-border activity face operational capital requirements under the Fed’s advanced approaches protocol, which calls for banks to use internal models to assess their operational risks and corresponding capital needs.
During a speech in October, Fed Vice Chair for Supervision Michael Barr said that operational risk is “inherent in all banking products, activities, processes and systems.” He also argued that the current system for addressing these risks leaves too much room for variance between banks and suffers from a lack of transparency.
“These models can present substantial uncertainty and volatility,” Barr said. “In the agencies’ proposal, the operational risk capital requirements would be standardized rather than modeled and would be a function of a banking organization’s business volume and historical operational losses.”
The switch to a standardized regime was called for by the Basel Committee for Bank Supervision’s latest international standards, which were finalized in 2017. But the accord, known as the Basel III endgame or Basel IV, provided national discretion over certain components of the operational risk regime. This included a provision about whether to factor past operational losses into future capital requirements. The U.S. opted to include this component, while other regulatory jurisdictions — including the European Union and the United Kingdom — have indicated that they will not.
The proposal establishes operational requirements through a multi-step process. First, bank measure their business volume over the past three years in three categories: Net interest income from financial assets and liabilities, trading activities, and fee-income. Those indicators are then subjected to steadily higher multipliers based on the size of each business, such that the larger the business, the greater the requirements. Those figures are then multiplied by an average of the bank’s average net operating losses over the previous 10 years, a factor known as the internal loss multiplier.
The net effect of the framework is that all parts of a bank’s business activities are subject to a risk capital weight that results in higher standards for larger banks, and made still higher for banks with track records of incurring losses.
“Research suggests that banking organizations with higher overall business volume are likely to have exposure to higher operational risk,” Barr said in his October speech. “Further, higher operational losses are associated with higher future operational risk exposure.”
The proposal asserts that this approach will result in greater risk sensitivity in the operational capital framework while eliminating “subjectivity” and “unwarranted variability.” But some say the proposal is emphasizing the wrong risks and could have unintended consequences.
Karen Petrou, managing partner at Federal Financial Analytics, said capital is a “poor palliative” for operational risks, because it is different from other types of risks. While strong capital buffers can ensure banks can continue lending when facing market volatility or economic headwinds, it does little to address the range of idiosyncrasies that come with operational risk, not all of which can be solved with capital.
“Operational risk is very different from credit and market risk. It’s equivalent to what you do when the lights go out, and the approach that somehow, if you have a pot of money, you will see better is nonsensical,” Petrou said. “What you actually need is a generator, and that costs money.”
Proponents of the new operational requirements say they are necessary both for consistency and to ensure the growth of emerging risks — such as cybercrime and climate change — are adequately accounted for.
“Operational risk is significant and growing, which is why it has long been on the Basel and capital agenda,” said Dennis Kelleher, head of the consumer advocacy group Better Markets. “Measuring operational risk and other types of risk in a standardized way as the rule calls for is critically important for financial stability. Moreover, less reliance on banks’ internal models also reduces operational risk, which their very models can create.”
But Petrou notes that the rule retains the seven categories of operational risk — internal fraud, external fraud, employee practices and workplace safety, products and business practices, damage to physical assets, systems failures and process management — remain unchanged by the proposal. She also noted that the best way to address future risks is not to look at past outcomes, but for bank supervisors to diligently manage existing risks.
“These rules reflect the fact that regulators don’t trust themselves,” Petrou said. “They’re using capital as a stand-in for effective supervision, which would be far more effective when it comes to operational risk.”
Industry groups have argued that full force of the Basel rules were not designed with U.S. banks in mind, many of which have adopted fee-based business models to a greater degree than their international counterparts.
But while the operational risk provisions have drawn the most fire from the rule’s opponents, it may also indicate that there is a path forward for the broader proposal if a compromise on operational risk can be struck.
Waller, who cast one of two dissenting votes on Board of Governors against the capital proposal in July, said his concerns could be assuaged if operational elements of the frame were changed for the final rule. Fed Chair Jerome Powell and Barr have both said they would pursue “consensus” among their fellow board members, with Powell saying the final rule will need “broad support.” Barr has made it clear that unanimity will not be the standard, but said he is open to making changes where appropriate.
But revising the operational risk provisions may not be the only obstacle in the way of a Basel capital rule that everyone can live with — there are also legal and logistical challenges posed by the Administrative Procedure Act. For changes to be dramatic enough to satisfy the objections of Waller and banks, the agencies would likely have to re-propose the entire rule, setting back the timeline for completion and implementation significantly.
Petrou said the issues presented by the proposed treatment of operational risks could not be addressed by small tweaks. Instead, she said, it requires “redesigning” to a degree that the agency would have to put forth a new rule to satisfy the Administrative Procedure Act.
During a notice-and-comment rulemaking process, agencies can make changes within a final rule so long as they are a “logical outgrowth” of the initial proposal. If a change is more substantial than that, the APA dictates that the agency must issue a new proposal. Determining whether a change meets the “logical outgrowth” standard is somewhat subjective, as there is no set framework for doing so.
“A final rule that only modestly changes the proposal is possible, but only modest changes to the proposal will have a lot of perverse consequences,” Petrou said.
The Federal Housing Finance Agency said it is not currently exploring the feasibility of portable mortgages, but the fringe idea — already present in Canada and the U.K. — is gaining traction among some housing market watchers as a solution to the so-called interest rate lock-in effect.
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With mortgage lending ground to a halt in the face of rising interest rates, many in and around the banking and real estate industries are looking for ways to unlock the market. Some say the answer lies to the north — in Canada.
These market participants say many of the sector’s woes could be resolved if U.S. lenders and regulators emulated their peers in Canada and some other advanced economies by allowing homeowners to carry mortgages with them from one property to another.
Mortgage portability is a feature available to borrowers in Canada as well as Australia, the United Kingdom and other countries. It allows them to retain the deal, the interest rate or — in some cases — the entire loan after selling one home and buying another.
If brought to the U.S. today, Andy Heart, CEO of North Carolina-based Delegate Advisors and a former banker, said this option would remove the “golden handcuffs” from homeowners who — despite continued property value appreciation — are unwilling or unable to foot the bill for new mortgages should they move.
“That low-cost mortgage becomes low-cost housing for the remaining term of that mortgage,” Heart said. “It’s like all of a sudden you’ve turned your biggest liability into your biggest asset.”
Yet, while the adoption of portability would benefit existing homeowners and potentially boost the broader for-sale housing industry, some policy experts say the shift would create more problems than it would solve.
Mark Calabria, the former head of the Federal Housing Finance Agency, said incentivizing borrowers to hold their loans longer would amplify risks for any entity with mortgages or mortgage-backed securities on their balance sheets.
“It’s a fair amount of interest rate risk you’re taking on,” Calabria said. “Pre-record low rates, pre-pandemic, the typical 30-year mortgage only really was around for about seven years before people refinanced or prepaid. Portable means, from the lender’s perspective, that 30-year [mortgage] may actually turn into 30 years.”
Proponents of portability argue that duration risk is baked into the origination or purchase of a 30-year mortgage. Anyone engaged in the space, they say, when interest rates were at record lows during and following the COVID-19 pandemic should have hedged against the risk of slower repayment times.
“Whether it’s a five-year mortgage or whether it’s a 30-year mortgage, you’re still doing the same job from an interest rate risk management perspective. Duration of the instrument doesn’t matter to me, you should be understanding that the price volatility and sensitivity of your earnings to a change in interest rates is higher when the duration is longer,” Heart said. “I don’t have a lot of sympathy for people who didn’t do the job on the asset-liability matching front.”
But industry participants note that they do incorporate interest rate volatility into their underwriting, but they have done so under the current regime, which does not allow for portability.
Christopher Maher, CEO of Toms River, New Jersey-based OceanFirst Bank, said the U.S. mortgage market is directed by the government-sponsored enterprises Fannie Mae and Freddie Mac, which dictate the standards mortgages must meet to be eligible for purchase and securitization. They also set expectations for investors in mortgage-backed securities, one of which is that all qualifying mortgages have a due-on-sale clause, requiring loans to be satisfied when a property is sold.
Maher said the GSEs could change their standards to allow for portability, but doing so would have to be done carefully so as not to disrupt the markets that supported the low-cost, long-term mortgages in question.
“Fannie Mae and Freddie Mac are still in conservatorship, so the owning investor there is the U.S. government,” he said. “If they were motivated to do something [with portability], they would have an opportunity, but I think it’d be a very complicated thing for them to figure out.”
A spokesperson for the Federal Housing Finance Agency, the entity that oversees the GSE conservatorship, said it is not exploring mortgage portability at this time.
Mortgage portability as a solution to a lack of housing supply remains a fringe theory; no policymaker, regulator or industry group is championing the cause. But the concept has made its way into various corners of the housing finance landscape.
Pete Mills, senior vice president of residential policy and member engagement at the Mortgage Bankers’ Association, said the trade group is exploring the potential impact of portable mortgages in response to an uptick in member inquiries. Specifically, the MBA is looking into the “legal, constitutional and investor implications” of the practice.
Allowing borrowers to port their mortgages would necessitate a host of procedural changes in the mortgage sector. Processes would have to be developed to handle mortgages while they are being transferred from one property to another and appraising newly purchased properties. Some speculate the change could shift the focus of underwriting away from the collateral value of underlying properties to the creditworthiness of individual borrowers. There’s also a matter of establishing a fee structure for porting.
There would also be unknown implications on mortgage-backed securities. While some fear a sweeping change in mortgage terms would be detrimental to mortgage-backed securities holders, some research — including a study from the analytics firm MSCI this past summer — suggests portability could be a boon to valuations.
Skeptics of portability are quick to point out that the U.S. housing finance system differs significantly from other markets.
In Canada, for example, most mortgages have five-year terms amortized over 25 years, meaning they must be renewed, refinanced or sold off every five years. Unlike the 30-year mortgage seen in the U.S., borrowers face a prepayment penalty if they sell their home and pay off a mortgage before their term is up.
“The resulting penalty could wipe out tens of thousands of dollars from the proceeds of the sale,” said Clay Jarvis, a Canadian real estate and mortgage expert with the personal finance firm Nerdwallet. “But if you port, prepayment charges shouldn’t be an issue because you’re technically not breaking your mortgage.”
While portability is meant to offset the challenges created by Canada’s five-year term regime, Jarvis noted that not all mortgages are portable. Variable rate loans and certain restrict-rate mortgages cannot be ported. Also, he said the feature is not widely known or used by homeowners in the country.
Much of the debate over whether the U.S. should adopt mortgage portability centers on the degree to which the so-called lock-in effect that has gripped the housing market will reshape mortgage borrower activity and for how long.
According to the home listing company Redfin, more than 90% of homeowners have a mortgage rate below 6%, including 82% with 5% or less and 63% with rates below 4%. Rates are currently more than 7.5% after peaking above 8% in October. As a result, home sales volumes and mortgage originations have cratered to their lowest levels in 10 and 20 years, respectively.
Portability advocates say these dynamics could lead many borrowers to hold mortgages for their full terms anyway. They argue that portability would create more lending opportunities in the form of second-lien mortgages to make up the gap between the values of the existing mortgage and the new home.
Some banks and other lenders, on the other hand, would rather wait out the current conditions and see how prepayment rates evolve. Maher said eventually consumers will adapt to higher rates and homeowners will encounter reasons to give up ultra-low rate mortgages.
“Time has a way of marching on, and we’ve already been in this higher rate environment for more than a year now,” Maher said. “Eventually, people will make life decisions to sell their homes and give up 3% mortgages for a variety of reasons.”
Others who are active in the housing space say the option is a needed solution for the housing sector. Drew Uher, CEO of HomeLight, a tech platform that connects real estate agencies with buyers and sellers, said the shift would benefit individual homeowners as well as the various industries that have been decimated by the sharp drop in transaction activities.
“Mortgage portability is not only an opportunity for consumers to rejoin the housing market, but also sets up a unique opportunity for real estate professionals — specifically real estate agents and lenders — to continue to grow their businesses and be at the center of the transaction,” Uher said. “There needs to be innovation for agents and lenders to offer this solution to their clients to support the restabilization of the market as well, as they guide clients towards smarter financial decisions and homeownership.”
Heart said the shift to portability would have to be initiated by Congress and implemented by federal regulators, but he noted there is precedent for such a shift. He points to reforms enacted after the Savings and Loan Crisis of the 1980s and ’90s that made commercial loans on bank balance sheets liquid, a move that facilitated the creation of the senior secured loan market.
He argues that such policies should be politically feasible given the benefits to consumers and the broader economy.
“Who wouldn’t want to go into the ’24 election saying, ‘Hey, by the way, I voted to give you low-cost housing for the next 20 to 30 years, thank you very much,’” Heart said.
Sandra Thompson, director of the Federal Housing Finance Agency, released a report Tuesday outlining potential changes to the Federal Home Loan Bank system — which FHFA supervises — that would more closely tether the FHLBs’ housing and liquidity missions to each other. But experts say doing that in practice will be challenging, particularly if the Home Loan Banks themselves oppose the measures.
Bloomberg News
The Federal Housing Finance Agency wants to more closely tie the liquidity that the Federal Home Loan Banks provide to financial institutions to the system’s mission of promoting housing and community development, but bringing those dual missions in line may be easier said than done.
A main takeaway of the 115-page report released Tuesday is that FHFA plans to issue a proposed rule that would clarify the mission of the Federal Home Loan Bank System while providing metrics and thresholds for measuring how each of the 11 FHLBs advance that mission. FHFA also is considering how to incorporate what it calls “mission achievement” in its exam processes, and may potentially include a stand-alone “mission examination” rating for each of the banks.
But one key concern about such a proposal is whether the Home Loan Banks will embrace the FHFA’s suggestions, given that the Home Loan Banks have been championing their role of providing liquidity and thus financial stability to member institutions, and the possibility that many of the proposed changes would cut into profits that members receive in the form of hefty dividends.
“There are ways to make this work, but at the end of the day none of this will work if the FHLBs don’t get engaged,” said Peter Knight, the cofounder of Policy Kinetics, who worked for 19 years as a director of government relations at the Federal Home Loan Bank of Pittsburgh.
Experts who have followed the FHLBs for decades called the report and its suggestions an ambitious undertaking. The FHFA’s recommendations are the beginning of a multi-year effort to encourage the government-sponsored enterprise to do more to promote liquidity alongside housing and community development. Most of the changes will be implemented through ongoing supervision, guidance and rules. But some of the more sweeping changes — such as increasing the amount of liquidity steered toward affordable housing and oversight of executive compensation — would require Congressional action.
Former FHFA Director Mark Calabria, a senior advisor at the Cato Institute, said the report’s findings and recommendations were in line with what he expected, and were reasonable given the lack of specificity in the Federal Home Loan Bank Act of 1932 about membership eligibility and other key provisions.
Calabria said the FHFA was justified in seeking congressional input on whether there should be a renewed focus on housing finance, one that could put stricter limits on the types of institutions that can access FHLB advances or the types of activities they can engage in. But he urged his former agency not to wait for Congress to take action, noting that some changes are already well within its reach.
“It would be great if Congress would come in and clarify some of these things, and FHFA is not without justification in asking if there should be a refocus of purpose,” Calabria said. “But there are aspects, like limiting the exposure of any one member, that FHFA can do on its own.”
Michael Ericson, president and CEO the FHLB Chicago, said in an interview that “a tremendous amount” of borrowing by members goes toward supporting housing and community development. As an example, he cited a program in Chicago that provides interest-free advances to member institutions that make direct small business loans that support community development. He said the FHLBs are not doing enough to promote their work.
“This report doesn’t change anything that we do today. We’re doing activities in our members’ districts to support economic development, to support small businesses, to support housing. These are all things that we’re doing today,” Ericson said. “I think what gets missed in a lot of this is, historically, we have not highlighted all of the great things that we’ve been doing. But this process has educated us that we need to do a much better job of informing others about the great things that we are doing. And I think that’s been missed in some of the narratives.”
Ericson pushed back against the FHFA’s plans to propose a rule that would require that certain members hold at least 10% of their assets in residential mortgage loans on an ongoing basis to remain eligible for FHLB financing. FHFA said in the report that it expects to analyze the impacts of a 10% asset requirement on different member institutions, such as insurance companies and community development financial institutions, as part of the rulemaking process.
“There are certain things in the report that we wouldn’t agree with and this is an area that we would object to,” Ericson said.
He noted that in 2014, the FHFA proposed a similar rule that the FHLBs also objected to.
“This isn’t really new ground that the finance agency is potentially charting here,” he said. “There are a number of factors in place that impact a member institutions’ assets they have on their balance sheet. One day, they could easily pass the test and the next day, they may not be able to. If you are a stable, reliable partner to your member institutions, they need to know that and they need to know what the rules are. And introducing volatility like that would be very difficult to manage, so it’s not something that we would agree to.”
The review of the Home Loan Bank began in July 2022, well before the March 2023 liquidity crisis led to increased scrutiny of FHLBs after it was discovered that they lent billions to three banks that later failed — Silicon Valley Bank, Signature Bank and First Republic Bank — and to another, crypto-friendly Silvergate Bank, which self-liquidated. Those banks all received short-term loans, known as advances, in an attempt to make up for massive declines in deposits. In the first week of March 2023 alone the FHLBs funded $675.6 billion in advances — the largest one-week volume in the history of the government-sponsored enterprise.
Calabria said it was predictable that the FHFA report would focus on the role federal regulators play in monitoring the health of member banks, given the string of large bank failures this spring. But he argued that the FHLBs already rely too heavily on the Fed, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency to assess the creditworthiness of banks. He urged the FHLBs to take a more discerning approach to issuing advances moving forward.
“The Federal Home Loan Banks need to take a separate view of their members than their primary regulators. They can share information but they shouldn’t be overly deferential,” Calabria said. “Supervising a bank and dealing with a counterparty are two different things with two different sets of goals. I worry that this report blurs that line.”
The FHFA specified in the report that the FHLBs should not be used as a “lender of last resort,” noting that banks should not be “overly reliant” on the FHLBs for liquidity. Moreover, banks should have the necessary agreements or collateral positions in place to borrow from the Federal Reserve’s discount window, the report said.
“The reliance of some large, troubled members on the FHLBanks, rather than the Federal Reserve, for liquidity during periods of significant financial stress may be inconsistent with the relative responsibilities of the FHLBanks and the Federal Reserve,” the FHFA report said.
To that end, FHFA plans to address weaknesses in the FHLB’s oversight of its members’ liquidity and credit risk management, which Ericson said is already underway.
“We will implement recommendations that the Finance Agency has provided to the Federal Home Loan Banks,” Ericson said. “The banks have robust credit risk management practices in place today and they had credit risk management practices in place going into the crisis. And we’re implementing the guidance that the Finance Agency has provided to us.”
Cornelius Hurley, an advisor to the Coalition for FHLB Reform and a former independent director of the FHLB of Boston, said the debate about the FHLBs should focus on the subsidy that members receive through the implied government guarantee on the debt the system issues.
“The Home Loan Banks and their members view the FHLB system as an entitlement to low-cost funds, and they are enriching themselves without providing something in return,” Hurley said.
The FHFA report estimated the value of the implicit guarantee at $4.7 billion in 2022. By comparison, the FHLBs collectively contributed roughly $200 million in affordable housing subsidies last year. The Bank Act requires that each FHLB contribute at least 10% of its prior year’s net earnings on an annual basis to fund affordable housing programs.
Kathryn Judge, a law professor at Columbia University who has researched the FHLBs, said the report was a step in the right direction, but said that more needs to be done. She said the report identifies several key challenges in the current system, including the risks to the Federal Deposit Insurance Corp. and the National Credit Union Administration, which are responsible for paying off advances to the FHLBs ahead of other creditors when institutions fail. She applauded many of the changes outlined in the report, including those that would require the FHLBs to ensure members are financially healthy before making advances.
“In light of what transpired this spring, those bank regulators should be eager to work more closely with the Federal Home Loan Banks,” she said.
But Judge said the report fails to meaningfully address what she sees as the core issue of the FHLB system: its mission. As it stands now, the FHLBs extend loans to banks of all sizes for all types of uses, a reality that she said goes against the spirit of the system, which was conceived to support thrifts at a time when they could not access the Fed’s discount window.
“The short-term goal should be to implement as many suggested rules as possible,” Judge said. “Then there should be conversations about how to help the public enjoy the benefits from the public subsidies the system enjoys and how to harness the system to support small institutions and create credit access.”
Federal Deposit Insurance Corp. board member Jonathan McKernan said in his dissent over a newly-finalized Community Reinvestment Act overhaul that he has “not seen a convincing argument that we have the authority” to make some of the important changes in the rule.
WASHINGTON — Dissenting members of the Federal Reserve and Federal Deposit Insurance Corp. gave voice to a number of potential legal challenges to a newly-finalized revamp of the Community Reinvestment Act, but it remains unclear whether banks will want to challenge the anti-redlining regulations in court.
Columbia Law Professor Todd Baker said there are a number of legal theories that banks could include in a legal challenge. One, which was outlined by FDIC vice chair Travis Hill, is that regulated banks were given insufficient time to consider such a long and complicated rulemaking. That kind of argument would likely gain a favorable reception at the Supreme Court, he said.
“If the regulators go ahead without more industry discussion and negotiation, there are likely to be legal challenges under the Administrative Procedures Act alleging that the CRA rule failed to comply with procedural requirements — in this case a longer notice and comment period given the new mandates in the proposed rule — or is ‘arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law,’” Baker said. “A filing with a conservative District Court in the Fifth Circuit could lead to an injunction, appeals and an ultimate decision by a Supreme Court that increasingly eschews Chevron deference to agency interpretation and has a hostile view of regulation in general.”
Ian Katz, managing director at Capital Alpha Partners, wouldn’t speculate on whether banks will challenge the rule, but acknowledged that if they try, there are venues out there where they could successfully make their case.
“The banks have a sympathetic judiciary, especially in the Fifth District, so they might feel they have a strong enough case to win there,” he said. “That makes a suit a real possibility.”
Katz added the CRA rule may be a difficult one to argue as hastily crafted, given how long it has been in the works and how many different iterations of it have been presented.
“On the other hand, this rulemaking has been in the works a long time, with a couple of iterations of proposals, he noted. “It might be harder to make the case that it wasn’t studied or analyzed sufficiently. But you only need one interested party to sue, so of course it’s possible.”
APA compliance isn’t the only legal grounds that dissenting regulators raised over the CRA rule. FDIC board member Jonathan McKernan said Tuesday that he was concerned that certain aspects of the agencies’ final rule might be exceeding the statute’s original Congressional intent.
“I have yet to be convinced that the regulators have statutory authority to prescribe important aspects of the rule,” he said at the board meeting. “The CRA requires each agency to assess a bank’s record of ‘meeting the credit needs of its entire community,’ [and] I have not seen a convincing argument that we have the authority to consider lending activities outside a bank’s facility-based assessment areas.”
Federal Reserve Board Governor Michelle Bowman seized on a similar argument Tuesday, saying legislators, not regulators, would be more appropriate arbiters of change to the CRA.
“Congress, not the banking agencies, is responsible for modernizing the statute,” she said. “In my view, some of the changes being made by the agencies in this rule, including those that evaluate banks outside of their deposit-taking footprint, are likely beyond the scope of our authority under the statute.”
Ken Thomas, President of the Miami-based Community Development Fund Advisors LLC, said there is considerable potential for legal action on the CRA Final Rule considering the dissents echoed by Bowman and Hill.
“It is very unusual to have so many very strong dissents from [members of] two of the three regulators on such an important topic,” he wrote in an email. “They toned down the over-the-top [notice of proposed rulemaking] a bit … but not enough to prevent a legal challenge. The Final Rule is riddled with numerous unintended consequences for both banks — and even many communities — that can easily be translated into economic damages.”
Banks have already raised the possibility of litigation before. The Bank Policy Institute previously hinted at a legal challenge to the CRA rewrite after the regulators denied their request to extend the rule’s comment period. BPI also indicated they believed interested industry parties should be afforded the opportunity to further comment on the CRA proposal given the coinciding revised capital framework earlier this year.
“The agencies should reevaluate the proposed CRA rules and consider proposing changes for public comment,” BPI’s Senior Vice President Paige Paridon said in August. “If the agencies finalize the CRA rules before the outcome of these recent developments is clear, the public will not have had a meaningful opportunity to respond to the full range of regulatory effects.”
But just because banks can sue the regulators doesn’t necessarily mean that they will, and a big part of that decision rests on how costly the rule would be to comply with and how long they have to comply. Jaret Seiberg, an analyst with TD Cowen, said while the final rule will moderately increase costs for publicly-traded banks, evidence from the the last CRA overhaul in the 1990s suggests banks will take the revised reinvestment rules in stride.
“Banks likely will need to invest in new systems, but our experience is that banks are adept at these challenges [so] it should not be a long-term drag on banks,” he wrote in a note. “The big changes are not until Jan. 1, 2026 [a]nd the current interest rate environment makes bank M&A less attractive. It is why we believe banks have runway before this could be a problem.”
The Federal Reserve’s FedNow payments rail has garnered only about 140 adopters three months after its launch, but experts say they expect more financial institutions to join over time as more and more uses for the faster payments platform are developed.
Rafael Henrique – Adobe Stock
The Federal Reserve’s instant payments network has been live for three months, but the system is still waiting on banks — and their customers — to get with the program.
FedNow has attracted dozens of banks and credit unions interested in supercharging their intake of funds. But getting more to connect and transmit through the system will rely on the discovery of new use cases, experts say.
Since FedNow launched in July, nearly 140 financial institutions and 22 certified service providers have signed up for the network, according to a public register of users, a fraction of the nearly 10,000 institutions with access to the central bank’s other payments and settlements services. But early adopters and former Fed staffers say the rollout has played out as expected and compares favorably to the trajectory of the private RTP network, which has amassed roughly 400 participants since 2017.
Miriam Sheril, a former FedNow project manager at the Federal Reserve Banks of New York and Boston, said industry-wide adoption was never going to be instantaneous. She noted that most banks were reluctant to foot the bill of connecting to the system until they could see it in action.
“There was a lot of wait and see — to see when FedNow would land and, from a budgeting cycle perspective, banks weren’t willing to make commitments,” Sheril said.
Now the head of U.S. product at the payments service provider Form3, Sheril said she is seeing banks embrace the idea that instant payment capabilities could be beneficial, if not essential, in the not-too-distant future. But the lag between acceptance and adoption remains substantial.
“You can’t build and connect to a brand new rail in three months. It just doesn’t happen,” she said. “For all the banks that were waiting or were hesitant, even if they’re making the decision to connect now, they’re not going live right now, so FedNow is not going to miraculously have 1,000 banks come online overnight.”
Payments specialists say the launch of FedNow has benefited the instant payment space in multiple ways. Along with giving banks another option for facilitating faster transactions, it has also ended the stasis that came from financial institutions sitting on the sidelines until the Fed-back system debuted.
Rusiru Gunasena, senior vice president of RTP product management and strategy at The Clearing House — a private payments platform owned by a consortium of large U.S. banks — said the Fed’s announcement in 2020 that it would create an instant payments network caused many banks and credit unions to go into “hold mode” while they waited to see how the two offerings compared to one another.
“Finally, now the institutions can make a decision and move on,” Gunasena said. “They understand the value of real-time payments. It has created a renewed interest in the industry, in the marketplace among the financial institutions. Both banks and credit unions are now implementing real-time payments.”
Gunasena said there is now a “backlog” of interested counterparties looking to join the RTP network.
Similarly, Justin Jackson, vice president of integrated payment and bill payment at Fiserv, described the launch of FedNow as a dam breaking open. Since then, he has seen a surge in demand for groups to connect to FedNow or RTP — and, in many cases, both.
Jackson said many early adopters were motivated by a desire to be ahead of the curve rather than risk being left behind. Others, meanwhile, view it through a “dollars and cents” lens, he said, which has led to some mixed results. For now, he said, it is “significantly more common” for banks and credit unions to set up as receive-only participants in the FedNow network rather than send-and-receive — even though it is most cost effective to get set up for both functions at once.
“The economics are still pretty unsettled in this space. The transactions that are flowing across these rails, what type of transactions are they? Are they cannibalizing other revenue streams, like wire transactions? Are they a source of incremental revenue because they’re replacing an ACH payment and they’re adding real value there?” Jackson said. “The types of payments really influences the economics, so there are a lot of questions in play for institutions to consider.”
On the receiving side of the equation, Jackson said, the math is easier. Anything that lowers the barrier to banks receiving funding through deposits is going to be beneficial, he said, whether it comes in the form of a payroll direct deposit or an insurance disbursement.
Most of the origination activity on FedNow comes from a small number of financial institutions, though that group includes the U.S. Treasury. The story is similar on the RTP network, Gunasena said, though the sending contingent consists of TCH’s owner banks.
Overall, the strongest case for instant payments is being made by commercial banking customers, Jackson said, largely from entities that deal with large transactions that can take place outside traditional banking hours, such as auto purchases or certain homebuying-related activities. But he said he expects more applications to develop over time, creating greater adoption incentives for financial institutions.
“You will see originations on the retail side perhaps lag a little bit compared to originations on the commercial and business side,” he said. “But, eventually, both will be there with originations. That’s a short-term thing.”
On the topic of innovation, some in and around the payments space see meaningful differences between the FedNow and RTP networks.
Sheril said the messaging technology that underpins FedNow was designed to enable a wider variety of use cases. She cites the example of an option for selecting account types in transactions as a feature that could make it easier for creating specific payments products.
“None of these things say ‘I allow or don’t allow a use case’ — neither RTP nor FedNow say that, they say they’re agnostic, but they enable them,” she said. “FedNow has opened up the ISO messaging data to enable more things, and I think they’re trying to enable more use cases to let the banks and the industry drive what’s going to move over to the rail than RTP did at the beginning.”
Sheril noted that RTP has adopted its approach over time and she expects the two systems to push each other to be more innovative.
Jackson has noted that FedNow takes a more permissive approach to different use cases than RTP, but he sees the difference between the two as minimal and likely to close over time as participant demands and expectations solidify.
“For the Fed, once you’re connected to FedNow you can use FedNow, regardless of use case. TCH has certain use cases that are allowed to be supported on the network and others that are not, that is true, but I don’t know that that’s a long term thing,” he said “That that’s more about TCH wanting to make sure that they’re ready for each use case that comes on board.”
Jess Cheng, a lawyer with Wilson Sonsini Goodrich & Rosati and a former Fed attorney, said the legal framework within the FedNow system is advantageous to financial technology firms and other nonbank financial institutions.
Cheng, who helped draft the framework during her time working for the Fed Board of Governors, noted that while both FedNow and RTP require fintech to partner with an approved financial institution to access their networks, the Fed’s process is less onerous on fintechs.
“It’s just a different approach, one that’s just more open to nonbanks,” Cheng said. “It’s not like any and everyone can just use it, but it is a different approach that the Fed has taken and in part it’s relying more on the bank, the FedNow participant that a nonbank is partnering with, and expecting them to do the risk management.”
Gunasena said RTP and FedNow are subject to the same regulations regarding access to payment rails and chalks up the differences between the two networks to lessons learned during the past six years of operation.
“Both networks operate as the financial institutions being a part of the network, they are the participants and then their customers will integrate either directly to the network or through a financial instrument. Both models are the same,” he said. “I would say we have streamlined operations throughout the years from the lessons learned and the feedback.”
Senator Tim Scott, R-S.C., who serves as ranking member on the Senate Banking Committee, did not join a letter to the Federal Reserve last week concerning the leak of confidential supervisory information, but “continues to rigorously monitor how the Fed handles confidential supervisory information, and he appreciates Banking Committee Republicans’ attention to this issue,” according to a spokesperson.
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Recent disclosures — both authorized and otherwise — of supervisory activities have reignited a debate over the secrecy standards applied to such information.
Banks and their allies say the leaks, coupled with the deliberate release of CSI related to Silicon Valley Bank following its failure this past spring, demonstrate how the current confidentiality standards enable examiners to wield unchecked power against banks.
“A regime that really is intended to protect a candid back and forth between banks and their regulators and to protect bank’s sensitive commercial and proprietary information has been, somewhat perversely, converted into a shroud of secrecy that principally serves to insulate the regulators’ actions from public scrutiny,” said Jeremy Newell, a senior fellow at the Bank Policy Institute, a lobbying organization for large banks.
Banks argue that various forms of supervisory guidance — including the issuance of so-called matters requiring attention, or MRAs, and matters requiring immediate attention, or MRIAs — are being used in lieu of more public actions, such as rulemakings or enforcement actions, to steer banking activities.
Along with the actions taken against seven banks — Citizens Financial Group, Fifth Third Bancorp, M&T Bank Corp., KeyCorp, Huntington Bancshares, Regions Financial Corp. and First Citizens BankShares — the Bloomberg article also noted an “onslaught” of similar activities by Fed examiners against banks with more than $100 billion of assets since the failure of Silicon Valley Bank in March.
Banks say this uptick is emblematic of supervisors’ ability to scale the intensity of their actions on a whim behind the protective curtain of CSI.
“It allows the examiners to have far more discretion and take some liberties that they wouldn’t if they knew their exam reports were viewable,” said Anne Balcer, senior executive vice president and chief of government relations and public policy for the Independent Community Bankers of America, a trade group for small and mid-size banks.
Some from the regulatory space argue that claims about CSI being used to obfuscate the movement of supervisory policy ring hollow. Todd Phillips, a law professor at Georgia State University and former Federal Deposit Insurance Corp. lawyer, said banks have avenues for contesting supervisory actions if they feel they are unwarranted.
“If they are really concerned that supervisors are going too far, they can appeal. Every agency has a process for appealing material supervisory determinations and they can use that process,” Phillips said. “The fact that they are talking to the press rather than taking it through the legal process tells me that there’s something to what their supervisors are saying in their MRAs and banks are just upset about it.”
Potential motives for the recent leaks are difficult to ascertain. In their letter to the Fed, Senate Banking Republicans make the case that the leak came from the central bank to demonstrate a more aggressive approach to supervision. Such a theory undermines the banking sector’s belief that examiners benefit from operating in the shadows.
Others suggest the banks or their representatives could have disseminated the information to open the Fed up to criticism, but such an orchestrated act would open up involved parties to significant penalties, including bans from banking and criminal prosecution. Banks often cited the complications of sharing CSI with their attorneys, consultants or even their corporate holding companies among their gripes against the current regime.
A spokesperson for Sen. Thom Tillis, R-N.C., the seniormost member of the Banking Committee to sign the letter, said the committee had not received a response to their letter as of Monday morning. Sen. Tim Scott, R-S.C., the ranking Republican on the committee and a presidential hopeful, did not join the inquiry, but Ryann Durant, a spokesperson for Scott, said he is tracking the issue independently.
“Ranking Member Scott takes oversight of our agencies seriously, and on this issue, he wanted to receive a briefing directly from the Federal Reserve, which his staff did on September 22nd,” Durant said in a statement to American Banker. “He continues to rigorously monitor how the Fed handles confidential supervisory information, and he appreciates Banking Committee Republicans’ attention to this issue.”
A Fed spokesperson declined to comment on the status of its response to the senators’ inquiry.
Regardless of who is behind the leak, Aaron Klein, a senior fellow of economic studies at the Brookings Institution, said the episode raises an important question about the reach of the CSI designation.
“Rather than point fingers at each other as to who leaked, step back and ask the question: should this information be kept secret in the first place?” Klein said. “The level of secrecy around bank supervision is too high. Unfortunately, both banks and their regulators have incentives to keep information about supervision a secret. As a result too much is kept from the public allowing both banks and their regulators to escape accountability for their errors.”
Klein is a proponent of making public the aggregate scores banks are given based on capital adequacy, asset quality, management, earnings, liquidity and sensitivity to market risk, abbreviated as CAMELS.
He argues that the FDIC’s quarterly report on the aggregate assets at troubled banks would essentially identify the largest banks should their supervisory marks decline. Making all aggregate CAMELS scores public, Klein said, would bring added accountability to both banks and their regulators.
Most banks and their representatives, however, would rather such information be shielded from the general public. A more palatable version of CSI reform would focus on making the designation more navigable, said David Sewell, a partner at the law firm Freshfields and a former lawyer for the Federal Reserve Bank of New York.
Sewell said the three federal prudential bank regulators — the Fed, FDIC and the Office of the Comptroller of the Currency — and the Consumer Financial Protection Bureau and various state-level bank regulators all have their own definitions and standards for what constitutes CSI as well as their own requirements about the conditions under which the materials can be shared, even with other regulatory agencies.
“The definition of what is CSI is so broad that almost anything touching the supervisory process can be considered CSI, including factual documents and conversation with regulators,” Sewell said. “It would be helpful if the regimes were harmonized on the definition of what is CSI, if there was clarity of what that definition is and if there was a common mechanism for sharing it between agencies.”
By law, CSI is owned by the agency, a distinction that allows the material to be shielded from the Freedom of Information Act, which typically makes all correspondence with the government available to the public upon request. To the frustration of banks, this designation trumps other protective legal mechanisms, such as attorney-client privilege and conversations held under non-disclosure agreements.
Cliff Stanford, a partner with the law firm Alston & Bird and a former Atlanta Fed lawyer, said this status is particularly cumbersome during merger and acquisitions discussions, in which banks must contend with CSI rules while still attempting to be forthcoming with potential counterparties about ongoing issues.
“In the context of an M&A transaction, we have to be very careful not to disclose CSI to a counterparty, even though there’s a nondisclosure agreement, even though there’s diligence underway to assess whether or not a transaction makes sense,” Stanford said. “That just tests the definitional coherence of what is CSI and what is not.”
Recent years have seen moves to apply more transparency to certain types of CSI, especially at the Fed. In 2018, the central bank began releasing a quarterly report on supervision and regulation, which includes a wide range of industry-level information, including the overall number of outstanding supervisory findings. Even the disclosure of wide swaths of the supervisory record on Silicon Valley Bank in the years leading up to its failure represented a level of openness not previously seen.
Stanford said these efforts around transparency have encouraged parties in and around the banking sector to think about CSI differently.
“CSI has gotten increased attention from the banks, their supervisors, policymakers, media and investors. It’s become something that’s been raised in the consciousness, potentially because the added transparency has led to additional curiosity,” he said. “It may also lead to further assessment of whether there is information that can be disclosed if there are additional guardrails put in place.”
Sewell said the Fed’s progress on bringing transparency to its monetary policy actions could be a model for updating its approach to supervisory disclosures. Much like the Federal Open Market Committee releases information from its meetings over time, first as minutes then later as a full transcript, he said supervisory information could similarly be disseminated in a way that mitigates its potential impact.
He noted that a swift change in disclosure policy would likely lead to bad outcomes for banks, but a gradual transition to a more open regime could allow regulators to share more information about supervisory actions at specific banks without inducing panic among depositors or investors.
“More frequent disclosures about MRA findings could destigmatize it over time, if it were done in an orderly way,” Sewell said.
But Phillips said there is a reason why regulators take such a strict approach to confidentiality. He noted that even if banks were to disclose positive information about their supervisory treatment, this could have residual effects on the parts of the sector with less favorable remarks.
“If some banks start advertising that regulators have given them a clean bill of health, institutions that don’t do that may be seen as not having a clean bill of health,” he said. “It creates an incentive that everyone has to disclose information.”
Jeremy Kress, a law professor at the University of Michigan and a former Fed attorney, said there are merits to arguments both for and against changing the rules around CSI, but he does not anticipate changes materializing anytime soon.
While some argue that agencies can work amongst themselves independently or through the Federal Financial Institutions Examination Council to create a more unified framework for defining and handling CSI, Kress and others believe getting the agencies to do so would take an act of Congress.
“It’s a complex debate that has no easy answers,” Kress said. “Any reforms would have to come from Congress, so you can reach your own conclusion about how likely that is.”
Christopher Waller, governor of the Federal Reserve, said Friday afternoon that there are “well over 100” banks and credit unions currently using the FedNow real-time payment settlement service, and that he expects that number to continue to grow.
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WASHINGTON — Federal Reserve Gov. Christopher Waller said Friday that the Fed’s real-time payment settlement service FedNow has already grown from a few dozen banks and credit unions as customers to “well over 100” today, and said internal estimates suggest that number could rise up to 350 by year’s end.
Speaking at a payments conference at the Brookings Institution Friday afternoon, Waller pushed back against the suggestion that banks’ uptake of the long-awaited Fed payments settlement service has been lower than expected or a sign of insufficient demand on the part of depository institutions or their customers.
“We never expected that we would launch it and there would be 4,000 banks joining it. That was never the expectation or a reality,” Waller said. “We have a pipeline of banks that want to join. This will grow over time.”
Waller added that from the launch of FedNow in July, when the service had 51 depository institutions signed up, the number is “well over 100” today, and that the service is steadily expanding its reach.
“There are various estimates that we’ll have 250 to 350 by the end of year, and just continue to grow as banks do it,” Waller said. “But banks have to see some value proposition to make the investment to join, and that depends on what the customers want.”
The road to the launch of the FedNow payments service has been circuitous. The central bank began mulling whether to develop its own payment settlement service more than a decade ago and ultimately decided to develop the system in 2019.
FedNow competes with another private instant settlement service: Real Time Payments, or RTP, which is operated by The Clearing House, which is itself owned by the largest banks in the country. While RTP has been available to banks and other institutions since 2017, some smaller banks have been skeptical of using a platform owned by their larger competitors. The rollout of FedNow is seen by many as a necessary step to making instant payment settlement ubiquitous throughout the U.S. banking system.
Waller also reiterated his position that a central bank digital currency would offer little utility for the Fed, banks or consumers, saying that the existing system of intermediation by banks has been equally effective. Even though some other countries have moved forward with developing a CBDC, he said, there remains no clear use case that could justify having the Fed develop one for the United States.
“The basic question I asked is what a typical economist would ask, which is: ‘What is the major market failure in the payment system that requires a CBDC — and only a CBDC — to solve?’” Waller said. “I posed that question two years ago and I have not heard one satisfactory answer to that question yet. It makes me think that a CBDC is something you could do but there’s nothing that makes you need it.”
Waller accounted for the flurry of activity and discussion around developing a CBDC as investigative in nature, rather than reflective of a policy preference for the central bank to embark on a digital currency.
“We always have to be prepared for the fact that if Congress were to in fact tell us: ‘Do this,’ that we would have the technology and know-how to do it,” Waller said. “That’s most of what we do, is just explore how we would do this, how would we manage it, how would we do the record keeping — so it’s just trying to understand the technology so that if one day Congress said ‘You need to do it’, we could do it.”
Michael Barr, vice chair for supervision at the Federal Reserve, said Sept. 8 that “stablecoins are a form of money, and the ultimate source of credibility in money is the central bank.”
Bloomberg News
The Federal Reserve wants oversight of stablecoins, but some lawyers and policy analysts say the only things keeping the central bank from exerting that authority are its own words and actions.
Earlier this month, Fed Vice Chair for Supervision Michael Barr said he is “deeply concerned” about unregulated stablecoins, stressing that their proliferation could “pose significant risks to financial stability, monetary policy, and the U.S. payments system.” The comments echoed previous comments by other officials, including Fed Chair Jerome Powell, who called for Fed oversight of dollar-backed digital assets a year ago.
Yet, some say the Fed’s official position that stablecoins should be within its regulatory perimeter is undermined by supervisory guidance on the matter, its denial of membership to state-chartered banks that transact with stablecoins, and the agency’s overall tone of commentary about the risks posed by the asset class.
“It sometimes feels like it’s a little bit of a tug of war,” said Joseph Silvia, partner at the law firm Dickinson Wright and a former counsel at the Federal Reserve Bank of Chicago. “There’s guidance on how to do it, but it’s very clear that the Fed still doesn’t like it. They see too much risk or volatility.”
In his first remarks on crypto assets last October, Barr urged banks to be cautious when engaging with the novel technologies. The comments came just weeks before the collapse of the crypto exchange FTX in November. A rash of guidance from the Fed, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency in the months that followed emphasized stern warnings about volatility and run risks in the stablecoin sector.
Barr, like other Fed officials, wants Congress to codify a regulatory framework for stablecoins, but such efforts have repeatedly stalled in the House and have gained virtually no traction in the Senate. He has also argued that stablecoins constitute private money, a designation that would give the Fed jurisdiction over digital assets pegged to the value of the U.S. dollar.
“Stablecoins are a form of money, and the ultimate source of credibility in money is the central bank,” Barr said last week. “If non-federally regulated stablecoins were to become a widespread means of payment and store of value, they could pose significant risks to financial stability, monetary policy, and the U.S. payments system.”
Lawyers familiar with the matter say there is no specific statute in the Federal Reserve Act that directs the central bank to regulate private money, but there is a consensus that payments-related issues are firmly within the Fed’s remit.
“The history and origin of the Fed was to provide a central clearing mechanism for what was essentially private money for a long time and normalize our money around the U.S. dollar,” said Cliff Stanford, a partner at the law firm Alston & Bird and a former assistant general counsel at the Federal Reserve Bank of Atlanta. “That has long been their historic role and they’ve done a good job with it.”
As the hope for a legislative solution for stablecoin oversight wanes, Clifford said regulators have other avenues they could explore that would not be reliant on a bitterly divided Congress. This includes going through Financial Stability Oversight Council to designate individual stablecoin issuers as financial market utilities or having stablecoin issuance broadly deemed a systemically important activity. Though, he notes, FSOC is not known for acting swiftly.
Silva said the most direct way for the Fed to bring stablecoins into its orbit is by providing banks clear guidelines on how to engage with them, and pairing that guidance with “consistent support around those practices.”
Another option, Stanford said, is for the Fed to allow state-chartered banks that are already engaged in issuing, holding or transacting with stablecoins into the federal banking system as state member banks. He noted that the Fed has broad authority to grant master accounts, which serve as a single point of access for the Fed’s various financial services — including its payments systems — for member banks.
“That’s another lever in the existing authority of the Fed,” he said. “If there was to be a new charter type that was stood up just to hold deposits to back stablecoins or that sort of thing, the Fed could use its operational authority over granting or not granting — under its scheme of hierarchy and tiers — master accounts.”
Norbert Michel, director of the conservative Cato Institute’s Center for Monetary and Financial Alternatives, said recent Fed actions around master accounts have demonstrated that it has broad discretion over the types of institutions and activities it allows into the regulated banking system.
“That gets to an even bigger question for me, which is: Should the Fed have so much control over the payment system?” Michel said. “Why should we be in a world where the Fed gets to decide Circle gets to have a master account but Custodia does not?”
Custodia Bank is a Cheyenne, Wyoming-based digital asset bank that had its applications for membership in the Federal Reserve System and a master account through the Federal Reserve Bank of Kansas City denied in January.
Custodia founder and CEO Caitlin Long has said her bank — which is chartered through Wyoming’s crypto-focused Special Purpose Depository Institutions regime — sought to be a regulated bridge between the traditional banking sector and the world of digital assets. After Barr’s speech earlier this month, Long argued that the Fed squandered an opportunity to address its oversight problem when it denied Custodia’s applications.
“[W]hy did Barr block the path for state-chartered payment banks to become Fed member banks in January, which would have solved that very problem,” Long wrote on X, formerly known as Twitter. “Does it wish it could have its vote back?”
Custodia is suing the Federal Reserve Board and the Kansas City Fed in federal court, claiming they unlawfully denied the firm a master account. The bank argues that all state-chartered banks are entitled to access the Fed’s payment systems.
The Fed, meanwhile, has maintained that it has discretion over which institutions are suitable for master accounts, and Custodia did not meet that standard. In a published version of their denial decision, Fed officials wrote that Custodia had insufficient risk controls in place and inexperienced executive leadership. The Fed also noted that the bank was too reliant on highly volatile and unproven business models, including its dealings with stablecoins.
Silva said the Custodia ordeal embodies the paradox of the Fed’s approach to stablecoins. While it is open to banks engaging in the activity in theory, in practice, he said, the Fed expects banks to meet an unobtainable standard to do so.
“It seems like they would be looking for a bank that is devoid of other risks so that it could focus on the risks with respect to banking in the stablecoin industry. That just doesn’t exist. Banks are risk management entities,” Silva said. “The Fed was looking for a cleaner option to start engaging with stablecoins, and I don’t know that they’ll get that. I don’t know that they’ll get their pristine, white unicorn of a neobank to really engage with.”
Federal Deposit Insurance Corp. vice chair Travis Hill said in a speech Thursday that regulators should table their ambitious rulemaking agenda until interest rates have stabilized, arguing that combining economic uncertainty with regulatory uncertainty could spur banks to hold back on consumer lending when it is needed most.
Bloomberg News
WASHINGTON — Federal Deposit Insurance Corp. Board Vice Chair Travis Hill said Thursday that regulators should pump the brakes on a host of proposed regulations until interest rates have stabilized.
In remarks delivered to the Cato Institute Thursday, Hill said that completing a slate of ambitious new rules around capital, liquidity, living wills and other cost-intensive areas — combined with an already precarious economy and a tighter interest rate environment — could lead to unintended consequences.
“While I think that some response to the bank failures is warranted, I worry that an overreaction is underway, and that we are moving too quickly to impose a long list of new rules and expectations at a time when conditions remain precarious,” Hill said, “There’s a compelling case to at least try to get through the rate cycle and sort of see where we are when the dust settles, and then we can kind of take stock of what all the lessons learned are, and sort of decide which of the policy proposals are most worthwhile.”
Regulators have unveiled a laundry list of new regulations including those implementing international banking standards related to capital retention and others responding to March’s bank failures.
Often referred to as the Basel endgame proposal, the rules would compel banks with between $100 billion and $700 billion in total assets to use standardized risk models for market, credit, and operational risk rather than allowing them to self evaluate such indicators. Firms would also need to include unrealized gains and losses on available-for-sale securities when calculating capital and lower the threshold for application of the supplementary leverage ratio and the countercyclical capital buffer from $250 billion to $100 billion in total assets.
Hill echoed banking trade groups in asserting that regulators recently proposed rules implementing Basel III standards were unnecessary and would incentivize banks to reduce the availability of and raise the cost of loans to consumers.
“Our capital rules for our largest banks are already meaningfully more conservative than those in other developed jurisdictions,” Hill noted. “The result [of these rules] will be some combination of higher prices and less availability of products and services.”
Hill had more mixed feelings about other rulemakings pending at his agency aimed at improving the likelihood of orderly resolving large banks. He said he broadly agreed with the FDIC’s recent proposal to impose a long term debt requirement on large regional banks.
“There were several aspects of the proposal that I would have addressed differently, but I still think the proposal was worth issuing to receive comments,” he said. “The presence of long term debt would be helpful regardless of how a bank is resolved.”
But he disagreed with the FDIC’s recent proposal to revamp resolution reporting for banks.
“While resolution plans can provide the FDIC with some useful information and certain aspects of the proposed changes might be helpful, I think the proposal could have better focus on key areas of resolution planning, such as maximizing the likelihood of a weekend sale in the event of a regional bank failure,” he noted.
“Rather than make the merger process more difficult, we should instead try to address some of the underlying causes of consolidation, which includes the ever-rising cost of compliance, the steep challenges associated with technology adoption, and the dramatic decline of de novo activity since the 2008 financial crisis,” he said. “Additionally, the current merger application process is in many cases too long and too opaque.”
Hill expressed concern about potential changes to liquidity rules for large banks, including altering the liquidity coverage ratio, or LCR — a cache of high quality liquid assets that regulators required from banks since the 2008 crisis which could be sold or monetized in times of stress. Hill said the recent spate of bank failures showed that banks in trouble tend to leverage their high quality liquid assets rather than sell them outright — an aspect of the LCR that has not been sufficiently considered.
“I understand the impulse to reconsider aspects of our liquidity rules in light of lessons learned but if we do we should do so holistically,” he said. “If we’re going to change outflow assumptions for uninsured deposits to reflect the possibility that they may run more quickly than previously expected, we should also consider that in such an event, banks are unlikely to firesale their stockpile of high quality liquid assets in a matter of hours, and instead will more likely pledge all assets available to borrow against.”
He said he generally agreed with reexamining supervisory practices like monitoring interest rate risk, concentrations of uninsured deposits, liquidity risk management and contingency funding, but that ultimately it is paramount that supervisors step up their game.
“Bank supervision cannot and should not prevent all bank failures,” he said. “As we consider ways to ensure timely remediation of supervisory issues, supervisors also need to consider ways to, first, complete exams and communicate findings in a more timely way, and second, better prioritize core safety and soundness risks.”
Hill also disagreed with the FDIC’s focus on addressing climate related financial risk, saying he had never witnessed a climate induced bank failure. Rather, he said, climate disasters are moments of opportunity for firms.
“Never once have I ever heard a bank supervisor or FDIC staff member mention a climate event as causing stress at a particular bank, [and] there is no record of banks ever failing because of climate-related events,” he said. “Banks often benefit in the aftermath as demand for loans grows, recovery funds flow into the community and economic activity rebounds.”
He went on to indicate that, much like the reaction to higher capital, banks would likely react to climate risk guidance by retracting credit or charging low and moderate income consumers and businesses more for loans. Regulators have declared weather-related emergencies during three natural disasters so far this year.
Hill’s hypothesis that higher capital cushions at banks reduce lending is far from a settled fact, however. A 2019 review of academic literature by The Bank for International Settlements found no evidence of any negative correlation between bank capital and the growth of loans or GDP, but instead found that higher levels of capital were shown to bolster lending in times of financial crisis.
FDIC chairman Martin Gruenberg echoed the idea that stronger cushions of capital against losses ultimately bolster a bank’s long term ability to provide services through hard times and would only cause a modest reduction in banks’ short term profitability, since most banks already have adequate capital to meet the rules.
“The majority of banks that would be subject to the proposed rule currently have enough capital to meet the proposed requirements,” Gruenberg noted when the Basel III proposal was issued.
The Federal Reserve Board of Governors will have a full complement of seven governors for the first time in seven months as it heads into its monetary policy meeting next week.
Adriana Kugler, the executive director of the World Bank and professor at Georgetown University, was sworn in as the seventh member of the board on Wednesday morning. She will complete the term vacated by former Gov. Lael Brainard, who left to become the White House’s chief economist in February. That term ends in 2026.
Gov. Lisa Cook, whose term was set to expire at the end of January 2024, was also sworn into a new, 14-year term on the board, running through 2037. Gov. Philip Jefferson, meanwhile, was sworn in as the Fed’s vice chair — a position also previously held by Brainard — for a four-year term.
President Joe Biden nominated Kugler and Jefferson to their new positions, along with renominating Cook, on May 23. All three were approved by the Senate Banking Committee and confirmed by a vote of the full Senate last week. Kugler and Cook cleared the Senate on a largely party line vote, with Sens. Mike Rounds, R-S.D., Susan Collins, R-Maine, and Lisa Murkowski, R-Alaska, being the only Republicans to vote in their favor. Jefferson enjoyed board bipartisan support, garnering 88 out of 98 votes cast on the floor.
Fed Chair Jerome Powell administered the oath of office to all three governors on Wednesday morning.
Kugler is on leave from Georgetown, where she is a professor of economics and public policy and serves as vice provost for faculty.
In 2021, Biden appointed Kugler U.S. executive director of the World Bank’s International Bank for Reconstruction and Development. Before that she was the chief economist in the Labor Department during the Obama administration from 2011 to 2013, and she held research positions at the National Bureau of Economic Research and at Stanford University.
She holds a Bachelor’s degree in economics and political science from McGill University and a doctorate in economics from the University of California, Berkeley.
Kugler, whose parents immigrated to the U.S. from Colombia, is now the first Fed governor with acknowledged Hispanic heritage, satisfying a call for Latino representation at the highest levels of the central bank that advocates — including Sen. Bob Mendendez, D-N.J. — have been making for years.
Cook, who similarly made history last year as the first Black woman to join the Fed Board of Governors, has added another distinction to her resume: the first Black woman confirmed to a full 14-year term.
Before joining the Fed, Cook worked as a professor of economics and international relations at Michigan State University. Before that she was a faculty member at Harvard University’s Kennedy School of Government. Her prior government experience includes work done on the Council of Economic Advisors during the Obama administration and a research position at the Treasury Department’s Office of International Affairs.
Since joining the Fed last year, Jefferson has taken on the role of chair of the Fed’s internal Committee on Board Affairs and has served as oversight governor for the office of the Fed’s chief operating officer.
Before being confirmed to the board last year, Jefferson was vice president for academic affairs and dean of faculty at Davidson College, where he also taught economics. Before that, he was a staff researcher for the Board of Governors and served on the advisory board for the Opportunity and Inclusive Growth Institute at the Federal Reserve Bank of Minneapolis.
Since Brainard’s departure to lead the National Economic Council, the Fed’s Federal Open Market Committee — which consists of governors in Washington and a rotating group of regional reserve bank presidents — has been short one voting member for the past four meetings.
Next week’s FOMC meeting, which runs from Tuesday morning to Wednesday afternoon, is one of three remaining gatherings for the committee, with the final two convening on Oct. 31 and Dec. 12, respectively.
After multiple months of lower inflation readings and loosening labor market conditions, market participants broadly expect the FOMC to hold the target range for the federal funds rate at 5.25% to 5.5% next week. Opinions vary more widely about what the committee will do at subsequent meetings, with one final hike, a continued hold and potential rate cut all seen as being in play.
The Department of Health and Human Services’ recommendation last month that the Drug Enforcement Administration reschedule cannabis from a Category I to a Category III substance will have little impact on legal cannabis businesses or the banks that serve them — and could even sap urgency from Congressional efforts to provide more meaningful relief.
Bloomberg News
WASHINGTON — The Department of Health and Human Services’ recommendation that cannabis be reclassified as a less dangerous drug has renewed interest in Congress in bringing legalized cannabis businesses into the economic fold, but offers cannabis businesses and their banks little relief in itself, experts say.
HHS issued a recommendation to the Drug Enforcement Administration that the DEA reschedule cannabis, also known as marijuana, as a Schedule III substance under the Controlled Substances Act rather than a Schedule I substance — placing it alongside Tylenol and codeine rather than harder drugs like heroin and LSD.
But Vince Sliwoski, an attorney with Harris Bricken, said rescheduling won’t immediately change how cannabis firms do business or expand the universe of banking partners they can choose from.
“At Schedule III, marijuana would still be a controlled substance and state-licensed businesses would still be “trafficking” in a controlled substance, contrary to federal law,” he wrote in a recent piece. “The analysis for financial institutions won’t fundamentally change.”
Sliwoski added that the main vehicle for normalizing cannabis’ relationship to the broader economy is for Congress to pass the Secure and Fair Enforcement Act, or SAFE Banking Act, which has been stalled in one chamber of Congress or the other for years.
“We need the perpetually stalled SAFE Banking Act or some other act of Congress to fix this, so long as cannabis remains on any CSA schedule,” Sliwoski said. “Even if marijuana is moved to Schedule III, cannabis businesses would be stuck with current options — which aren’t as bad as advertised.”
The SAFE Banking Act would establish federal protections for financial institutions that provide financial services to State-sanctioned marijuana businesses, but the legislation has failed to get tacked onto any of the various must-pass bills late last year.
The rescheduling effort initiated by HHS last month would bring cannabis under the regulatory umbrella of the Food and Drug Administration, alongside other drugs that require a prescription. Companies also need FDA approval before they can offer a Schedule III drug.
Shane Pennington, a partner at Porter Wright, said these stipulations mean firms will still be hesitant to bank companies which technically still violate federal law, even if the violations are less severe.
“Until marijuana is clinically proven and approved by the FDA to safely and effectively address medical conditions such as chronic pain or aiding cancer patient recovery, marijuana producers, distributors, and dispensaries will likely continue to have limited access to the financial services industry even if marijuana is rescheduled,” Pennington said.
He also noted that DEA’s process for rescheduling is long and multifaceted, making it a long shot to happen before the 2024 presidential election. The DEA may need to submit its proposed rule to the Office of Management and Budget before publication in the Federal Register, allowing other executive agencies to weigh in on whether and how the rule contradicts other administration policy initiatives. And after publication, the DEA is required to accept and respond to public comments and hold public hearings on the rule, further delaying the process.
“The OMB review, the number of comment letters received, and the number of public hearing requests are elements of the rescheduling review and rulemaking process that cannot be controlled by DEA,” he said. “Each element by itself could extend DEA’s review and rulemaking process [making] it challenging for DEA to publish a final rule prior to the 2024 presidential election, in our view.”
And a Republican victory in the presidential election would likely quash any effort — regulatory or otherwise — to reconsider the federal ban on cannabis, according to Ed Groshans, senior policy and research analyst at Compass Point Research & Trading.
“If President Biden is re-elected, marijuana will likely be placed on Schedule III in 2025,” Groshans said. “If President Biden loses, the rescheduling process will likely cease to be expedited and the likelihood of the Drug Enforcement Agency using international narcotic treaties to maintain Schedule I status increases significantly.”
While HHS’ recommendation could take some time to make its way through the DEA rulemaking, the announcement has reignited interest in Congress. Bri Padilla, executive director of The Chamber of Cannabis, said in a recent interview with Forbes that while not a panacea, rescheduling is a step in the right direction, and could pave the way for the kinds of broader measures SAFE Banking could provide.
“Rescheduling might indeed pave the way for the passage of the Safe Banking Act, offering a partial solution to the banking problem that has plagued the industry,” she said. “While federal legalization would provide the most comprehensive remedy, rescheduling could serve as an intermediate step to ease financial hurdles for cannabis businesses, allowing them to operate more transparently within the existing financial system.”
Jaret Seiberg, managing director at TD Cowen, said he expects the committee to vote on SAFE as soon as September 20, opening up the possibility of a full Senate floor vote late in the year. He believes the SAFE Act has a filibuster-proof 60 vote consensus, a potential pathway to passage through the chamber.
“It is likely that Senate Majority Leader Chuck Schumer (D.-N.Y.) will seek to pass SAFE through the full Senate in Q4 2023,” he wrote in an email. “We believe it is likely to get a vote as we expect there will be at least 60 senators backing it — enough to overcome a filibuster.”
While Democratic-led Senate could very well pass the Act, the Republican-held House is another story according to Seiberg. He said the majority GOP chamber will oppose certain social justice clauses in the Act, since its leadership has been lukewarm at best towards the measure.
“Passage in Senate Banking would be a positive, as would passage by the full Senate,” he said. “However, the most likely path [to full enactment] will be as a provision included in a broader package that Congress tries to enact next year … often referred to as an omnibus. It usually becomes law during the lame duck session after the election [and is] when the most horse-trading occurs among leadership to get bills enacted before the next Congress takes over.”
And that’s not to say Senate passage is a fait accompli either. Some Democrats have previously expressed concern with a clause in the bill which would repeal Operation Choke Point — an Obama era policy which critics say the executive branch wielded to discourage banks from doing business with certain kinds of businesses like pawn shops and gun manufacturers. Proponents of the policy believe its repeal would make it harder for regulators to pressure banks to cut ties with certain customers for reputational risk reasons.
SAFE banking lobbyist Don Murphy agreed talk of rescheduling could be pivotal for the legislation, but he hopes Congress can act before the DEA does. Final rescheduling of cannabis in the absence of SAFE, he said, could actually undercut congressional enthusiasm toward its broader reforms.
“The recent recommendation by the Department of Health and Human Services could have significant implications for the bipartisan SAFE Banking Act,” he wrote in a message. “If the DEA accepts the HHS recommendation and moves cannabis to Schedule III before the SAFE Banking Act is passed by Congress, it could reduce the urgency and pressure for both Democrats and Republicans to support this legislation.”
As the Federal Reserve continues its quest to tame inflation, a stubborn lack of housing supply is propping up housing costs and even rental prices, complicating the central bank’s calculus on when and whether to delay rate hikes or even cut lending rates.
Bloomberg News
Federal Reserve officials anticipate moderating housing costs driving disinflation in the months ahead, but a national shortage of homes could spoil those expectations.
Last month, during his annual address in Jackson Hole, Wyo., Fed Chair Jerome Powell said the elevated housing costs captured by recent inflation readings do not reflect the central bank’s true progress on curbing price growth in that sector.
“The market rent slowdown has only recently begun to show through to that measure,” Powell said. “The slowing growth in rents for new leases over roughly the past year can be thought of as ‘in the pipeline’ and will affect measured housing services inflation over the coming year.”
Economists agree that rent growth rates have slowed down since peaking during the pandemic years and that such a trend often takes time to show up in inflation reports, given how housing costs are measured. But some say the trajectory of where shelter costs are heading is muddied by shortages in most major markets across the country.
The Fed’s primary monetary policy tool — the federal funds rate — is used to influence consumer spending, to help steer demand for goods and services into alignment with their supply. For housing, which has been underbuilt since 2008 and artificially restricted with building codes and other localized rules for decades, supply is still well short of demand, KPMG chief economist Diane Swonk said.
“Getting supply to meet demand in a market where supply has been so dramatically constrained — not just temporarily, but structurally for decades — is difficult,” Swonk said. “We’re a long way from the market being anywhere near in balance, and that’s something the Fed has to watch because price is the ultimate equalizer, and prices don’t come down when supply and demand are so far out of balance.”
The Fed’s latest Beige Book, which compiles economic data from across the Federal Reserve System’s regional reserve banks, stated that “nearly all districts” reported dealing with constrained for-sale housing supply. Many also noted headwinds on financing new housing construction, both for sale and for rent.
While Fed officials have made no commitments about future rate hikes, recent readings on inflation data and employment figures have trended in a favorable direction and indicated that the Federal Open Market Committee, or FOMC, could soon stop raising rates.
The short supply of homes not only raises questions about the movement of prices in the months ahead, but also could also create issues for the Fed when the central bank decides to stop raising interest rates and, eventually, cut them. Swonk said other monetary authorities around the world have already had to quickly reverse course on policy changes after sharp rebounds in home buying activity.
“It’s forced other central banks to rethink and go back in and raise rates again,” she said. “It’s something the Fed is just concerned could be something that we have, especially given our extraordinary situation in the United States, where supply is so far below demand that it’s even been below the suppressed level of demand that we have because of higher rates.”
Powell acknowledged this risk in his Jackson Hole speech, noting that “after decelerating sharply over the past 18 months, the housing sector is showing signs of picking back up,” which “could warrant further tightening of monetary policy.”
Rising housing costs have consistently been among the leading drivers in overall inflation dating back to last year, even as many other price categories have stabilized. The White House Council of Economic Advisors estimates that shelter costs contributed to roughly half of overall headline inflation through the first quarter of this year, roughly double the share from June 2022.
The two main national price indices, the Consumer Price Index, or CPI, and Personal Consumption Expenditure, or PCE, index — the Fed’s preferred indicator — both measure housing costs by rents and rent equivalents for homeowners. In this sense, the Fed’s most direct impact on housing affordability — mortgage rates — do not directly factor into the data the Federal Open Market Committee considers when setting monetary policy.
David Wilcox, senior fellow at the Peterson Institute for International Economics and director of US economic research at Bloomberg Economics, said rents and home purchase prices tend to move in the same direction over time, but “economically, the mechanics of that relationship are pretty loose” and it could take years before that relationship “asserts itself,” meaning rents could continue to stabilize or even fall as sale prices rise.
“If you’re talking about what’s on the horizon for the next six months, the next year, the next 18 months, you would be well served to focus on what’s going on on the rental market and set aside the purchase market,” Wilcox said, referring to the housing portion of inflation indexes.
Still, mortgage rates are a key component of the housing sector, which is relevant to the labor market and overall economy. Because of this, Fed officials often point to mortgages as an example of the effectiveness of their monetary policy changes. In Jackson Hole, Powell noted that mortgage rates more than doubled over the course of 2022, moving up in lockstep with each rate hike.
The average rate on a new mortgage is now more than 7%, and the week ending Sept. 1 saw the lowest indexed level of mortgage application activity since December 1996, according to the Mortgage Bankers Association — a 30% drop from the same time period last year.
But some say this decline in activity has less to do with diminished demand than prospective homebuyers reacting to the extremely low levels of supply.
“There’s still a pretty good amount of competition whenever a unit comes on the market, despite rates being at over 7%,” said MBA vice president and deputy chief economist Joel Kan. “Rates are high, but because of how low inventory is and the fact that we still do have pretty healthy levels of housing demand … if there’s a need to buy, and the buyer has the means, they’re trying to go ahead with it.”
Swonk said the national housing shortage is the result of a “perfect storm” of market and policy trends dating back to the subprime mortgage crisis of 2007 and 2008. Since that episode — which was triggered by risky lending activity and overbuilding in many markets — home builders and lenders have shied away from speculative developments, she said, leading to sustained underbuilding. Meanwhile, restrictive zoning laws dating back to the 1970s have made it difficult to build multifamily and even entry-level single-family homes in many areas.
This limited supply was met with a surge in demand from 2020 into 2022 as the Fed slashed interest rates to their lower bound, resulting in a flurry of purchases and refinances. A report from the real estate listing website Redfin estimates that more than 90% of homeowners locked in a mortgage rate below 6% by the middle of last year, with more than 80% paying less than 5% and more than 60% below 4%.
Wilcox said this has contributed to a “lock-in” effect, which disincentivizes homeowners from putting their properties on market.
“Current, incumbent owners are reluctant to sell,” he said. “They’re locked into their current residences, and that means that there’s no supply on the market for purchasers to come in, and that puts a prop underneath purchase prices.”
For now, asking rents have largely stabilized. Over time that trend will work its way into inflation measures as more survey respondents report signing or renewing leases at prices reflecting those changes.
Some economists say rental rates could even come down in some markets, which are currently experiencing an uptick in apartment construction, particularly among properties with 20 or more units, according to the U.S. Census Bureau.
“Supply constraints seem to be easing,” Christian Weller, an economist and senior fellow at the Center for American Progress said. “Between construction starts and completion there is a time lag, so this will take some time, but given what we see in the rental market, with new rents close to flat relative to where they were in previous months, the hope is that we are in the process of easing prices.”
Fed Gov. Philip Jefferson was confirmed to Federal Reserve Board of Governors’ second-ranking position with strong bipartisan support in the Senate.
Anna Rose Layden/Bloomberg
Philip Jefferson has been confirmed the Federal Reserve Board’s second ranking position by a Senate vote of 88-10 on Wednesday.
The full Senate vote on Jefferson’s nomination was the first of three such votes expected to take place this week. Fed. Gov. Lisa Cook is up for a full 14-year term on the board and labor economist Adriana Kugler has been nominated to fill a vacant seat that expires in 2026.
President Joe Biden nominated Jefferson, an economist by training and a former college administrator, to be the Fed’s vice chair in May, less than three months after the previous vice chair, Lael Brainard, departed the board to become the White House’s top economist.
Sen. Sherrod Brown, D-Ohio, who chairs the Senate Banking Committee, lauded Jefferson as a “respected economist” with “outstanding academic credentials and strong leadership experience,” in remarks on the Senate floor Tuesday afternoon.
“Dr. Jefferson possesses a strong understanding of how higher prices hurt the most economically insecure Americans and that access to good paying jobs is the best antidote to poverty,” Brown said, noting that Jefferson garnered unanimous support from the Banking Committee earlier this year.
Sens. Mike Braun, R-Ind., Josh Hawley, R-Mo., James Lankford, R-Okla., Mike Lee, R-Utah, Cynthia Lummis, R-Wyo., Rand Paul, R-Ky., Eric Schmitt, R-Mo., Rick Scott, R-Fla., Dan Sullivan, R-Ak., and Tommy Tuberville, R-Ala., voted against invoking cloture.
Jefferson joined the board in May 2022. Since then, he has delivered several speeches on the economy, monetary policy and financial stability. He’s also taken the reins of the Fed’s internal Committee on Board Affairs as chair and oversight governor for the office of the Fed’s chief operating officer.
“I will evaluate any future proposed final rules on their merits. My views on any proposed final Basel III endgame requirements for U.S. banking organizations will be informed by the potential impact on banking sector resiliency, financial stability and the broader economy stemming from the implementation,” Jefferson said during an open meeting about the proposal in July. “I look forward to reading and digesting the comments we received from the public, which will inform my future decision on any eventual proposed final approvals.”
Jefferson enjoyed broad bipartisan support in his initial confirmation, which was approved by a vote of 91-7. This broad-based support was unique among Biden’s Fed nominees. His first pick for vice chair for supervision, Sarah Bloom Raskin, had to withdraw from consideration among staunch Republican opposition.
Meanwhile Cook, a former economic professor at Michigan State University, was confirmed by the thinnest of margins, with Vice President Kamala Harris casting the tie-breaking vote to secure her position on the board.
Brown called the Republican criticism of Cook during last year’s confirmation process an “underhanded and unfair attack on an eminently qualified woman of color,” but noted she had “proved her naysayers wrong” during the past 17 months. He noted that, if confirmed, Cook would be the first Black woman to be granted a full term on the Fed Board.
Brown urged Senators to vote in favor of Cook and Kugler this week. If confirmed, Kugler — who worked at the World Bank Group and served as the Labor Department’s chief economist under the Obama Administration — would become the first Fed governor of Latin American descent. Brown said confirming her would not only give the Fed a full complement of seven governors, but also a jolt of needed diversity.
“Her confirmation will be a critical step forward in bringing more diverse perspectives to our nation’s central bank, not just diversity in the way these nominees look, but diversity in the way they think, something we simply have not seen much of in these kind of elitist institutions like the Board of Governors of the Federal Reserve,” he said.
Consumer advocates also encourage the Senate to confirm all three Biden nominees this week.
In a statement, Dennis Kelleher, head of the advocacy group Better Markets, heralded the experience of all three economists, arguing that their expertise will be needed to address various challenges faced by the Fed and the country as a whole in the years ahead.
“Beyond technical and professional qualifications, the nominees bring diverse perspectives to the Board, which will be critical to successfully navigating the many looming challenges on topics ranging from inflation and bank capital rules to resolution planning and ethics,” Kelleher said. “The American people will surely benefit from Drs. Jefferson, Cook, and Kugler’s diversity of upbringings, educations, experiences and views.”
Federal Reserve officials have maintained that the historic levels of participation in the central bank’s overnight reverse repurchase agreement facility is nothing to be concerned about.
Graeme Sloan/Bloomberg
A key indicator of excess liquidity in the financial system has been falling since May, a development that holds promise for banks but raises questions for financial stability.
The Federal Reserve’s overnight reverse repurchase agreement, or ON RRP, facility has seen usage decline from nearly $2.3 trillion this spring to less than $1.7 trillion through the end of August, its lowest level since the central bank began raising interest rates in March 2022.
For banks, this was a desired outcome of the Fed’s effort to shrink its balance sheet. As the central bank allows assets — namely Treasuries and mortgage-backed securities — to roll off its books, its liabilities must decline commensurately. The more of that liability reduction that comes from ON RRP borrowing, the less has to come out of reserves, which banks use to settle transactions and meet regulatory obligations.
“What we’ve seen is the decline in the Fed holding has mostly come through on the liability side in terms of a decline in reverse repos, rather than reserves,” Derek Tang, co-founder of Monetary Policy Analytics, said. “This is, of course, welcome news to the Fed, because the Fed wants to make sure that there are enough reserve balances in the banking system to operate smoothly. So that’s good news.”
Yet, as participation in the ON RRP — through which nonbank financial firms buy assets from the Fed with an agreement to sell them back to the central bank at a higher price the next day — shrinks, some in and around the financial sector worry that funds are being redirected to riskier activities.
Darin Tuttle, a California-based investment manager and former Goldman Sachs analyst, said the decline in ON RRP usage has coincided with an uptick in stock market activity. His concern is that as firms seek higher returns, they are inflating asset prices through leveraged investments.
“I tracked the drawdown of the reverse repo from April when it started until about the beginning of August. The same time that $600 billion was pumped back into the markets is when markets really took off and exploded,” Tuttle said. “There’s some similarities there in drawing down the reverse repo and liquidity increasing in the markets to take on excessive risk.”
The Fed established the ON RRP facility in September 2014 ahead of its push to normalize monetary policy after the financial crisis of 2007 and 2008. The Fed intended the program to be a temporary tool for conveying monetary policy changes to the nonbank sector by allowing approved counterparties to get a return on unused funds by keeping them at the central bank overnight. The facility sets a floor for interest rates, with the rate it pays representing the first part of the Fed’s target range for its funds rate, which now sits at 5.25% to 5.5%.
For the first few years of its existence, the facility’s use typically ranged from $100 billion to $200 billion on a given night, according to data maintained by the Federal Reserve Bank of New York, which handle’s the Fed’s open market operations. From 2018 to early 2021, the usage was negligible, often totaling a few billion dollars or less.
In March 2021, ON RRP use began to climb steadily. It eclipsed $2 trillion in June 2022 and remained above that level for the next 12 months. Uptake peaked at $2.55 trillion on December 30 of last year, though that was partially the result of firms seeking to balance their year-end books.
While it is difficult to pinpoint why exactly ON RRP use has skyrocketed, most observers attribute it to a combination of factors arising from the government’s response to the COVID-19 pandemic, including the Fed’s asset purchases as well as government stimulus, which depleted another liability item on the Fed’s balance sheet: the Treasury General Account, or TGA.
Regardless of how it grew so large, few expected the ON RRP to ever reach such heights when it was first rolled out. Michael Redmond, an economist with Medley Advisors who previously worked at Federal Reserve Bank of Kansas City and the Treasury Department, said the situation raises questions about whether the Fed’s engagement with the nonbank sector through the facility ultimately does more harm than good.
“The ON RRP, when it was initially envisioned as a facility, was not expected to be this actively used. The Fed definitely has increased its footprint in the financial system, outside of the usual set of counterparties with it,” Redmond said. “The debate is whether that increases financial instability, because obviously it is nice to have the stabilizing force of the Fed’s balance sheet there, but it also potentially leads to counterproductive pressures on private entities that need to essentially compete with the Fed for reserves.”
Fed officials have maintained that the soaring use of the facility should not be a cause for concern. In a June 2021 press conference, as ON RRP borrowing was nearing $1 trillion, Fed Chair Jerome Powell said the facility was “doing what it’s supposed to do, which is to provide a floor under money market rates and keep the federal funds rate well within its — well, within its range.”
Fed Gov. Christopher Waller, in public remarks, has described the swollen ON RRP as a representation of excess liquidity in the financial system, arguing that counterparties place funds in it because they cannot put them to a higher and better use.
“Everyday firms are handing us over $2 trillion in liquidity they don’t need. They give us reserves, we give them securities. They don’t need the cash,” Waller said during an event hosted by the Council on Foreign Relations in January. “It sounds like you should be able to take $2 trillion out and nobody will miss it, because they’re already trying to give it back and get rid of it.”
But not all were quite so confident that the ON RRP would absorb the Fed’s balance sheet reductions. Tang said there have been concerns about bank reserves becoming scarce ever since the Fed began shrinking its balance sheet last fall, but those fears peaked this past spring, after the debt ceiling was lifted and Treasury was able to replenish its depleted general account.
“If the Treasury is increasing its cash holdings, then other parts of the Fed’s balance sheet, other liabilities have to decline and there was a big worry that reserves could start declining very quickly,” Tang said. “The Treasury was going from $100 billion to $700 billion, so if that $600 billion came out of reserves, we could have been in trouble.”
Instead, the bulk of the liabilities have come out of the ON RRP, a result Tang attributes to money market funds moving their resources away from the facility to instead purchase newly issued Treasury bills.
The question now is whether that trend will continue and for how long. While Fed officials say the ON RRP facility can fall all the way to zero without adverse impacts on the financial sector, it is unclear whether it will actually reach that level without intervention from the Fed, such as a lowering of the program’s offering rate or lowering the counterparty cap below $160 billion.
A New York Fed survey of primary dealers in July found that most expected use of the ON RRP to continue falling over the next year. The median estimate was that the facility would close the year at less than $1.6 trillion and continue falling to $1.1 trillion by the end of next year.
Those same respondents also expect reserves to continue dwindling as well, with the median expectation being less than $2.9 trillion by year end and roughly $2.6 trillion by the end of this year. As of Aug. 31, there were just shy of $3.2 trillion reserves at the Fed.
“The Fed’s view is that there are two types of entities with reserves, the banks that have more than enough and they don’t know what to do with, and the ones that are having some problems and need to pay up to attract deposits, which ultimately are reserves,” Redmond said. “When there are fluctuations in reserves, it’s hard to tell how much of that is shedding of excess reserves by banks that are flush with them, and how much is a sign that this is going to be a tougher funding environment for banks.”
Tuttle said a balance-sheet reduction strategy that relies on a shrinking ON RRP is not inherently risky, but he would like to hear more from the Fed about how it sees this playing out in the months ahead.
“We have gotten zero guidance on the drawdown of reverse repo,” he said. “Everything is just happening in the shadows.”
Senate Banking Committee ranking member Tim Scott, R-S.C., and House Financial Services Committee chair Patrick McHenry, R-N.C., would be in a position to rescind any banking rules if they are finalized within 60 legislative days of the opening of the 119th Congress in January 2025 if Republicans win both chambers and the presidency.
Bloomberg News
WASHINGTON — As Congress stirs back to life after its August recess, regulators are now up against a looming Congressional Review Act deadline to finish their most important rulemakings.
Should Congress and the administration flip to Republican control in 2024, the incoming Congress would be able to initiate a Congressional Review Act nullification of any rules issued within the last 60 legislative days of the prior Congress. Legislative days can be tricky to predict because of unscheduled breaks, campaign breaks and emergency sessions, but with all of that being considered the deadline for Biden’s regulators to finalize rules and publish them in the Federal Register would be in May or June of 2024.
The Congressional Review Act dynamic is always present in any election year, but it’s especially important this election cycle now that regulators have proposed a slew of important regulations in the wake of this spring’s bank failures — rules that would have a big impact on bank capital, fee income and supervisory stringency.
Here are the top rules under consideration by the Biden administration that regulators will have to compete ahead of that May/June Congressional Review Act deadline.
House Judiciary Committee Chair Jim Jordan, R-Ohio, said in a cover letter for a subpoena to Citigroup last week that law enforcement’s use of “back-channel discussions with financial institutions” to collect data on suspects related to the Jan. 6, 2021, attack on the Capitol was “alarming.”
Bloomberg News
WASHINGTON — House Republicans’ subpoena of Citibank over concerns about how some large banks allegedly shared data with law enforcement may be the latest example of politics leaking into the banking sector, but banks shouldn’t easily dismiss the incident as partisan bickering.
Underlying the conflict is a longstanding tension between data privacy and banks’ obligations to cooperate with law enforcement, especially when it comes to anti-money-laundering and counterterrorism financing laws, experts say. It’s a growing concern for banks, as they grapple with how to walk the tightrope between cooperating with government agencies and protecting consumers’ privacy — and how to do that in an increasingly politicized country.
“Data is the lifeblood of the system, and it’s where you’re going to get the most details about someone,” said Brian Knight, senior research fellow at the Mercatus Center at George Mason University. “So if I wanted to paint a picture about somebody, I would go for the financial data because that’s going to tell you so much about a person and their views and their habits. Part of this is two sides yelling at each other, but underlying that is how that information is treated so it’s not abused by whichever side happens to have access to it.”
Last week, the House Judiciary Committee subpoenaed Citibank for documents related to House Republicans’ belief that major banks illegally shared private financial data with the Federal Bureau of Investigation related to the Jan. 6 insurrection at the U.S. Capitol.
House Republicans said they are concerned that at least one institution — Bank of America — appears to have shared some data about individuals who made certain purchases and transactions. The transactions in question include Airbnb, hotel or airline travel reservations in the Washington, D.C., area in the days leading up to Jan. 6.
Of particular concern to Rep. Jim Jordan, R-Ohio, chairman of the Judiciary Committee and the Select Subcommittee on the Weaponization of the Federal Government, is the release of data on individuals who purchased a firearm with a Bank of America credit card that supposedly went to the top of the list provided to the FBI, according to a cover letter attached to the subpoena.
The GOP lawmakers say this sharing was done without the proper process, although they don’t specify what that process would have been.
“Federal law enforcement’s use of back-channel discussions with financial institutions as a method to investigate and obtain private financial data of Americans is alarming,” Jordan said. “The documents received to date only bolsters our need for all materials responsive to our request.”
The letter to Citibank also included a screenshot of an email sent to Citibank and other banks from the FBI, inviting them to participate in a meeting on “identifying the best approach to information sharing.”
American Banker was unable to independently verify the accuracy of the letter’s accusations. Citi and Bank of America did not respond to requests for comment when the subpoena was issued, and the FBI did not immediately respond to a request for comment.
Experts say that the issue will come down to the details of how this information was allegedly provided, and an interpretation of the Right to Financial Privacy Act of 1978, which generally requires that individuals receive notice and an opportunity to object before a bank can disclose personal financial information to a federal government agency, often in the context of law enforcement. Typically — although with significant exceptions — law enforcement agencies need to file a subpoena to receive that information.
There’s an exemption to the law when terrorism is involved, or if a financial institution has filed a Suspicious Activity Report. Based on the public documents, it’s not possible to know if the FBI or the Financial Crimes Enforcement Network presented this as a domestic terrorism investigation to the banks.
Without knowing the precise nature of the request banks received from law enforcement, experts said it can be tricky for banks to know what to do when law enforcement agencies request information and where to draw the line between complying and protecting their consumers’ data.
“There is a perceived tension between complying with AML regulations and financial privacy laws,” said Alison Jimenez, president and founder of Dynamic Securities Analytics, Inc. “Banks need to provide nuanced training to staff on how to comply with financial privacy requirements, but without chilling compliance with SAR filings.”
Knight said it’s difficult to know what’s normal in these kinds of situations, because the public doesn’t usually have a window into this process. The incentives, however, favor banks erring on the side of providing information to law enforcement in the form of Suspicious Activity Reports.
“Banks are constantly complaining that the burden of complying with the suspicious activity reporting system is very high,” Knight said. “Because they have to file a lot of reports, and if they file a lot of reports and it turns out it was unnecessary, nothing happens to them. If they fail to file a report and it turns out that it was relevant, they get in trouble.”
Bankers generally lean toward complying with law enforcement requests, said Dina Ellis Rochkind, a lawyer at Paul Hastings. Since the 9/11 terrorism attacks, AML and anti-terrorism funding has tended to be one of the few bipartisan and industry-supported regulations in Washington.
“The banks, especially after 9/11, recognized that they needed to do more on national security,” she said. “Keep in mind that Wall Street is in New York, so AML rules are one of those things where banks work with the regulators to come up with workable solutions. The banks had a personal connection to the aftermath of 9/11 and willingly stepped up to safeguard the U.S.”
Knight said that, while he is unsure how this dynamic will play out, the ideal resolution would be for regulators and lawmakers to have a productive conversation about making SAR filings and other bank information available to law enforcement helpful in prosecuting crimes.
“My somewhat optimal scenario would be we’d have an intelligent conversation about the tradeoffs — about how useful this type of data is with suspicious activity reports,” Knight said. “Those things actually are for law enforcement, [but] are they actually useful for preventing terrorist attacks?”
