The FHFA’s Home Loan bank report is that rare thing you never see in the nation’s capital anymore — a balanced plan on a complex issue that could have lasting impact on a difficult problem, writes Joe Neri.
The average rent for an American has increased by 22% and the average home price has climbed by a whopping46% since late 2019. Both the dream of first-time homeownership and the reality of monthly rent are increasingly unattainable for many young families. As the nationwide housing crisis escalates, the inadequacies of today’s Home Loan Bank System — designed during the Great Depression to make home ownership achievable to more Americans — become even more glaring. It’s time for a change.
The FHFA report offers over 50 specific recommendations to address the system’s shortfalls and is worth serious consideration.
But there’s another reason to act on this report: It’s a policy unicorn. It’s that rare thing you never see in the nation’s capital anymore — a balanced plan on a complex issue that could have lasting impact on a difficult problem with broad public support and no impact on federal spending or taxes.
As the CEO ofIFF, one of the firstCommunity Development Financial Institutions to join the Home Loan Bank System in 2010 after Congress opened the doors to us through legislation, I am both a booster and reformer of the system. I know firsthand how the Home Loan banks’ liquidity can get more capital into communities. But I have also seen CDFIs struggle to access liquidity through opaque, inconsistent and unreasonable collateral requirements.
As the chair of the CDFI-FHLB Working Group, I lead a coalition of 35 non-depository Home Loan bank-member CDFIs working for better access to capital for affordable housing and community development projects. We are active shareholding members of the Home Loan banks — with a stake in the system’s success — but also mission-driven financial institutions deeply committed to building thriving and more equitable communities, not simply to maximizing shareholder profits.
The report delineates a clear path for the FHFA, the Home Loan banks and member CDFIs to collaborate, using the system’s tools and resources in service to our nation’s communities. Rather than get stuck on a few hot-button issues, we see an opportunity to build upon the constructive conversations that led up to the report.
First, let’s start with what we all agree is most important and achievable: clarifying the public mission of the Home Loan Bank System and creating clear metrics of accountability.
Without a clear imperative for how the system should meet its mission, all other recommendations are meaningless. The system presently views its primary mission as providing liquidity to its private institutional members. But the FHFA’s report clearly states that this liquidity must be in service to a public purpose like affordable housing and economic development, not simply private speculation likecryptocurrency investments. For the Home Loan Bank System to work for everyone, we must clarify its mission and how to measure it. The old business adage “what gets measured gets done” holds true here.
Second, let’s immediately move forward on a major point of consensus: directing more of the system’s attention and profits toward affordable housing and community development.
Another key recommendation is for the Home Loan banks to voluntarily increase their Affordable Housing Program (AHP) contributions to at least 20% of their prior year’s net earnings, up from the statutorily required minimum of 10%. The FHFA report makes clear that the Federal Home Loan banks retain substantially more earnings and, thus, could easily contribute more for the benefit of communities. That’s the least they can do in exchange for their tax exemption, which allows them to pay hefty dividends to their members. No legislation is needed for this increase, and the Home Loan banks andthe CEOs of our nation’s largest banks have already agreed to an increase to 15%.
Third, let’s work together to realize the system’s public mission, starting with a “mission-oriented collateral” program that treats CDFIs like community financial institutions.
Home Loan banks still struggle to understand and fairly treat CDFIs’ collateral. To address this, the FHFA report recommends the creation of mission-oriented collateral programs, allowing CDFIs to pledge collateral with a strong connection to the system’s public mission. It calls for the banks to expand voluntary and pilot programs, which help increase the production, rehabilitation and preservation of multifamily housing.
Private banks have long understood that CDFIs can more effectively deploy capital to disinvested communities and borrowers. They invest hundreds of millions of dollars into CDFIs to meet their Community Reinvestment Act obligations. Home Loan banks should similarly model their partnership with CDFI members.
We shouldn’t be surprised by the incredible potential of the FHFA’s report. Its review process was thorough and transparent, includingdozens of public roundtables and listening sessions and hundreds of written comments from a range of stakeholders. The report wasn’t assembled in a smoke-filled room in Washington, D.C., but it’s not without controversy. Any full-fledged review of the Home Loan Bank System — a complex, cooperative network of government-sponsored financial institutions — was bound to touch on a few sensitive issues.
Perhaps most sensitive is the FHFA’s consideration of a new rule requiring most Home Loan bank members to maintain at least 10% of their assets in residential mortgages or other mission assets. Today’s banking and mortgage lending have changed so much that enforcing this requirement is trickier than it might seem. But why focus on the report’s more contentious recommendations when others are so readily achievable to create tangible and lasting impact?
The Home Loan bank presidents have an opportunity for action to help real people in real communities, rather than reaction to maintain the status quo through PR consultants and lobbyists. This public review of the system has shown that the status quo is not sustainable. By implementing the most important recommendations in the report, the Federal Home Loan Bank System can once again be a vital instrument in making housing affordable and communities thriving and stable.
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.
Bloomberg News
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.
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.
Bloomberg News
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.
Sen. Joe Manchin, a Democrat from West Virginia, and Sen. John Moran, a Republican from Kansas, reintroduced the Fair Audits and Inspections for Regulators (FAIR) Exams Act this month in an effort to enhance transparency of bank examinations.
Anna Rose Layden/Bloomberg
Banking-as-a-service institutions are applauding legislators’ calls for fairer exams and increased transparency from federal financial regulators.
Last week, the American Fintech Council, which represents BaaS banks, supported the introduction of the Fair Audits and Inspections for Regulators (FAIR) Exams Act by Sens. John Moran, a Republican from Kansas., and Joe Manchin, a Democrat from West Virginia.
David Patti, director of communications and government relations at Customers Bank, said financial institutions would prefer to be told what the exact expectations are, instead of guessing until they get it wrong. Brian Graham, a co-founder and partner at Klaros Group, said regulators haven’t issued many clear-cut rules for BaaS, and the process for challenging those agencies can be precarious.
“There’s a legitimate point to be made that much more of the public policy around banking is happening outside of the law and regulation process, and [instead] in the supervisory process, which can both feel more arbitrary and unfair and sometimes can be arbitrary and unfair,” Graham said.
Phil Goldfeder, CEO of the American Fintech Council, said in a prepared statement in response to the proposed legislation that, “innovative banks are rightfully held to the highest standard of transparency, compliance and responsibility,” but added that regulators should meet the same bar.
Banking-as-a-service [BaaS], when fintechs and banks partner to deliver services, has been high on regulators’ radars in the last couple of years. In June, the Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corporation issued guidance for how banks can assess and monitor third-party relationships, but bankers and trade groups said the report still wasn’t specific enough.
Patti said that Customers, a player in the BaaS space, is in constant communication with its regulators to make policy decisions for the bank to follow. But if regulators make individual decisions with each financial institution, it’s hard to know if each bank is treated consistently, he said.
“In the absence of bright lines, it depends on relationships [with regulators],” Patti said. “So there’s probably not much transparency….it’s not transparent and not public.”
BaaS sponsor banks, which bear the brunt of the regulatory burden in these relationships, have also relied on other banks’ mistakes as blueprints for what not to do due to a lack of formal rules, Graham said. Blue Ridge Bank, Cross River Bank and First Fed Bank have each been hit with enforcement actions regarding their BaaS practices in the last year and a half.
These regulatory decisions can also seem ad hoc or idiosyncratic, Graham said, as determinations are made based on internal assessments, instead of publicly available information.
“Right now, BaaS activities are a significant area of focus for the regulators, fair or unfair,” Graham said. “It does appear that much of what the regulators want to achieve in the space — from a policy point of view or risk management point of view or compliance point of view — is being done through enforcement actions.”
Patti said that Customers has a good relationship with its overseers, but he thinks an independent examination review protocol would increase visibility of policies.
The full text of the Fair Exams Act hasn’t been published, but other aspects of the bill include requiring agencies to issue timely responses to bankers during exams and creating an independent examination review director within the Federal Financial Institutions Examinations Council to inspect exams upon banks’ requests. The American Bankers Association and Independent Community Bankers of America also supported the proposal in written statements.
The FDIC, Fed and OCC each have ombudsman offices designed for banks to appeal or question regulatory decisions without fear of retaliation. Graham said, however, that banks he’s spoken to don’t see these units as a practical option, since the process is still under the regulators’ umbrella.
The Fed and FDIC declined to comment. The OCC did not respond to a request for comment.
Neither Graham nor Patti think the FAIR Exams Act will pass. But similar to how regulators can use actions to make policy, Patti thinks it’s possible a recent case heard by the U.S. Supreme Court could lead to more “neutral” enforcement and appeals processes. In Securities and Exchange Commission v. Jarkesy, a hedge-fund founder challenged the constitutionality of the agency’s administrative enforcement proceedings. The case could have implications for banking regulators too, potentially requiring court involvement in enforcement actions.
The court hasn’t yet issued a decision on the case, but justices expressed skepticism in comments about the use of in-house judges.
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.
Bloomberg News
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.
Bloomberg News
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.”
Isabel Guzman, administrator of the Small Business Administration, speaks during a National Small Business Week event in the Rose Garden of the White House in May. She has advocated for expanding participation in her agency’s flagship 7(a) program as a way to reach groups that often struggle to obtain credit.
Ting Shen/Bloomberg
Following a selection process that lasted nearly seven months, the Small Business Administration has licensed three new small-business lending companies. The move came despite continuing objections from lawmakers as well as groups representing banks and credit unions.
Small-business lending companies, known as SBLCs, are nondepository lenders authorized to participate in the agency’s flagship 7(a) lending program, otherwise dominated by banks and credit unions. SBLC participation had been capped at 14 companies since 1982, so the new licensees announced Wednesday brought the total to 17. SBA ended the moratorium in a rule finalized in April.
The new SBLCs are: Arkansas Capital Corp., a community development financial institution; McKinley Alaska Growth Capital, an alternative lending firm that is also a CDFI; and the fintech Funding Circle. All three have expressed a desire to expand their 7(a) operations nationwide.
Already a prominent small-business lender, Funding Circle lobbied hard for an end to the SBLC moratorium, then sought aggressively to secure one of the three available licenses. It plans a measured 7(a) rollout with a focus on making quality loans, rather than on quantity. “It will take time to ramp up, but it’s important that we get it right from the first loan through full scale,” Ryan Metcalf, the company’s head of public affairs, said Thursday.
Denver-based Funding Circle’s ultimate ambitions are writ large. “Our goal is to be the No. 1 SBA lender for loans under $500,000,” Metcalf said. To that end, it has hired Kaustubh Joshi, a high-ranking Goldman Sachs executive, to drive its strategy of partnering with community banks and credit unions, which Funding Circle sees as a fertile source of referrals. Of the more than 9,000 community banks and credit unions currently operating, fewer than 1,500 participated in the 7(a) program during the just completed 2023 fiscal year.
“If you’re a small- or medium-size institution, how do you keep up?” Metcalf said. “You could make a costly decision to build your own platform, or buy one, or you could partner with Funding Circle and leverage our embedded platform, which we believe is more efficient and cost-effective.”
Arkansas Capital in Fayetteville and the Anchorage-based McKinley Alaska Growth Capital are also eyeing growth opportunities. “Arkansas Capital has bolstered regional economic development, but now with this SBLC license, we can widen our SBA 7(a) footprint as well, expanding our services to rural and poverty-stricken areas in the South to start,” CEO Sam Walls said Wednesday in a press release issued by the SBA.
“Our business model thrives on local collaboration and creative partnerships, and with this SBLC license, we will be able to offer our services to even more underserved markets outside of Alaska,” McKinley Alaska President Logan Birch said in the press release. “Our experienced, hands-on team of SBA lenders looks forward to helping support the next generation of entrepreneurs.”
Trade groups representing banks and credit unions are still pinning their hopes on a bill introduced this summer by Senate Small Business Committee Chairman Ben Cardin, D-Maryland, and Sen. Joni Ernst of Iowa, the committee’s ranking Republican, that would strictly limit additional SBLC participation in 7(a). “It’s still very much a live effort,” Steve Keen, senior vice president of congressional relations at the Independent Community Bankers of America, said Friday in an interview. “This is not a dead bill. It’s still very much alive. Hopefully, we’ll have some results that you can see publicly sooner rather than later.”
“What we are calling for specifically is to issue no more [SBLC licenses],” Keen added.
SBA Administrator Isabel Guzman has advocated wider participation in 7(a) as a tool to boost small-dollar lending, as well as access to capital by disadvantaged groups. “The Biden-Harris administration remains committed to filling capital market gaps, and the expansion of the SBA’s SBLC program after more than forty years is a monumental step forward in this crucial effort,” Guzman said in the press release.
Banks and credit unions fear the policy will result in more defaults and fraud. They have often pointed to fraud that occurred during the Paycheck Protection Program — which was administered by the SBA — as a reason to limit involvement by nonbank and fintech lenders in the 7(a) program.
“SBA rule changes that lift the moratorium on the number of institutions that can lend under the 7(a) program while loosening underwriting standards will undermine the program and unintentionally harm the very borrowers the SBA is trying to aid,” ICBA President and CEO Rebeca Romero Rainey said Friday in a statement.
The operational risk component of the agencies’ capital proposal could not possibly pass any cost-benefit analysis, write Grag Baer and Francisco Covas, of Bank Policy Institute.
MQ-Illustrations – stock.adobe.com
If the capital rule recently proposed by the federal banking agencies is adopted, U.S. banks will end up holding over $300 billion in capital against “operational risk.” The capital charge comes because the proposed rule would create more than $3.5 trillion in phantom assets to represent operational risk and then impose a capital charge against those assets. For capital purposes, approximately 24% of banks’ collective risk-weighted assets would be these phantom assets. By the standard measure used by global regulators, this requirement alone would permanently reduce U.S. GDP by nearly $90 billion annually; operational risk charges would attach to every loan or other bank product, raising their cost to bank customers. There is no reason to believe that operational risk justifies this self-inflicted wound to our country’s economic growth.
In fact, in a study published yesterday that relied on 20 years of actual loss data for U.S. banks, BPI analysis based onORX data (the most complete data repository for operational risk losses) has demonstrated that the proposed Basel operational risk charge, in combination with the existing stress capital charge, results in operational risk losses that are approximately five times higher than almost all of the largest losses experienced by banks in the worst year over that 20-year period, including all litigation losses associated with the global financial crisis.
Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. Cyber risk is universally considered the largest operational risk facing banks. That said, it is hard to find any record of a large U.S. bank ever failing for operational risk, or even suffering a material loss as a result of a cyberattack, an information technology failure or any other true operational risk event. Certainly, the proposed rule cites not a single case.
Instead, when regulators talk about large operational risk losses, they are generally referring to a type of operational risk loss that might not immediately come to mind: fines imposed by the agencies themselves, and judgments obtained in follow-on civil litigation. The largest such fines in the past have come from failure to monitor for money laundering or sanctions compliance; most recently, the banking industry has been assessed over $2.5 billion in fines for failing to monitor texts sent via employees’ personal phones. Even here, none has ever produced a bank failure.
But, stepping back, consider how strange this idea is. Basically, the agencies are requiring banks to hold capital every day of the week against the risk that the agencies themselves will at some point impose ruinous fines on those banks.
There is a larger, conceptual problem. Future potential fines and litigation judgments are unlikely to coincide with very large market risk, credit risk and counterparty risk losses that are also being capitalized by the proposal. The agencies are no more or less likely to fine a bank for sanctions compliance during a credit crisis or a market crisis. While one could note that the global financial crisis produced large fines and litigation judgments as well as credit and market losses, the fines and litigation losses (either judgments or reserves established in anticipation of judgment) came several years later. For capital purposes, the origin story of the loss is not important; it is when the loss is incurred (either paid for or reserved against). And nobody was paying out mortgage judgments on Lehman weekend. Most of the judgments were not paid until 2014; some cases are only being paid now.
Thus, a bank fined for some perceived past misdeed will in most cases be able to pay that fine out of earnings, but even in extreme cases will be able to use some of its otherwise-required capital to pay the fine and rebuild its capital over time through earnings. By analogy, a single airbag can guard against a variety of potential collisions.
Indeed, the agencies recognized this logic in their prior iteration of Basel implementation,explaining that “the existing risk-based capital rules were designed to cover all risks, and therefore implicitly cover operational risk.” They are now reversing course without explanation and conclusively presuming that there is perfect correlation among all these risks.
The only thing odder than taxing bank customers permanently for one-time losses would be taxing them twice, but that is exactly what the agencies propose to do. The proposed rule would create $2 trillion in phantom operational risk assets; the other $1.5 trillion come from the Federal Reserve’s annual stress test, whose latest iteration assumed $188 billion in aggregate operational risk losses. So, the same risk is being counted twice. By definition, operational risk events are stress events, so both charges are for stress. Notably, the United States would be the only country in the world to double-count risk in this way, as no other country includes a stress capital charge, much less one with an operational risk component.
And then of course there is the calibration. The proposed rule contains no historical data or analysis to justify the charges it imposes, and as noted, the best data available suggests that it overstates the risk by a factor of five.
Why does this matter? If a bank is fined $1 billion, that fine is paid from current earnings and is basically incurred by the bank’s shareholders; in investor parlance, it is a “one-timer.” However, if the bank is assessed a permanent capital charge for the risk of future such fines, that charge is paid by the bank’s customers — consumers and businesses — and ultimately by the economy.
The operational risk component of the agencies’ capital proposal could not possibly pass any cost-benefit analysis. Perhaps that is why the agencies’ capital proposal on operational risk did not contain one. The current proposal needs to be rethought and recalibrated, and once it is adopted, the operational risk component of the Federal Reserve’s stress test needs to be eliminated.
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.”
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.
Bloomberg News
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.”
Federal Reserve Bank of Cleveland President Loretta Mester said Friday’s jobs report didn’t change her view that the labor market remains strong, and that further interest-rate hikes will depend on additional incoming data.
“The inflation rate is still too high, the level of inflation remains high, but at least we’re seeing progress on it,” Mester said Friday during an interview with CNN International. “And whether we need to tighten monetary policy a bit further or not is really going to depend on all the data that we get between now and our next meeting.”
Despite the continued strength, Mester said the labor market is gradually cooling, with employers in her district telling her they’re not having as much trouble finding workers. She also pointed to the cooldown in wages in Friday’s report as further evidence of slowing inflation.
Mester said also policymakers’ discussion is moving to how long the Fed should hold its benchmark rate high for now that rates are either at or near their peak.
“I thought it was pretty likely we might need to do another rate hike this year, but I’ll make that decision once I get into the room in November, at our next meeting,” she said.
Fed officials last month left the target range for their benchmark rate unchanged at 5.25% to 5.5%, a 22-year high. Projections published at the same time showed 12 out of 19 policymakers expected one more rate increase for this year, and that officials see fewer rate cuts in 2024 than previously anticipated.
US employers added a whopping 336,000 jobs in September, far above economists’ projections ahead of Bureau of Labor Statistic’s release Friday. Average hourly earnings increased 0.2% last month and were up 4.2% from a year earlier, the smallest annual advance since mid-2021. Earnings for nonsupervisory employees, who make up the majority of workers, posted the smallest back-to-back monthly increases since 2020.
Mester said growth is “strikingly strong,” and reiterated she would like the Fed to reach its 2% inflation target by the end of 2025.
Mester said earlier this week that she would support another interest-rate increase at the Fed’s next policy meeting if the economy is performing about the same as at the time of the September gathering, adding that the decision will be based on incoming data. The Cleveland Fed chief does not vote on monetary policy decisions this year.
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.
Bloomberg News
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.”
Joshua trees were burned by the York Fire in San Bernardino County, California, earlier this year. Studies have found that climate change is leading to increases in the frequency of wildfires and the length of wildfire season.
But now the state of California appears poised to act first, which could complicate the reporting requirements for many banks — assuming the Golden State’s legislation survives likely legal challenges.
Earlier this month, lawmakers in Sacramento passed two bills that would require larger companies that operate in California to report expansive measurements of their emissions, as well as to account for the financial risks of climate change.
Banking industry groups are taking issue with the inclusion of so-called Scope 3 emissions in the California legislation. Those are greenhouse gas emissions that result from the value chains of companies’ products and services. In the case of banks, Scope 3 emissions may result from their financing activities.
Financial industry trade groups have also been arguing that the California requirements could conflict with the forthcoming SEC rules, as well as upcoming international standards.
“We strongly recommend that any California requirements align with, or be compatible with, federal standards or other international standards incorporated by U.S. authorities,” the industry groups wrote in a recent letter to Democratic state Sen. Scott Wiener, who sponsored one of the bills.
The letter was signed by the American Bankers Association, the Bank Policy Institute, the California Bankers Association and the California Credit Union League, among other financial industry groups.
Senate Bill 253, sponsored by Wiener, directs regulators to adopt rules by 2025 for companies that generate more than $1 billion in annual revenue and operate in California. Those companies would have to report various emissions measurements, including those associated with their financing activities.
The affected firms would also have to report Scope 1 emissions, which involve pollutants sourced directly from a company’s operations, and Scope 2 emissions, which result from the generation of purchased energy.
The other piece of legislation, Senate Bill 261, was sponsored by Democratic state Sen. Henry Stern. It would require companies that do business in California — and have more than $500 million in annual revenue — to report on their climate-related financial risks and transition plans.
At a climate event earlier this month, California Gov. Gavin Newsom said that he plans to sign both bills, though he added a caveat about the need for “some cleanup on some little language.”
The bills were written in a way that would not penalize companies headquartered in the nation’s most populous state. Instead, they would apply broadly to large firms that do business in California.
Still, the bills could face court challenges based on a legal doctrine that bars states from placing undue burdens on interstate commerce, said Loyti Cheng, an attorney at the law firm Davis Polk & Wardwell.
The legislation’s opponents may also argue that mandating climate disclosures violates the First Amendment’s protection from compelled speech, Cheng said.
Thomas Gorman, a partner at Dorsey & Whitney, said that how courts respond to the likely legal challenges will have important implications. “These will be important decisions for regulating the environment,” he said.
The California bills could also have an impact on the forthcoming SEC regulations, according to Joseph Grundfest, a former SEC commissioner. He said that climate disclosures mandated by other regulators are a “blessing for the SEC and not a problem.”
“The commission can take advantage from these developments by refashioning its rule proposal, so that it doesn’t itself require any company to measure Scope 1, Scope 2 or Scope 3 emissions,” said Grundfest, who is a law and business professor at Stanford University.
“Instead, it can simply require efficient, low-cost aggregation and disclosure in one place of all of these other metrics, and thereby avoid a legal war over whether it has authority to demand emissions measurement by any company,” he said.
The SEC issued draft rules in March 2022, but it has delayed releasing a final rule after receiving a high volume of public feedback.
Danielle Fugere, president and chief counsel of the environmental advocacy group As You Sow, argued that California’s enactment of Senate Bill 253 will “shore up” the SEC’s draft proposal.
“There’s been a lot of discussion around whether Scope 3 requirements will be removed from the SEC’s proposal,” Fugere said, adding that she is hopeful that the California measure “will help the SEC stand firm.”
Federal Reserve Bank of Boston President Susan Collins said further interest-rate increases are possible and borrowing costs may need to stay higher for longer than previously expected for the US central bank to achieve its 2% inflation goal.
“I expect rates may have to stay higher, and for longer, than previous projections had suggested, and further tightening is certainly not off the table,” Collins said Friday in remarks prepared for an event hosted by the Maine Bankers Association.
Fed officials left their benchmark interest rate unchanged this week and signaled borrowing costs will likely remain at elevated levels for longer than estimated just a few months ago, after one more rate increase later this year. Chair Jerome Powell said policymakers can afford to “proceed carefully” after a series of rapid rate increases rolled out over the past 18 months.
Collins, who does not vote in monetary policy decisions this year, said she “fully” supported the guidance offered in Fed officials’ quarterly economic projections, and said that the current phase of policy will require “considerable patience.”
The US economy has so far been resilient against the Fed’s historic tightening campaign, which lifted the target range for the federal funds rate from nearly zero in March 2022 to 5.25% to 5.5% in July, a 22-year high. In their latest economic forecasts, 12 of 19 Fed officials said they expect to raise rates once more this year.
The forecasts also showed policymakers expect it will be appropriate to reduce the federal funds rate to 5.1% by the end of 2024, according to their median estimate, up from 4.6% when projections were last updated in June.
Collins said inflation has moderated, but progress has been uneven and more time is needed to be sure price gains are on a steady downward path. While many households and businesses who built up savings or locked in lower rates on loans have been shielded against the Fed’s rate increases, demand is likely to cool as those savings are spent and debt-market activity picks up, she said.
The Boston Fed chief said earlier this month officials will need to be patient as they assess economic data to figure out their next steps and that further tightening may still be required.
She reiterated that sentiment Friday while also noting that there are uncertainties in the economic outlook.
“The risk of inflation remaining persistently high must be weighed against the risk that activity will slow more than expected,” Collins said.
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.”
