Fed Gov. Philip Jefferson was confirmed to Federal Reserve Board of Governors’ second-ranking position with strong bipartisan support in the Senate.
Anna Rose Layden/Bloomberg
Philip Jefferson has been confirmed the Federal Reserve Board’s second ranking position by a Senate vote of 88-10 on Wednesday.
The full Senate vote on Jefferson’s nomination was the first of three such votes expected to take place this week. Fed. Gov. Lisa Cook is up for a full 14-year term on the board and labor economist Adriana Kugler has been nominated to fill a vacant seat that expires in 2026.
President Joe Biden nominated Jefferson, an economist by training and a former college administrator, to be the Fed’s vice chair in May, less than three months after the previous vice chair, Lael Brainard, departed the board to become the White House’s top economist.
Sen. Sherrod Brown, D-Ohio, who chairs the Senate Banking Committee, lauded Jefferson as a “respected economist” with “outstanding academic credentials and strong leadership experience,” in remarks on the Senate floor Tuesday afternoon.
“Dr. Jefferson possesses a strong understanding of how higher prices hurt the most economically insecure Americans and that access to good paying jobs is the best antidote to poverty,” Brown said, noting that Jefferson garnered unanimous support from the Banking Committee earlier this year.
Sens. Mike Braun, R-Ind., Josh Hawley, R-Mo., James Lankford, R-Okla., Mike Lee, R-Utah, Cynthia Lummis, R-Wyo., Rand Paul, R-Ky., Eric Schmitt, R-Mo., Rick Scott, R-Fla., Dan Sullivan, R-Ak., and Tommy Tuberville, R-Ala., voted against invoking cloture.
Jefferson joined the board in May 2022. Since then, he has delivered several speeches on the economy, monetary policy and financial stability. He’s also taken the reins of the Fed’s internal Committee on Board Affairs as chair and oversight governor for the office of the Fed’s chief operating officer.
“I will evaluate any future proposed final rules on their merits. My views on any proposed final Basel III endgame requirements for U.S. banking organizations will be informed by the potential impact on banking sector resiliency, financial stability and the broader economy stemming from the implementation,” Jefferson said during an open meeting about the proposal in July. “I look forward to reading and digesting the comments we received from the public, which will inform my future decision on any eventual proposed final approvals.”
Jefferson enjoyed broad bipartisan support in his initial confirmation, which was approved by a vote of 91-7. This broad-based support was unique among Biden’s Fed nominees. His first pick for vice chair for supervision, Sarah Bloom Raskin, had to withdraw from consideration among staunch Republican opposition.
Meanwhile Cook, a former economic professor at Michigan State University, was confirmed by the thinnest of margins, with Vice President Kamala Harris casting the tie-breaking vote to secure her position on the board.
Brown called the Republican criticism of Cook during last year’s confirmation process an “underhanded and unfair attack on an eminently qualified woman of color,” but noted she had “proved her naysayers wrong” during the past 17 months. He noted that, if confirmed, Cook would be the first Black woman to be granted a full term on the Fed Board.
Brown urged Senators to vote in favor of Cook and Kugler this week. If confirmed, Kugler — who worked at the World Bank Group and served as the Labor Department’s chief economist under the Obama Administration — would become the first Fed governor of Latin American descent. Brown said confirming her would not only give the Fed a full complement of seven governors, but also a jolt of needed diversity.
“Her confirmation will be a critical step forward in bringing more diverse perspectives to our nation’s central bank, not just diversity in the way these nominees look, but diversity in the way they think, something we simply have not seen much of in these kind of elitist institutions like the Board of Governors of the Federal Reserve,” he said.
Consumer advocates also encourage the Senate to confirm all three Biden nominees this week.
In a statement, Dennis Kelleher, head of the advocacy group Better Markets, heralded the experience of all three economists, arguing that their expertise will be needed to address various challenges faced by the Fed and the country as a whole in the years ahead.
“Beyond technical and professional qualifications, the nominees bring diverse perspectives to the Board, which will be critical to successfully navigating the many looming challenges on topics ranging from inflation and bank capital rules to resolution planning and ethics,” Kelleher said. “The American people will surely benefit from Drs. Jefferson, Cook, and Kugler’s diversity of upbringings, educations, experiences and views.”
Senate Banking Committee ranking member Tim Scott, R-S.C., and House Financial Services Committee chair Patrick McHenry, R-N.C., would be in a position to rescind any banking rules if they are finalized within 60 legislative days of the opening of the 119th Congress in January 2025 if Republicans win both chambers and the presidency.
Bloomberg News
WASHINGTON — As Congress stirs back to life after its August recess, regulators are now up against a looming Congressional Review Act deadline to finish their most important rulemakings.
Should Congress and the administration flip to Republican control in 2024, the incoming Congress would be able to initiate a Congressional Review Act nullification of any rules issued within the last 60 legislative days of the prior Congress. Legislative days can be tricky to predict because of unscheduled breaks, campaign breaks and emergency sessions, but with all of that being considered the deadline for Biden’s regulators to finalize rules and publish them in the Federal Register would be in May or June of 2024.
The Congressional Review Act dynamic is always present in any election year, but it’s especially important this election cycle now that regulators have proposed a slew of important regulations in the wake of this spring’s bank failures — rules that would have a big impact on bank capital, fee income and supervisory stringency.
Here are the top rules under consideration by the Biden administration that regulators will have to compete ahead of that May/June Congressional Review Act deadline.
House Judiciary Committee Chair Jim Jordan, R-Ohio, said in a cover letter for a subpoena to Citigroup last week that law enforcement’s use of “back-channel discussions with financial institutions” to collect data on suspects related to the Jan. 6, 2021, attack on the Capitol was “alarming.”
Bloomberg News
WASHINGTON — House Republicans’ subpoena of Citibank over concerns about how some large banks allegedly shared data with law enforcement may be the latest example of politics leaking into the banking sector, but banks shouldn’t easily dismiss the incident as partisan bickering.
Underlying the conflict is a longstanding tension between data privacy and banks’ obligations to cooperate with law enforcement, especially when it comes to anti-money-laundering and counterterrorism financing laws, experts say. It’s a growing concern for banks, as they grapple with how to walk the tightrope between cooperating with government agencies and protecting consumers’ privacy — and how to do that in an increasingly politicized country.
“Data is the lifeblood of the system, and it’s where you’re going to get the most details about someone,” said Brian Knight, senior research fellow at the Mercatus Center at George Mason University. “So if I wanted to paint a picture about somebody, I would go for the financial data because that’s going to tell you so much about a person and their views and their habits. Part of this is two sides yelling at each other, but underlying that is how that information is treated so it’s not abused by whichever side happens to have access to it.”
Last week, the House Judiciary Committee subpoenaed Citibank for documents related to House Republicans’ belief that major banks illegally shared private financial data with the Federal Bureau of Investigation related to the Jan. 6 insurrection at the U.S. Capitol.
House Republicans said they are concerned that at least one institution — Bank of America — appears to have shared some data about individuals who made certain purchases and transactions. The transactions in question include Airbnb, hotel or airline travel reservations in the Washington, D.C., area in the days leading up to Jan. 6.
Of particular concern to Rep. Jim Jordan, R-Ohio, chairman of the Judiciary Committee and the Select Subcommittee on the Weaponization of the Federal Government, is the release of data on individuals who purchased a firearm with a Bank of America credit card that supposedly went to the top of the list provided to the FBI, according to a cover letter attached to the subpoena.
The GOP lawmakers say this sharing was done without the proper process, although they don’t specify what that process would have been.
“Federal law enforcement’s use of back-channel discussions with financial institutions as a method to investigate and obtain private financial data of Americans is alarming,” Jordan said. “The documents received to date only bolsters our need for all materials responsive to our request.”
The letter to Citibank also included a screenshot of an email sent to Citibank and other banks from the FBI, inviting them to participate in a meeting on “identifying the best approach to information sharing.”
American Banker was unable to independently verify the accuracy of the letter’s accusations. Citi and Bank of America did not respond to requests for comment when the subpoena was issued, and the FBI did not immediately respond to a request for comment.
Experts say that the issue will come down to the details of how this information was allegedly provided, and an interpretation of the Right to Financial Privacy Act of 1978, which generally requires that individuals receive notice and an opportunity to object before a bank can disclose personal financial information to a federal government agency, often in the context of law enforcement. Typically — although with significant exceptions — law enforcement agencies need to file a subpoena to receive that information.
There’s an exemption to the law when terrorism is involved, or if a financial institution has filed a Suspicious Activity Report. Based on the public documents, it’s not possible to know if the FBI or the Financial Crimes Enforcement Network presented this as a domestic terrorism investigation to the banks.
Without knowing the precise nature of the request banks received from law enforcement, experts said it can be tricky for banks to know what to do when law enforcement agencies request information and where to draw the line between complying and protecting their consumers’ data.
“There is a perceived tension between complying with AML regulations and financial privacy laws,” said Alison Jimenez, president and founder of Dynamic Securities Analytics, Inc. “Banks need to provide nuanced training to staff on how to comply with financial privacy requirements, but without chilling compliance with SAR filings.”
Knight said it’s difficult to know what’s normal in these kinds of situations, because the public doesn’t usually have a window into this process. The incentives, however, favor banks erring on the side of providing information to law enforcement in the form of Suspicious Activity Reports.
“Banks are constantly complaining that the burden of complying with the suspicious activity reporting system is very high,” Knight said. “Because they have to file a lot of reports, and if they file a lot of reports and it turns out it was unnecessary, nothing happens to them. If they fail to file a report and it turns out that it was relevant, they get in trouble.”
Bankers generally lean toward complying with law enforcement requests, said Dina Ellis Rochkind, a lawyer at Paul Hastings. Since the 9/11 terrorism attacks, AML and anti-terrorism funding has tended to be one of the few bipartisan and industry-supported regulations in Washington.
“The banks, especially after 9/11, recognized that they needed to do more on national security,” she said. “Keep in mind that Wall Street is in New York, so AML rules are one of those things where banks work with the regulators to come up with workable solutions. The banks had a personal connection to the aftermath of 9/11 and willingly stepped up to safeguard the U.S.”
Knight said that, while he is unsure how this dynamic will play out, the ideal resolution would be for regulators and lawmakers to have a productive conversation about making SAR filings and other bank information available to law enforcement helpful in prosecuting crimes.
“My somewhat optimal scenario would be we’d have an intelligent conversation about the tradeoffs — about how useful this type of data is with suspicious activity reports,” Knight said. “Those things actually are for law enforcement, [but] are they actually useful for preventing terrorist attacks?”
Key findings about discrimination in home valuations are under dispute. That hasn’t stopped them from informing policy decisions.
During the past two years, regulators and lawmakers have introduced and adopted new rules and guidelines aimed at curbing the impacts of racial bias on home valuations. But some appraisers and researchers insist these efforts have been based on faulty data.
Conflicting findings from a pair of non-profit research groups call into question whether or not recent actions will improve financial outcomes for minority homeowners without leading to banks and other mortgage lenders taking on undue risks.
The debate centers on a 2018 report from the Brookings Institution, which found that homes in majority-Black neighborhoods are routinely discounted relative to equivalent properties in areas with little or no Black population, a trend that has exacerbated the country’s racial wealth gap. The study, which adjusts for various home and neighborhood characteristics, found that homes in Black neighborhoods were valued 23% less than homes in other areas.
“We believe anti-Black bias is the reason this undervaluation happens,” the report concludes, “and we hope to better understand the precise beliefs and behaviors that drive this process in future research.”
The study, titled “Devaluation of assets in Black neighborhoods,” has been cited by subsequent reports published by Fannie Mae and Freddie Mac, academics and White House’s Property Appraisal and Valuation Equity, or PAVE, task force, which used the data to inform its March 2022 action plan to address racial bias in home appraisal.
Meanwhile, as the Brookings’ findings proliferated, another set of research — based on the same models and data — has largely gone untouched by policymakers. In 2021, the American Enterprise Institute replicated the Brookings study but applied additional proxies for the socioeconomic status of borrowers.
By simply adding a control for the Equifax credit risk score for borrowers, the AEI research asserts, the average property devaluation for properties in Black neighborhoods falls to 0.3%. The researchers also examined valuation differences between low socioeconomic borrowers and high socioeconomic borrowers in areas that were effectively all white and found that the level of devaluation was equal to and, in some cases, greater than that observed between Black-majority and Black-minority neighborhoods.
“That, to us, really suggests that it cannot be race but it has to be due to other factors — socioeconomic status, in particular — that is driving these differences in home valuation,” said Tobias Peter, one of the two researchers at the AEI Housing Center who critiqued the Brookings study.
Contrasting conclusions
Peter and his co-author, Edward Pinto, who leads the AEI Housing Center, acknowledge that there could be bad actors in the appraisal space who, either intentionally or through negligence, improperly undervalue homes in Black neighborhoods. But, they argue, the issue is not systemic and therefore does not call for the time of sweeping changes that the PAVE task force has requested.
Brookings researchers have refuted the AEI findings, arguing that, among other things, their controls sufficiently rule out socioeconomic differences between borrowers as the cause of valuation differences. They also attribute the different outcomes in the AEI tests to the omission of the very richest and very poorest neighborhoods.
Jonathan Rothwell, one of the three Brookings researchers along with Andre Perry and David Harshbarger, said the conclusion reached by AEI’s researchers ignored the well documented history of racial bias in housing.
“No matter how nuanced and compelling the research is, no one can publish anything about racial bias in housing markets, without our friends Peter and Pinto insisting there is no racial bias in housing markets,” Rothwell said. “Everyone agrees that there used to be racial bias in housing markets. I don’t know when it expired.”
Mark A. Willis, a senior policy fellow at New York University’s Furman Center for Real Estate and Urban Policy, said the source of the two sets of findings might have contributed to the response each has seen. While both organizations are non-partisan, AEI, which leans more conservative, is seen as having a defined agenda, while the centrist Brookings enjoys a more neutral reputation.
Still, Willis — who is familiar with both studies but has not tested their findings — said while the Brookings report notes legitimate disparities between communities, the AEI findings demonstrate that such differences cannot solely be attributed to racial discrimination.
“The real issue here is there are differences across neighborhoods in the value of buildings that visibly look alike, maybe even technically the neighborhood characteristics look alike, but aren’t valued the same way in the market,” Willis said. “Whatever that variable is, Brookings hasn’t necessarily found that there’s bias in addition to all of the other real differences between neighborhoods.”
Setting the course or getting off track?
The two sets of findings have become endemic to the competing views of home appraisers that have emerged in recent years. On one side, those in favor of reforming the home buying process — including fair housing and racial justice advocates, along with emerging disruptors from the tech world — point to the Brookings report as a seminal moment in the current push to root out discriminatory practices on a broad scale.
“It’s been really helpful in driving the conversation forward, to help us better define what is bias and be specific about how we communicate about it, because there’s a number of different types of bias potentially in the housing process,” Kenon Chen, founder of the tech-focused appraisal management company Clear Capital, said. “That report really … did a good job of highlighting systemic concerns and how, as an industry, we can start to take a look at some of the things that are historical.”
Appraisers, meanwhile, say the Brookings findings made them a scapegoat for issues that extend beyond their remit and set them on course for enhanced regulatory scrutiny.
“What’s causing the racial wealth gap is not 80,000 rogue appraisers who are a bunch of racists and are going out and undervaluing homes based on the race of the homeowner or the buyer, but rather it’s a deeply rooted socioeconomic issue and it has everything to do with buying power and and socioeconomic status,” Jeremy Bagott, a California-based appraiser, said. “It’s not a problem that appraisers are responsible for; we’re just providing the message about the reality in the market.”
Responses to the Brookings study and other related findings include supervisory guidelines around the handling of algorithmic appraisal tools, efforts to reduce barriers to entry into the appraisal profession and greater data transparency around home valuation across census tracts.
But appraisers say other initiatives — including what some see as a lowering of the threshold for challenging an appraisal — will make it harder for them to perform their key duty of ensuring banks do not overextend themselves based on inflated asset prices.
Even those who favor reform within the profession have taken issue with the Brookings’ findings. Jonathan Miller, a New York-based appraiser who has deep concerns about the lack of diversity with the field — which is more than 90% white, mostly male and aging rapidly — said using the study as a basis for policy change put the government on the wrong track.
“There’s something wrong in the appraisal profession, and it’s that minorities are not even close to being fairly represented, but the Brookings study doesn’t connect to the appraisal industry at all,” Miller said. “Yet, that is the linchpin that began this movement. … I’m in favor of more diversity, but the Brookings’ findings are extremely misleading.”
Willis, who previously led JPMorgan Chase’s community development program, said appraisers are justified in their concerns over new policies, noting this is not the first time the profession has shouldered a heavy blame for systemic failures. The government rolled out new reforms for appraisers following both the savings and loan crisis of the 1980s and the subprime lending crisis of 2007 and 2008.
But, ultimately, Willis added, appraisers have left themselves open to such attacks by allowing bad — either malicious or incompetent — actors to enter their field and failing to diversify their ranks.
“It seems clear that the burden is on the industry to ensure that everybody is up to the same quality level,” he said. “Unless the industry polices itself better and is more diverse, it is going to remain very vulnerable to criticism.”
Rohit Chopra, director of the Consumer Financial Protection Bureau said the agency is poised to propose a rule that would “ensure that modern-day data brokers in the surveillance industry know that they cannot engage in illegal collection and sharing of our data.”
Bloomberg News
Rohit Chopra, the director of the Consumer Financial Protection Bureau, on Tuesday plans to announce from the White House a new rule that would strictly limit the types of consumer data that can be sold by businesses as part of a federal crackdown on third-party data brokers.
The CFPB plans to propose rules that would require data brokers — or any other company in the surveillance industry — be covered by the Fair Credit Reporting Act. The 1970 law strictly limits the use of credit report data from being sold for any reason other than what Congress has specified as having a “permissible purpose,” such as credit underwriting. The law prohibits the sale of data for advertising, training and artificial intelligence.
Many third-party data brokers that collect, aggregate, sell and resell personal information are not currently covered by the FCRA, which mandates that credit reporting agencies and data collectors only collect and report accurate credit information. Individuals would have the right to obtain their data from third-party brokers and dispute inaccuracies.
“The CFPB will be taking steps to ensure that modern-day data brokers in the surveillance industry know that they cannot engage in illegal collection and sharing of our data,” Chopra said in prepared remarks. “Reports about monetization of sensitive information — everything from the financial details of members of the U.S. military to lists of specific people experiencing dementia — are particularly worrisome when data is powering ‘artificial intelligence’ and other automated decision-making about our lives.”
In March, the CFPB issued a request for information to better understand data brokers’ business practices and to ensure that they are complying with federal law. The bureau plans to issue a proposed rule by first convening a panel of small businesses that will take feedback on proposals.
The CFPB already has reached out to trade groups asking for a wide range of small business experts to serve on the panel. The small business panel, required by the Small Business Regulatory Enforcement Fairness Act, is expected to release an outline of proposals under consideration and the CFPB will issue a report by year-end summarizing the feedback. The CFPB may make changes to the proposal in a final rule that is expected to be formally proposed in 2024.
One of the proposals under consideration would designate data brokers as credit reporting companies under the FCRA if they sell certain types of data including a consumer’s payment history, income or criminal records. The CFPB is considering whether to outlaw the sale of so-called “credit header data,” which is the portion of a credit report that contains an individual’s name, birth date, Social Security number, phone numbers and current and past addresses. Data brokers rely on credit header data purchased from the three main credit bureaus to create dossiers on individuals.
For the past five years, credit reporting has been the most complained-about product. Last year, 76% of the complaints submitted to the CFPB were about credit reporting and specifically inaccuracies on credit reports.
Congress passed the FCRA in response to concerns about data brokers assembling detailed dossiers about consumers and selling this information to those making employment, credit, and other decisions. The CFPB has said that citizens have little choice about whether to enter into business relationships with data brokers or whether they will be tracked but the data being collected may play a decisive role in significant life decisions such as buying a home or finding a job.
The FCRA provides a range of protections, including accuracy standards, dispute rights, and restrictions on how data can be used. Enforcement of the FCRA is split between the CFPB and the Federal Trade Commission.
Reining in data brokers has drawn bipartisan support in Congress. In April, a House Energy and Commerce subcommittee held hearings in which lawmakers heard from several experts that claimed data brokers are threatening the civil rights of individuals by selling private health and other sensitive information without individuals’ knowledge or permission. Some advocates claim data brokers sell consumer credit data to predatory marketers and scammers.
“A stunning amount of information and data is being collected on Americans — their physical health, mental health, their location, what they are buying, what they are eating,” said Cathy McMorris Rodgers, R-Wash., during the fifth hearing focused on data brokers this year. The failure of Congress to pass a federal data privacy law that would replace state regulations has bolstered calls for more regulation of data brokers.
The CFPB declined to comment on specific companies that would be swept into a new rule. Senior CFPB officials said on a call with reporters late Monday that the agency “wants to ensure that all companies are held to the same rules and consumers are protected.”
A bank capital proposal issued by the Federal Reserve, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency has many in the housing policy community concerned that revised risk weights for bank-held mortgages could further erode banks’ market share in residential mortgages.
Trade groups representing banks and various parts of the mortgage industry have come out against the rules, as have housing affordability advocates. These groups say the impact of the proposed rule changes would be felt by the housing sector more so than the banks themselves.
“In the housing sector, which has just been in a sort of boxing ring getting punched, one after another, and getting exhausted from all that’s coming at them, this one is pretty incredible,” said David Stevens, a long-time mortgage executive who now heads Mountain Lake Consulting in Virginia. “We thought the current Basel rule made sense, but this one’s going to have downstream effects that are going to be very broad in the housing system.”
The change is expected to have at least a moderate impact on banks’ willingness to originate. While banks have been steadily ceding market share to independent mortgage banks and other nonbank lenders since the subprime mortgage crisis, they still play a key role in the so-called jumbo mortgage market, which consists of loans too large to be securitized and sold to the government sponsored enterprises Fannie Mae and Freddie Mac.
“The big, traditional mortgage lending banks have largely exited the field and that’s been going on for some time. This is the next nail in the coffin,” said Edward Pinto, director of the AEI Housing Center at the American Enterprise Institute. “This nail will make it harder for banks to compete with Fannie and Freddie, generally, and then take the one market they’ve had left to themselves, the jumbo market, and make it harder to originate because of the capital requirements.”
Some policy experts say the bigger impacts could come from the second-order effects of the regulation. In particular, they point to the treatment of mortgage servicing assets — the salable right to collect fees for providing day-to-day services to mortgages — as a change that could crimp the flow of credit throughout the housing finance sector and lead to higher costs being passed along to individual households.
“With potential borrowers already facing record high interest rates, steep home prices, and supply-chain issues, increased fees and scarcity of bank lenders could be another brick in the wall stopping Americans from obtaining meaningful homeownership and wealth creation,” said Andy Duane, a lawyer with mortgage-focused law firm Polunsky Beitel Green.
The proposal, put forth by the Federal Reserve, Federal Deposit Insurance Corp. and Office of the Comptroller on the Currency, notes that the rule change could result in second-order effects on other banks, but it largely focuses on benefits that large banks could enjoy relative to smaller banks as a result of the new rules. It notes that such risks are offset by a requirement that banks adhere to both the new framework and the existing one, to ensure they do not see their regulatory capital levels dip below that of the standardized approach.
Still, the regulators are aware that the change could have unintended consequences on the mortgage industry and housing attainability. Because of this, their proposal includes several questions about the subject.
“We want to ensure that the proposal does not unduly affect mortgage lending, including mortgages to underserved borrowers,” Fed Vice Chair for Supervision Michael Barr said while introducing the proposal in an open meeting last month. He added that housing affordability was one of “several areas that I will pay close attention to and encourage thoughtful comments.”
However, the proposal dismissed the idea that the new risk weights on residential mortgages would have a material impact on bank lending in that space. Citing various policy papers, academic studies and regulatory reports, the agencies assert that the risk-weight changes would lead banks adjusting their portfolios “only by a few percentage points.”
Stevens — who served as an assistant secretary in the Department of Housing and Urban Development in the Obama administration, a commissioner for the Federal Housing Administration and president of the Mortgage Bankers Association — said he is not convinced regulators have done sufficient analysis to rule out the type of sweeping, negative implications that he and others fear. He noted that the 1,087-page proposal includes fewer than 20 pages of economic analysis.
“I just don’t think they’ve thought through the downstream effects and the lack of analysis, in terms of actual financial estimates of the implications, is really concerning,” He said. “This will be a really big change, and that’s why you see everybody up in arms and the trade groups aligned against this proposal.”
Like other components of the bank regulators’ Basel III endgame proposal, the components related to mortgages would create standardized capital rules for large banks and do away with the ability for large institutions to use internal models. It also extends these requirements to all banks with more than $100 billion of assets, rather than only the largest, global systemically important banks.
The key provision in the package of proposed rules is the use of loan-to-value, or LTV, ratios to determine risk-weights for residential mortgage exposure.
The change could allow banks to hold less capital against lower LTV mortgages, though there is some skepticism about much of a reduction in capital that change will ultimately entail, especially for GSIBs that previously relied on internal models, said Pete Mills, senior vice president of residential policy for the Mortgage Bankers Association.
“Those risk weights aren’t published, so we don’t know what they are, but they are probably lower than 50% for low-LTV products,” Mills said.
The Basel Committee’s latest regulatory accord, which was finalized in December 2017, envisions LTV ratios as a means of assigning risk weights. But Mills said many in the mortgage banking space were caught off guard by how much further U.S. regulators went beyond their global counterparts. The joint proposal from the Fed, FDIC and OCC calls for a 20 percentage point increase across all LTV bands, meaning while mortgages with LTVs below 50% are assigned a 20% risk-weight under the Basel rule, the U.S. proposal calls for a 40% risk-weight. Similarly, where the Basel framework maxes out at a 70% risk-weight for mortgages with LTVs of 100% or more, the U.S. version has a top weight of 90%.
Under the current rules, most mortgages in the U.S. are assigned a 50% risk weight, so loans with LTVs between 61% and 80% would see their capital treatment stay the same, and any mortgages with LTVs of 60% or lower would see a lower capital requirement. Loans with an LTV of 80% or higher, meanwhile, would likely see a higher capital requirement.
“For GSIBs, that’s probably an increase in capital throughout the LTV rank,” Mills said. “For the rest, it’s a higher risk weight for higher-LTV mortgages and maybe slightly lower in other bands, but, in aggregate, that’s not good for the mortgage market. It’s a higher risk weighting for most mortgages.”
Approximately 25% of first-lien mortgages held by large banks began with an LTV of 80% or higher, according to data compiled by the Federal Reserve Bank of Philadelphia. Roughly 10% have an LTV of 90% or higher, while half were 70% or lower.
Mark Calabria, former head of the Federal Housing Finance Agency, said he is not surprised by the proposed treatment of mortgages, calling it a “natural evolution” of where regulators have been moving. He added that some elements of the proposal resemble changes he oversaw at Fannie Mae and Freddie Mac in 2020.
Calabria said mortgage risk is an issue in the financial system in need of regulatory reform, but he questions the methods being considered by bank regulators.
“I worry that they’re making the problem in the system worse by driving this risk off the balance sheets of depositories, which is probably actually where it should be in the first place,” he said. “I’m not opposed to them tinkering in this space they just need to be more holistic about it.”
The proposal also notes that the new treatment of residential mortgages is aimed at preventing large banks from having an unfair advantage over smaller competitors.
“Without the adjustment relative to Basel III risk weights in this proposal, marginal funding costs on residential real estate and retail credit exposures for many large banking organizations could have been substantially lower than for smaller organizations not subject to the proposal,” the document notes. “Though the larger organizations would have still been subject to higher overall capital requirements, the lower marginal funding costs could have created a competitive disadvantage for smaller firms.”
Yet, while regulators say the proposed rules promote a level playing field, some see it giving an unfair advantage to government-backed lenders.
Pinto sees the proposal as a continuation of a decades-long trend of federal regulators putting private lenders at a disadvantage to the governmental and quasi-governmental entities. He noted that if securities from Fannie and Freddie and loans backed by the FHA and Department of Veterans Affairs, which tend to have very high LTVs, are not given the same capital treatment as private-label mortgages, the net result will be the government playing an even larger role in the mortgage market that it already plays.
Pinto said despite these government programs targeting improved affordability, their provision of easy credit only drives up the cost of housing even further. He added that he hopes regulators reverse course on their treatment of mortgages in their final rule.
“They should just back off on this entirely. It’s inappropriate,” Pinto said. “They need to look at the overall impact they’re having on the mortgage market, and the housing and the finance market, and the role of the federal government, and the fact that the federal government is getting larger and larger in its role, which is inappropriate.”
The other concern is a lower cap on mortgage servicing assets that can be reflected in a bank’s regulatory capital. The proposal would see the cap changed from 25% of Common Equity Tier 1 capital to 10%.
Mills said the capital charge for mortgage servicing rights is already “punitive” at a risk weight of 250%. By lowering the cap, he said, banks will be forced to hold an additional dollar of capital for every dollar of exposure beyond that cap. He noted that regulators had raised the cap to 25% five years ago for banks with between $100 billion and $250 billion of assets to provide some relief to large regional banks interested in that market.
If the cap is lowered, Mills said banks will be inclined to shed assets and shy away from mortgage servicing assets. Such moves would force pricing on servicing rights broadly, a trend that would ultimately lead to higher costs for borrowers.
“MSRs are going to be sold into a less liquid, less deep market, and there are consumer impacts here because MSR premiums are embedded in every mortgage note interest rate,” Mills said. “If MSR values are impacted by this significantly, that rolls downhill through the system. An opportunistic buyer might be able to buy rights at a depressed value, but that depressed value flows through to the consumer in the form of a higher interest rate.”
The proposal will be open to public comment through the end of November, after which regulators will review the input and incorporate elements of it into a final rule. Between the questions raised in the proposal, the acknowledgement by Fed and FDIC officials that the changes could hurt housing affordability, and the strong negative response to the proposal, there is optimism that the ultimate treatment of residential mortgages will be less impactful.
“Nobody seems to be pushing for this, and nobody other than the Fed seems to like it,” Calabria said. “If I was a betting man, it’s hard for me to believe that this is finalized the way it is now in terms of mortgages.”
Teresa Bryce Bazemore, President and CEO of the Federal Home Loan Bank of San Francisco, announced her intention to retire after her current contract expires in 2024. The Home Loan Bank of San Francisco came under heightened scrutiny for issuing advances to Silicon Valley Bank and Silvergate Bank before they went defunct earlier this year.
Alex Lowy
Teresa Bryce Bazemore, who held a front-row seat during the bank liquidity crisis this year as president and CEO of the Federal Home Loan Bank of San Francisco, plans to retire when her term expires in 2024, citing personal reasons.
The San Francisco bank’s board chose not to renew Bazemore’s contract after she asked to retire in 2025, though her contract expires in 2024. The board instead initiated a search for a new CEO, said Simone Lagomarsino, the board’s chairman, who also is president and CEO at Luther Burbank Savings.
Bazemore “indicated that, due to personal and other considerations, she would like to retire in March 2025,” Lagomarsino said in a press release. “As a result, and in consultation with Teresa, the board has decided to move forward with a search to identify a new CEO who will deliver long-term continuity and engaged leadership.”
The decision followed “extensive deliberation and discussion” about the Home Loan bank’s long-term goals, including “the implementation and integration of strategic changes that may arise from the ‘FHLBank System at 100’ review currently being conducted by the Federal Housing Finance Agency,” Lagomarsino said in the release. “The board recognized the critical importance of a CEO who would be engaged for the next several years to lead the organization forward and implement a vision and strategy to align with the outcome of the FHFA’s review.”
The San Francisco Home Loan Bank played a central role in the bank liquidity crisis in March, when it served as lender of next-to-last-resort to Silicon Valley Bank, which was taken over by the Federal Deposit Insurance Corp. and ultimately sold to First Citizens BancShares in Raleigh, N.C. Other major borrowers of the San Francisco Home Loan bank this year included San Francisco-based First Republic Bank, which was sold to JPMorgan Chase in May, and Silvergate Bank of La Jolla, Calif., which self-liquidated in March.
Last year, Bazemore earned $2.4 million, which included a base salary of $910,000 and other incentive compensation. When she joined the San Francisco Home Loan bank in 2021, she received a $100,000 signing bonus. Her employment agreement provides for 12 months of severance pay, equal to her base salary, plus other awards, according to the Home Loan banks’ combined financial report for 2022.
Last year, the Federal Housing Finance Agency that oversees that Home Loan bank system, launched a holistic review of the government-sponsored enterprise, its first in 90 years. Critics have questioned the system’s hybrid public-private business model and whether the banks are engaged in the primary mission of supporting housing. FHFA Director Sandra Thompson is set to issue a report with policy and congressional recommendations sometime later this year.
Separately, Fitch Ratings on Thursday downgraded certain ratings of the Federal Home Loan banks of Atlanta and Des Moines citing the “high and growing general government debt burden,” of the U.S. government. The ratings actions followed the downgrade of the U.S. to ‘AA+,’ from ‘AAA.’
The Home Loan banks are bank cooperatives that provide low-cost funding to 6,500 members including banks, insurance companies and credit unions. Created in 1932 to bolster housing during the Depression, the system incentivizes banks to buy mortgage-backed securities and agency bonds that can be pledged as collateral in exchange for liquidity.
Michael Barr, vice chair for supervision at the Federal Reserve, said in a speech Tuesday that artificial intelligence in mortgage underwriting could exacerbate racial bias if left unchecked.
Bloomberg News
The Federal Reserve’s top regulator is wary of the use of artificial intelligence in mortgage underwriting.
Speaking at the National Fair Housing Alliance’s national conference Tuesday morning, Fed Vice Chair for Supervision Michael Barr said advancements in mortgage origination technology could lead to discriminatory lending practices.
Barr called for transparency around the models used by artificial intelligence, or AI, programs. He also noted that the Fed factoring tech advancements into its bank oversight responsibilities under the Fair Housing Act and Equal Credit Opportunity Act.
“While banks are still in the early days of adopting artificial intelligence and other machine learning technologies, we are working to ensure that our supervision keeps pace,” Barr said. “Through our supervisory process, we evaluate whether firms have proper risk management and controls, including with respect to those new technologies.”
Barr’s remarks on AI supervision were part of a broader speech commemorating the 55th anniversary of the Fair Housing Act, a landmark piece of legislation prohibiting racial discrimination in housing sales and rentals.
Barr acknowledged that machine learning capabilities could be used to expand the availability of credit to prospective borrowers without credit scores. This can be done by capturing a wider array of information than what traditional credit rating agencies consider. If these programs operate at a large enough scale, he said, that could also enable them to expand credit more broadly.
Yet, he also noted that these AI programs could “perpetuate or even amplify” certain biases by drawing from data that is flawed or incomplete and thereby reach inaccurate conclusions about borrowers based on their race, color, national origin, religion, sex, familial status or disability. On the other hand, he added, inadequate technology could steer minority borrowers toward more expensive or lower quality financial products — a dynamic Barr described as “reverse redlining.”
Barr’s concerns around algorithmic bias are shared by other regulators in Washington. Consumer Financial Protection Bureau Director Rohit Chopra has been a frequent skeptic of AI-based underwriting and customer engagement. He has pushed for banks and other financial firms to exercise caution when using such technologies.
During his speech, Barr nodded to joint efforts by federal regulators to address bias in home appraisals. Last month, the Fed, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency, the CFPB and the National Credit Union Administration issued two notices of proposed rulemaking, one that would establish best practices for the use of so-called automated valuation models, or AVMS, and another that would codify how borrowers could challenge appraisals that they believe to be inaccurate.
“Deficient collateral valuations can contain inaccuracies because of errors, omissions, or discrimination that affects the value of the appraisal, and a reconsideration of value may help to properly value the real estate,” Barr said. “I am fully supportive of both these proposals because homeownership is an important way for families to build wealth, and we should give them every opportunity to share in those benefits.”
Barr also gave a brief update on regulators’ efforts to reform the Community Reinvestment Act, a 1970s-era regulation that encourages banks to lend in the underserved communities around their branches. The current push aims to modernize the act to account for the impacts of digital and mobile banking, which enable banks to serve areas well beyond their physical locations.
Barr did not say when a final rule would be proposed, but he noted that regulators are working to incorporate the suggestions and address the concerns raised by members of the public earlier this year.
“The agencies are benefitting from the thoughtful comment letters we received on the proposal, and all three agencies are hard at work finalizing the rule,” he said. “Once finalized, it is my hope and belief that this new CRA final rule, in parallel with the existing protections of the Fair Housing Act and ECOA, will support bank lending, investing, and services that meet the needs of all communities, including those that continue to be underserved.”
It is Congress that has the authority to establish a regulatory regime for the emerging crypto ecosystem — not the SEC, writes securities lawyer James Murphy.
Vitalii Vodolazskyi – stock.adob
The key sentence in the recent U.S. Supreme Court decision striking down the student loan forgiveness plan is this:
“The question here is not whether something should be done; it is who has authority to do it.”
Exactly.
The Supreme Court struck down the $500 billion student loan forgiveness plan constructed by the U.S. Department of Education because it is Congress, and not the executive branch, which has authority to fashion a comprehensive student loan forgiveness policy — if there is to be one.
This should come as no surprise to anyone.
In 2021, the speaker of the House of Representatives, Nancy Pelosi, addressed this very question and explained:
“People think that the president has the power for debt forgiveness. He does not. He can postpone. He can delay. But he does not have that power. That has to be an act of Congress.”
This same separation of powers issue is now winding its way through the courts, presenting the question of who gets to decide how the trillion-dollar cryptocurrency industry will be regulated.
Nearly everyone involved in crypto now agrees that a regulatory regime is sorely needed in the U.S.
Nobody wants another FTX — most especially those who actually invest in crypto.
So, as the Supreme Court succinctly put it, it’s “not whether something should be done; it is who has the authority to do it.”
In our constitutional system, it is Congress that has the authority to establish a regulatory regime for the emerging crypto ecosystem — not the SEC.
As Supreme Court jurisprudence shows, only Congress can decide major policy questions affecting a significant segment of our economy.
Not so long ago, Securities and Exchange Commission Chairman Gary Gensler agreed with this obvious premise.
On May 6, 2021, Chairman Gensler testified before Congress that the SEC had no authority to regulate crypto exchanges and he urged Congress to pass legislation to establish a regulatory framework for crypto exchanges.
Just as Speaker Pelosi was right about student loan forgiveness, so too was Chairman Gensler right about who has the authority to establish a regulatory framework for crypto exchanges — it’s Congress.
There are many pieces of legislation under active consideration that would establish a regulatory framework for crypto, including crypto exchanges. None has yet passed into law.
Chairman Gensler’s testimony was not controversial in 2021 because everyone understood that it would have to be Congress to fashion a regulatory regime for crypto exchanges.
But then something went horribly wrong at the SEC.
Chairman Gensler suddenly turned 180 degrees and began to proclaim in speeches that: (a) the SEC actually does have authority to regulate crypto exchanges; and (b) there is an existing regulatory framework for crypto exchanges to register with the SEC.
Both of these claims are obviously false.
Nevertheless, without any congressional authorization, Chairman Gensler went on the attack using a “regulation-by-enforcement” strategy to drive crypto exchanges and ancillary businesses out of the U.S. through ruinously expensive investigations and lawsuits.
He has proven remarkably successful in this endeavor as crypto related businesses have exited the U.S. in droves to relocate in any of dozens of other countries that have established comprehensive regulatory frameworks for crypto.
But how can this runaway head of an executive agency be stopped?
Unfortunately, options are limited, slow and enormously expensive.
The affected parties have to resort to the courts.
I have been a lawyer for over 30 years, focusing my practice on securities law and regulation.
I am confident that our court system will eventually stop the SEC’s unlawful power grab, just as it has done with the EPA on carbon emissions and the Department of Education on student loan forgiveness.
But it may be a long and rocky road ahead.
It’s worth noting that the state of West Virginia initially lost its court challenge to the massive carbon emissions policy unilaterally adopted by the EPA before eventually prevailing in the Supreme Court.
Likewise, Missouri lost its challenge to the enormous student loan forgiveness program conceived by the Secretary of Education before it ultimately prevailed on appeal.
The question then is: How much damage will Chairman Gensler leave in his wake before the courts once again affirm that our elected representatives in Congress, not unelected political appointees, have the authority and the responsibility to make the important policy decisions in this country?
Michael Barr, vice chair for supervision at the Federal Reserve, left, and Martin Gruenberg, chairman of the Federal Deposit Insurance Corp., have discussed the potential for higher bank capital requirements to drive more lending out of the banking sector, but there is a spirited debate about what — if anything — to do about it.
Bloomberg News
With new, proposed capital rules set to debut this summer, some in and around the banking sector worry that stringent requirements could inadvertently make the financial system less safe.
The key issue for certain policymakers and analysts is whether heightened regulatory standards will push more lending activity away from banks and toward less-regulated entities, such as insurance companies, debt funds and other alternative capital sources.
“Rising bank capital requirements may exacerbate the competitive dynamics that result in advantages to nonbank competitors and push additional financial activity out of the regulated banking system,” Federal Reserve Gov. Michelle Bowman said in a speech Sunday. “This shift, while possibly leaving a stronger and more resilient banking system, could create a financial system in which banks simply can’t compete in a cost-effective manner.”
Regulators are poised to unveil a string of regulatory initiatives in the coming weeks and months, including a proposal for the final implementation of the Basel III international standards, which will be focused on risk modeling approaches for the largest banks. Federal Reserve Vice Chair for Supervision Michael Barr is also conducting a “holistic capital review” aimed at assessing the interaction between various standards as well as the capitalization of the banking system as a whole. And, at some point, regulators expect to introduce reforms aimed at addressing supervisory issues exposed by the failure of Silicon Valley Bank earlier this year — those changes will center on banks with between $100 billion and $250 billion of assets.
If regulatory changes play out as expected, large banks could face higher capital charges for certain operational risks related to activities such as securities brokerage and investment advisory. Other expenses, like a requirement to purchase long-term debt — an obligation currently faced by the largest banks that could be extended to all banks above the $100 billion threshold — could increase the cost of doing business across the board.
Greg Lyons, a partner at the law firm Debevoise & Plimpton, said activities like credit to middle market corporations, in which banks are already going head to head with private funds more frequently, are prime candidates for migrating to the nonbank sector. Meanwhile, access to other, less profitable types of loans, such as auto and commercial real estate, could dwindle if banks have to pull back.
“[Regulators] are basically telling banks that operational costs and capital are going to go up significantly, but unless merger approvals are easier to obtain, they can’t grow in a way to get economies of scale to offset that,” Lyons said. “So, the only practical option left for many is to reduce their balance sheet. All that does is drive more business out of the regional and super regional banking sector.”
The question of whether theoretical economic or financial stability implications should shape regulatory policies is a philosophical one on which Washington’s regulatory officials have a range of opinions.
Similarly, Federal Deposit Insurance Corp. Chair Martin Gruenberg has also acknowledged that the nonbank sector poses a significant threat to financial stability — in both the U.S. and internationally — but last week he argued that lighter touch regulation on banks is not the solution. Instead, he called for greater oversight of nonbank entities.
“It’s a key risk area that requires great attention, but it requires great attention on its own terms,” Gruenberg said during the question and answer portion of a speaking engagement at the Peterson Institute for International Economics last week. “We need to consider the means of addressing it, but this should not be, in a sense, a zero-sum game with the banking system. I don’t think we want to compromise appropriate capital requirements for the banks because of that concern.”
Gruenberg said mitigating the stability threats of nonbanks should be left to the Financial Stability Oversight Council, of which he is a voting member. Barr, another voting member of council, has also suggested that FSOC should explore designating more firms and business activities as systemically important.
But some see this two-track approach to regulation as shortsighted.
“It’s just a game of pass the potato,” Karen Petrou, managing partner of Federal Financial Analytics, said. “That’s an analytically unfortunate approach to thinking about capital requirements.”
Petrou said one of the goals of regulatory reform should be to reduce unintended consequences. While anticipating those consequences can be difficult, she said risk moving outside the banking system is a well-established reaction to higher regulatory requirements. She pointed to the residential mortgage market, which has been dominated by nonbanks since the reforms implemented after the subprime lending crisis of 2008.
Once a strong proponent of Barr’s holistic capital review as means for addressing overlaps and oversights in the current regulatory framework, Petrou said she is now skeptical the exercise can achieve that goal. Given the “piecemeal” changes that have been discussed since this spring’s run of bank failures — including amending the treatment of accumulated other comprehensive income and the introduction of so-called “reverse stress testing” — Petrou worries the net result of the review will be an entirely different regulatory regime.
“The idea was a very constructive one, but I think it will be extremely hard to pull off if by the time we start thinking holistically we’ve redesigned the system so incrementally that it’s operating in a wholly new way,” she said.
Others see the issue of nonbank risk in a very different light. Dennis Kelleher, head of the advocacy group Better Markets, argues that if higher capital requirements lead to risk migrating out of the banking system, it would be a win for financial stability.
Kelleher said there is little evidence that lending is moving from banks into systemically important nonbanks. Instead, he said, most of this activity is being absorbed by middle market firms whose failures would have little impact on the broader economy. He pointed to the bankruptcy of the derivatives firm MF Global in 2011 as an example of a large nonbank being able to fail with “no collateral consequences and no systemic consequences.”
“To the extent lending is being provided for higher-risk activities that the banks no longer participate in is a good thing, because it’s a migration of risk from systemically significant banks to non-systemically significant nonbanks,” Kelleher said. “Therefore the threat to the financial system in the economy has actually been reduced.”
Kelleher said nonbanks becoming so large that they are systemically important is a separate issue that needs its own solution.
“Yes, systemically significant nonbanks are not adequately regulated,” he said. “The answer is not to under regulate banks. It’s to properly regulate nonbanks.”
Michael Barr, vice chair for supervision at the Federal Reserve, left, and Martin Gruenberg, chairman of the Federal Deposit Insurance Corp., at a House Financial Services Committee earlier this year. Fed chair Jerome Powell and Gruenberg said last week that Basel III endgame rules will be proposed shortly, but will take months or even years to implement. Banks may move more quickly, however.
Bloomberg News
As federal regulators prepare to propose new capital standards this summer, a debate has emerged over their timing and potential impact on the real economy
In response, bank advocacy groups and some lawmakers have argued that rolling out new requirements — especially those that increase capital obligations — will have a swift impact on bank balance sheets and their willingness to lend. Such a shift, they warn, could put further strain on an already weakening economy.
“The risk that capital requirements start to take effect and start to crimp lending activity at a time when we’re facing economic headwinds is significant, in my opinion, and only continues to grow as the data makes itself evident,” said Sean Campbell, chief economist and head of policy research at the Financial Services Forum, a trade group representing the largest banks in the country.
Regulators waved off such concerns last week, noting that long-term regulatory concerns outweigh near-term economic uncertainties. Powell said banks will have “some years” to adjust to new policies, allowing them to do so with minimal disruption to their lending activities. Gruenberg said holding more capital could better position banks to support the economy in a downturn.
“History has proven that insufficient capital can lead to harmful economic results when banks are unable to provide financial services to households and businesses, as occurred during the 2008 financial crisis,” Gruenberg said during a speech last week. “Ensuring adequate amounts of bank capital provides a long-term benefit to the economy by enabling banks to play a counter-cyclical role during an economic downturn rather than a pro-cyclical one.”
By the letter of the law, regulatory change is a slow process. Once the Fed, FDIC and Office of the Comptroller of the Currency release their proposal for the Basel III endgame sometime in the coming weeks, it will be open to months of public review and commentary. After that, regulators will spend several more months incorporating that feedback before releasing — and ultimately voting on — a final rule. Once adopted, the rule’s requirements will likely be phased in gradually over several years.
But, in practice, the adaptation process can play out much more quickly. A working paper published by the Federal Reserve Bank of Cleveland last year notes that many mid-sized banks changed their balance sheets to accommodate for the first installment of the Basel III framework years before they were required to by law — in some instances, changes were made before regulators finalized the language of the rule.
Jan-Peter Siedlarek, a research economist at the Cleveland Fed and one of the author’s of the paper, said his study — which examined both small banks with $10 billion of assets or less and mid-tier banks with between $10 billion and $50 billion, just below the stress testing cutoff — found that banks that had ample warning that changes were coming their way, made those changes as quickly as they could.
“The key lesson that we want to get across in this paper is that, in a regulatory rulemaking process, the announcement of rules already matters. It’s already an important part of what both financial markets but also the regulated entities are looking at,” Siedlarek told American Banker.
Karen Petrou, managing partner at Federal Financial Analytics, said the process of investors responding to regulatory changes and banks responding to their investors has become a well documented cycle, especially under the post-Dodd-Frank regulatory regime.
“Investors are priced on a forward-looking basis, and they immediately run the numbers and price the new capital rules or new stress scenarios into their cost of equity,” Petrou said. “That immediately changes the bank’s strategic outlook. We know that because we see it year in, year out.”
Campbell noted that in addition to pressure from investors, bank’s also push one another to adopt policies promptly to avoid falling behind the pack.
“The competitive dynamic is such that you do not want to ever be the last bank to comply with changes to capital requirements, liquidity requirements or any other type of regulatory requirements,” he said. “Complying quickly sends a strong signal to the market about your financial wherewithal, your strength and your resiliency, so there’s a drive to comply as quickly as possible.”
Powell, who testified in front of the House Financial Services and Senate Banking committees last week, acknowledged that some banks might already be adjusting their balance sheet in anticipation of regulatory changes. He also noted that he would factor in the potential economic implications of capital changes when voting this summer’s proposal.
“Higher capital, you know, the benefit of it, of course, is to have stronger banks that can lend and maybe survive more kinds of crisis environments, but, you know, there are costs as well,” Powell said in the House. “I think it’s going to be, as always, a question of weighing and balancing those costs. That’s what I’ll be thinking about.”
While pulling back on lending is one way for banks to raise capital, other options are less damaging to the real economy. Many banks are already increasing their capital holdings in anticipation of both a recession and more stringent regulations, according to an analyst note from Autonomous Research last week, and doing so “organically,” meaning they are curbing stock buybacks and tempering expectations around dividends.
Some policy experts believe this is the most sensible course for all banks to take, if higher capital requirements come to pass. Dennis Kelleher, head of the consumer advocacy group Better Markets, called the argument that increasing capital requirements will hurt the availability of credit a “smoke screen.”
“The only people who are really hurt by higher capital are bank executives. The lower the capital, the higher the leverage, and the higher their compensation,” Kelleher said. “Their compensation is driven by return on equity, and equity is amplified by leverage. It’s just that simple.”
There are also questions about how quickly banks will be able to adapt to the specific changes set to be introduced this summer.
Patrick Haggerty, senior director at the advisory firm Klaros Group, said the nature of the Basel III endgame rules — many of which are focused on internal risk modeling — are nuanced and complex. Because of this, he said, banks will not be able to implement snap responses.
“They’re going to need to put a project team together and spend a period of months trying to get their arms around what is changing and how it flows through to their regulatory reporting and the technology needed to run the calculations,” Haggerty said. “That work is very expensive and resource-heavy. I can’t imagine the banks are going to start to undertake that based on a proposal.”
Siedlarek also noted that unlike the first phase of the Basel III framework, which had been well forecast based on its implementation in other jurisdictions around the world in a time of relative stability, the current proposals are subject to a higher degree of uncertainty. The failures of Silicon Valley Bank, Signature Bank and First Republic Bank this spring have raised a unique set of challenges with which the industry and regulators are still grappling.
“What happened in March was a change in the environment … the world before March and after March, I think they’re quite different as to the extent to which banks are looking at their own industry and how they’re going to position themselves,” he said. “So, I do see the parallels [between the regulatory processes] but I also know differences, and so it’s hard to see what’s there.”
“If you want to protect middle class borrowers in your district from a new tax, you will support this bill,” Rep. Patrick McHenry, R.-N.C., chairman of the House Financial Services Committee said Friday.
The bill aims to roll back the latest update of grids Fannie Mae and Freddie Mac use to give lower-income borrowers breaks with some cross-subsidizing increases for those more well off, while still ensuring risk-based pricing is maintained.
Supporters like Rep. Patrick McHenry, R.-N.C., chairman of the House Financial Services Committee, said they felt the regulator of the government-sponsored enterprises went too far in raising prices for higher-income borrowers and giving those with less wealth breaks.
“If you want to protect middle class borrowers in your district from a new tax, you will support this bill,” McHenry said Friday.
He and other supporters have shown particular concern that in some cases, the latest price breaks have gone to lower-income borrowers further down the credit spectrum than those receiving hikes.
Opponents of the bill have noted that while there have been relative increases for higher-income borrowers and some decreases for those with less wealth, those in the latter category generally are still paying more than in the former.
Reversing the small breaks for people with lower income would be harder on them than the increases would be on their wealthier counterparts, according to a letter Americans for Financial Reform recently sent to McHenry and Maxine Waters, D.-Calif., ranking member of the Committee.
“The bill’s title is ironic because it would, in fact, make mortgages more expensive for many middle-class American families,” AFR said in the letter.
The price changes have on a net basis increased fees overall in line with directives aimed at rebuilding capital at the GSEs.
Whether the legislation has enough momentum to get backing from both chambers of Congress in a situation where the House is narrowly controlled by Republicans and the Senate is dominated by a slim majority of Democrats remains to be seen.
WASHINGTON — House Democrats raised concerns with Treasury Secretary Janet Yellen Tuesday about whether invoking the systemic risk exception in Silicon Valley Bank and Signature Bank’s failures was the right call.
Rep. Bill Foster, D-Ill., expressed some concern that regulators ultimately resorted to selling First Republic Bank to the already largest U.S. bank — JPMorgan Chase.
“When resolving failed banks, there can sometimes be a tension between lowest-cost resolution and the bipartisan desire to discourage further bank consolidation into a smaller number of very large banks,” he noted.
First Republic Bank was seized by regulators and sold to JPMorgan Chase on May 1, a move designated as the least-cost option by the FDIC. The acquisition of First Republic Bank by JPMorgan Chase still caused a then-estimated $13 billion hit to the Deposit Insurance Fund, inflated the balance sheet of what was already the country’s largest bank.
As Yellen noted Tuesday, banks holding more than 10% of total uninsured deposits — like JPMorgan — are generally not permitted to acquire other banks under the Riegle-Neal Act of 1994. However, this prohibition has an exception, allowing firms above the 10% limit to acquire banks which are failing if necessary to prevent crises and maintain banking stability.
Rep. Stephen Lynch, D-Mass., asked whether the biggest banks were ultimately the best suited to absorb another bank that is failing or in receivership. Yellen noted that, ultimately, the winning bidder provided the least-costly deal regardless of how large they may be.
“When the FDIC resolves a bank, it is required by law to take the best offer it gets,” Yellen said. “In this case, it was JPMorgan Chase.”
Rep. Josh Gottheimer, D-N.J., questioned whether bigger banks may have had an advantage over smaller firms in the bidding process for First Republic.
“In First Republic’s receivership, I’m concerned that the largest banks were given preference in the bidding process, just enabling the biggest banks to grow even bigger,” he said. “My understanding is that the FDIC kept certain regional banks from even bidding on First Republic.”
Democrats also inquired about why Silicon Valley Bank and Signature Bank were granted systemic risk exceptions while First Republic did not. Rep. Lynch said regulators’ willingness to invoke a systemic risk exception this year could undermine the original statutory intent of least cost resolution if the exception becomes the rule in practice.
“The problem that I see is that the least-cost resolution preference was meant to lower the costs of resolution and it’s hard for me to imagine a similar situation ever arising where a systemic risk exception would not apply,” he told Yellen. “I’m just wondering if this exception has swallowed the rule.”
Yellen pushed back, citing past instances where regulators adhered to least-cost resolutions, including during the 2008 crisis and recently with the failure of First Republic Bank.
“Hundreds of banks failed in the aftermath of the global financial crisis and the FDIC resolved most of them and they used the least cost method of resolution. This is a very unusual situation where this exception had to be invoked,” she insisted. “First Republic was resolved, and it was also done in a least-cost resolution.”
The Secretary also weighed in on ongoing debates in Congress like digital asset regulation. When asked by Gottheimer where she sees holes within the crypto regulation space, Yellen said she believed Congress should consider regulating non-security crypto and stablecoins.
“One hole pertains to the supervision of spot-markets, where digital assets are not regarded as securities — so there needs to be regulatory authority there,” Yellen said. “Stablecoins are a type of digital asset that really requires a full-blown federal regulatory framework, and I think this is an area where congressional legislation is appropriate”
Rep. Brad Sherman, D-Calif., refuted the idea that crypto needs any new framework at all, concurring with the view of Securities and Exchange Commission chair Gary Gensler that most cryptocurrencies are securities.
“Chair [Hill] talked about crypto and said we need a regulatory scheme,” he said. “I want to say, we have a regulatory scheme, we have the securities laws and thank God Gensler is enforcing them.
After the collapse of Silicon Valley Bank, the public discourse has been brimming with hindsight advice on what regulators and lawmakers have missed. Yet nobody is talking about a major trend that is injecting future risk into the financial system: Big Tech’s entry into banking. Dangers are growing exponentially with the rise of decentralized finance (DeFi), but defining what tech titans should be allowed to do is tricky.
Over the last years tech giants have been racing toward financial services. Apple, Alphabet (Google’s parent company), Amazon and Meta (Facebook’s parent company) have all leaped into the payments market. Some partner with licensed banks to offer credit, while Amazon has even entered the corporate lending business. In perhaps the most ambitious initiative yet, Facebook led a group of corporations that attempted to issue a global super-currency far away from the reach of central banks. And though it eventually failed, there are already new plans to run money in the metaverse.
If you wonder how deep Big Tech can get into banking look to China. WeChat Pay and Alipay have long since dethroned credit card schemes and other incumbents. Alibaba’s interest-bearing micro-savings tool Yu’e Bao became the world’s largest money market fund in 2019. Tencent runs a licensed virtual bank together with traditional finance players. Examples abound.
Most of these forays went hand in hand with crucial innovation such as mobile payments or the proliferation of open banking. They slashed costs for consumers, boosted financial inclusion and enhanced usability. Yet these advances are also fraught with dangers.
Data privacy is a big one. Monopolistic tendencies are another. These are issues hotly debated by politicians across the globe, but what often goes unnoticed is the systemic risk Big Tech’s entry injects into the financial system.
TheInternational Monetary Fund, theFinancial Stability Board and theBank for International Settlements have all warned of the ensuing cross-sectoral, cross-border risks. Laws are not yet ready to let tech tycoons control the arteries of the global economy. And as the age of decentralized finance unfurls, the dangers are put under a magnifying glass.
While projects such as Apple or Google Pay were confined to one layer, the triumphal march of blockchain technology and digital assets lets Big Tech compete on the level of assets, settlements, gateways and applications. Facebook’s aforementioned digital currency, called Libra, is a case in point. Had it been successful, Facebook would have had a say in the issuance of the asset, the blockchain on which settlement occurred and the wallet by which users manage their money.
Digital assets are no isolated space anymore. Increasingly, real-life assets are merging with on-chain ones. This interconnectedness means that contagion can easily spread from the unregulated DeFi space to the traditional financial system.
Tech titans are already at the brink of turning into shadow banks. And if they are honest about achieving their visions, say of building the metaverse, then they will inevitably have to put their weight behind DeFi as well.
So how does all this trickle down to concrete policies? The first thing is to put competition on an equal footing, allowing technology giants, banks and fintechs to compete fairly in all areas of tomorrow’s world of finance. Laws cannot block one group from tinkering with crypto assets while giving another free rein. On- and off-chain assets will melt together, whether regulators like it or not. It is better to pen the rules early on than to sleepwalk into an inevitable future.
Unfortunately,some lawmakers are sprinting in the opposite direction. Rather than bringing the increasing DeFi activity onto regulated turf, they want to bar banks from even touching digital assets, hence leaving it to unregulated entities including Big Tech. But there is more to do.
Breaking up tech titans, as some politicians suggest, is not a viable option. Neither is banning them from financial services. Legislation such as the Keep Big Tech out of Finance Act would rob the banking sector of much-welcome innovation and competition. Yet while data giants are innovation powerhouses, they must not enjoy preferential treatment and they must not pile up risks unnoticed. The balancing act can only succeed if today’s approach of activity-based regulation yields to an entity-based one. It is not sufficient that tech titans must solely abide by isolated rules that govern, for example, payments or selling insurance. Due to their clout, tech goliaths must be designated as critical infrastructure providers and as such be regulated on the corporate level just like traditional banks, who have to abide by rules on capital requirements, corporate governance and reporting, as well as numerous restrictions on activities and exposures.
Furthermore, entity-based regulation impacts a company’s risk calculation. If regulated entities break the rules, they face losing the license to operate, not simply fines. “We’re sorry and we’re working on a solution” should not be an acceptable answer for companies dealing with data security and most certainly not for those managing money. Hence, activity-based rules can only be a supplement, not a substitute, for regulating systemically important organizations.
There will be those who argue that technology giants still make up a comparably small fraction of the financial system, yet we have seen that Big Tech is silent about its ambitions all the way up to a big bang announcement. Think Libra or Apple Pay. Due to their unparalleled consumer access, financial resources and technological know-how, these forays can upend a market overnight. And due to Big Tech’s nature of global and cross-industry operations this risk could spread through the world economy like a wildfire. Regulators and lawmakers would do well to act before another crisis ensues.
Federal Reserve vice chair for supervision Michael Barr, left, is joined by Federal Deposit Insurance Corp. chair Martin Gruenberg and Treasury under secretary for domestic finance Nellie Liang in the House Financial Services Committee earlier this month. Barr has hinted that regulators could avail themselves of so-called Pillar 2 provisions in the Basel III accords to put heightened supervisory pressure on banks in the wake of a string of bank failures this spring.
Bloomberg News
Regulatory changes are coming to the Federal Reserve in response to this spring’s three large bank failures, and while some will take years to hash out, others can be implemented much more quickly.
For an indication of what first order changes might look like, regulatory experts and analysts say banks should look to a provision of the Basel Committee on Banking Supervision’s international framework known as Pillar 2.
“In Pillar 2, there’s a couple of really key things that regulators already can use and should have been using for decades,” said Mayra Rodriguez Valladares, managing principal of the consultancy MRV Associates.
Pillar 2 was first introduced in the second iteration of the Basel framework, known as Basel II, which was adopted by U.S. regulators in 2007. While Pillar 1 of the framework set minimum capital requirements for participating regulatory agencies, Pillar 2 established the ability for supervisors to address issues within individual banks through other means, including applying additional capital requirements to offset specific risks.
“Pillar 1 is a rule,” David Zaring, professor of legal studies and business ethics at the University of Pennsylvania’s Wharton School of Business, said. “Pillar 2 is a license for regulators to go beyond the requirements of that rule.”
Fed Vice Chair for Supervision Michael Barr has noted that some post-crisis regulatory reforms — including long-term debt requirements and the treatment of unrealized gains and losses on held-to-maturity bonds — will require yearslong notice and comment rulemaking processes. Barr is also conducting a “holistic review” of capital requirements and has indicated that the overall level of equity in the banking system could be higher.
But, Barr has also emphasized that the supervisors have unused tools at their disposal. He has not invoked the Basel framework by name, but experts say his commentary on how to improve the “speed, force and agility” of the Fed’s bank oversight reflects elements of Pillar 2.
“Today, for example, the Federal Reserve generally does not require additional capital or liquidity beyond regulatory requirements for a bank with inadequate capital planning, liquidity risk management, or governance and controls,” Barr said in his written testimony to Congress earlier this month. “I believe that needs to change in appropriate cases. Higher capital or liquidity requirements can serve as an important safeguard until risk controls improve, and they can focus management’s attention on the most critical issues.”
Adam Gilbert, senior global regulatory advisor in PricewaterhouseCoopers’ Financial Services Risk and Regulatory Practice, said Barr’s remarks to Congress and his report on the failure of Silicon Valley Bank last month should be viewed as a warning to banks that the Fed has other tools at its disposal and its not afraid to use them.
“It’s a way of saying, ‘Look, we have other levers to pull if we’re not comfortable with the way you’re managing,’” Gilbert said. “And capital is one.”
The Fed’s ability to issue capital requirements as part of its supervisory regime likely predates Pillar 2, policy experts say, as its general safety and soundness authorities were broad before the Basel Committee issued its first accord in 1988.
Meanwhile, other Basel members have gone a different way. Zaring said regulators in the U.K. have taken a more “clubby,” principle-based approach to supervision, rather than rule-based regime in the U.S.
“For better or worse,” he said, “Pillar 2 permits different approaches.”
In Europe, supervisors regularly issue firm-level capital requirements based on qualitative concerns about capital planning, risk management, governance and other factors. Chen Xu, a regulatory lawyer with firm Debevoise & Plimpton said he expects the Fed to move more in this direction after the failures of Silicon Valley Bank, Signature Bank and First Republic Bank.
“There’s nothing stopping the U.S. from taking a more European approach to supervision,” Xu said. “Barr, in his report, signals the possibility of mandatory triggers based on more qualitative factors. So, that’s what you might see in the U.S. and it wouldn’t necessarily require rulemaking depending on the nature of the consequences. But even if it does, it’s certainly within the Fed’s statutory powers to pass those types of regulations.”
Karen Petrou, managing partner of Federal Financial Analytics, said Pillar 2 was created to address safety and soundness concerns that are difficult to control uniformly via top-down, standardized capital or liquidity requirements. It grants supervisors broad jurisdiction over concerns not explicitly addressed in Pillar 1 capital framework — namely credit risk, market risk and operational risk.
“When the Basel Committee was figuring out how to handle interest rate risk in the express capital standards, they said supervisors and regulators need to do this themselves, either by express interest rate risk capital requirements suitable for their jurisdiction or supervision,” Petrou said. “Same thing with sovereign risk concentrations and a number of other governance issues. When regulators issue core principles for bank governance, those are Pillar 2 standards.”
Some regulatory and supervisory practices at the Fed already fall under Pillar 2, including its stress testing regime and resolution requirements for large banks. But analysts say some under-utilized provisions of the law are likely to be revisited.
Rodriguez Valladares pointed to the Internal Capital Adequacy Assessment Process, or ICAAP, provision of Pillar 2, which sets standards on how regulators should oversee internal stress testing at the banks they supervise. In accordance with ICAAP, she said, the Fed could exercise more control over how banks measure certain risk factors, rather than leaving it up to each individual institution.
Pillar 2 also directs supervisors to make sure banks remain sufficiently above minimum capital and liquidity ratios based on certain risks, Rodriguez Valladares said, noting that the Fed could use it to create more uniform standards for modeling risks, such as rising interest rates.
“There’s definitely room for things to be asked for under Pillar 2,” she said. “You don’t have to go through some huge notice [of] proposed rulemaking.”
Some in and around the banking sector see a risk in drifting too far away from the Fed’s rules-based tradition for capital requirements. Gilbert said the Fed should have clear policies for when supervisors can force a bank to increase capital and how those requirements can be lifted.
“If you’re going to do something like that, you need to be transparent about how it’s going to be captured, how it’s going to be measured, how it’s going to be calculated and how do I get out of it?” Gilbert said. “Is it a roach motel, where I can get into higher capital requirements idiosyncratically, but I can’t get out?”
Greg Lyons, a partner at Debevoise & Plimpton, said if the Fed takes a more discretionary stance on its capital and regulatory regime, it could lead to uncertainty in the banking industry at a time when the sector can ill afford it.
“It’s trading off consistency for an ability to find more issues on a particular basis,” Lyons said. “I worry a little bit about that because these examiners are human beings, after all. I worry there’ll be more pressure to actually find things and raise issues just to ensure people aren’t criticized afterwards.”
A vote Thursday by the New York City Banking Commission means that KeyBank and Capital One won’t receive municipal deposits from the city for up to two years.
Bloomberg
The New York City Banking Commission voted Thursday to stop depositing city funds at Capital One Bank and KeyBank, saying that the banks failed to meet a requirement that they document their efforts to combat discrimination in lending and employment.
As a result of the 3-0 vote, Capital One and Key won’t receive new municipal deposits from New York City for up to two years. They also won’t be allowed to renew contracts or enter into new agreements with the city during the suspension.
Capital One held $7.2 million in New York City deposits across 108 accounts at the end of April, while KeyBank held $10 million across three accounts, according to a statement from the city’s banking commission following a public hearing Thursday.
The two banks “outright refused” to submit required certifications, which demonstrated a lack of effort to “root out discrimination,” the banking commission’s statement said.
A KeyBank spokesperson said Thursday that the bank provided the required information to the New York City Banking Commission.
“This is a misunderstanding and we look forward to clarifying this issue with the Banking Commission,” the spokesperson said in an email.
The KeyBank spokesperson also denied discrimination in any of the bank’s operations and said that the bank does not currently hold deposits with the City of New York.
A Capital One spokesperson said in an email that the McLean, Virginia-based lender prohibits discrimination against employees and clients, and that its submission to New York City officials was “consistent” with what it submitted in previous years.
In February, New York City tightened its rules for banks that want to receive municipal deposits. The new rules include a requirement that banks provide details about their anti-discriminatory lending and employment practices.
“Banks seeking to do business with New York City must demonstrate that they will be responsible managers of public funds and responsible actors in our communities,” Comptroller Brad Lander, who is a member of the New York City Banking Commission, said in a statement.
“KeyBank and Capital One have atrocious track records of not just under-serving but actively harming the interests of low-wealth communities and people of color,” Jesse Van Tol, president and CEO of the National Community Reinvestment Coalition, said in a press release.
During Thursday’s meeting, Lander also voted against making three other banks — Wells Fargo, PNC Bank and International Finance Bank — eligible to receive the city’s deposits.
Lander accused those three banks of failing to prevent discrimination. But he was not joined by the two other members of the Banking Commission — Deputy Comptroller for Policy Annie Levers and Tonya Jenerette, designee to the commission for Mayor Eric Adams — and the three banks were certified to receive New York City deposits.
A Wells Fargo spokesperson said the San Francisco-based bank values its relationship with New York City. “We are ready to continue serving its needs today and well into the future,” the Wells spokesperson said in an email.
Spokespeople for PNC and International Finance Bank did not respond to requests for comment.
During Thursday’s hearing, the banking commission also voted unanimously to certify 23 other banks to receive city deposits over the next two years.
The hearing was the first time that the city allowed public comments about its designation process. Residents and activists who attended spoke out against banks that were seeking to hold municipal deposits, calling on city officials to instead establish a public bank.
Allowing public comments is a “key first step toward establishing a public bank to hold city deposits and reinvest in communities,” Andy Morrison, associate director of the New Economy Project, said during the hearing.
“We urge the commission to use the full extent of its authority to ensure that public dollars work for the public good,” Morrison said.
Other speakers criticized banks for contributing to climate change, and for providing financing for unfair housing practices.
Alice Hu, senior climate campaigner at New York Communities for Change, pointed to banks’ loans to oil companies, saying that extreme weather events due to climate change impact lower-income New Yorkers “first and worst.”
Barika Williams, executive director at the Association for the Neighborhood & Housing Development, urged city officials to apply further scrutiny in granting deposit designations to banks.
“There must be additional efforts taken to deepen community engagement,” Williams said during the hearing. “[Banks’] ability to hold and profit from New Yorkers’ hard-earned city deposits should be a privilege, not a right, and one they should be required to earn.”
Michael Roffler, former chief executive officer of First Republic Bank, testified before the House Financial Services Committee Wednesday. Republicans and Democrats alike excoriated the failed bank CEOs for their mismanagement that led to their banks’ failures.
Bloomberg News
WASHINGTON — Former Silicon Valley Bank CEO Greg Becker continued to take heat from both sides of the aisle in his second — and last — day of Congressional testimony.
Becker was joined in the House Financial Services Committee’s joint hearing between the Subcommittees on Financial Institutions and Monetary Policy and Oversight and Investigations by Signature Bank founder Scott Shay and former First Republic CEO Michael Roffler. Shay appeared alongside Becker on Tuesday before the Senate Banking Committee, while this was Roffler’s first time speaking publicly after First Republic’s failure.
Roffler blamed the collapse of First Republic on a lack of confidence sparked by the failure of Silicon Valley Bank and Signature Bank.
“While First Republic understood and disclosed the earnings risks we were facing in 2023, we could not have anticipated that Silicon Valley Bank and Signature Bank would fail, or that the failure of those banks would trigger substantial deposit outflows at our bank,” he said. “Instead of dealing with temporary decreased earnings due to interest rate pressures, First Republic was contaminated overnight by the contagion that spread from the unprecedented failures of two regional banks.”
Most lawmakers laid most of the blame for the regional banking turmoil on Silicon Valley Bank. But while Becker fielded bipartisan attacks on his compensation, particularly his bonuses, in Tuesday’s Senate hearing, Republican lawmakers appeared more interested in questioning the former CEO about Silicon Valley Bank’s interactions with the Federal Reserve, particularly the San Francisco Fed.
“We are not here to defend management at any of the banks that failed or to put anyone on trial for prosecution,” said Rep. Andy Barr, R-Ky., the chairman of the financial services subcommittee. “In looking at the recent bank failures and the continued turbulence in our banking system, it is important to acknowledge that the bank failures did not occur in a macroeconomic vacuum.”
Becker, in particular, took the brunt of lawmaker anger. His bank was the first to fail, and the high share of uninsured deposits and lack of hedging against interest rate risk took heavy criticism from lawmakers.
“Such poor mismanagement, so reckless,” said Rep. Ann Wagner, R-Mo. “I’m just disgusted.”
The ire came from both sides of the aisle.
“I think you’re going to go down in history as absolutely being the most irresponsible leader of a bank in the history of this country,” said Rep. David Scott, D-Ga. to Becker.
Roffler said that the federal government should consider changes to the deposit insurance system. He, along with Shay, spoke about the days following the failure of Silicon Valley Bank, where they tried to calm panicked investors who they said wanted to pull their money and put it in too-big-to-fail banks.
The Federal Deposit Insurance Corp., has released a report suggesting that Congress look at expanding deposit insurance in some instances, but the measure would require both sides of Congress to come together on the issue — a far fetched wish in the midst of a deeply entrenched partisan divide.
Roffler said that changes to deposit insurance system could help “calm the waters”
“At the end of the day, when the panic sets in, it’s really hard to regain confidence,” Roffler said.
The Consumer Financial Protection Bureau has appealed a Fifth Circuit Court of Appeals ruling, which found that its funding structure was unconstitutional, to the Supreme Court.
Joshua Roberts/Bloomberg
In a brief filed Monday with the U.S. Supreme Court, more than 140 current and former Democratic lawmakers defended the constitutionality of the Consumer Financial Protection Bureau’s funding structure.
The legislators, who include key architects of the 2010 law that established the CFPB, urged the Supreme Court to overturn a high-stakes ruling last year by the 5th U.S. Circuit Court of Appeals. The appeals court found that the bureau’s funding, which comes from a portion of the Federal Reserve’s earnings, violates the Constitution’s separation of powers doctrine.
In their friend-of-the-court brief, the Democratic lawmakers argued that the CFPB’s funding structure aligns with how Congress wielded its appropriations powers in the early years of the United States. That kind of originalist argument has long been popular with conservative jurists.
The legislators wrote that it has been routine since 1789 for Congress to fund programs through assessments, fees and other agency revenues.
“By appropriating funds on a standing basis, rather than year by year, Congress matched the CFPB’s funding structure to the approach that it had already determined effective for other financial regulators, some going back over 150 years — but imposed more constraints on the CFPB,” the Democratic lawmakers wrote.
The brief cited four ways in which the CFPB is subject to greater constraints, or more oversight, than the Office of the Comptroller of the Currency. Like the CFPB, the OCC is not funded through the annual congressional appropriations process.
But the CFPB, unlike the OCC, is subject to an annual dollar limit on its budget, the Democratic lawmakers noted. And CFPB regulations are subject to a potential veto by the Financial Stability Oversight Council, which is not the case for OCC regulations.
“Congress’s long-exercised authority to structure appropriations as it sees fit to solve a wide array of national problems is as crucial now as it was at the Founding,” the Democratic lawmakers wrote.
In February, the Supreme Court agreed to hear the CFPB’s appeal of the 5th Circuit’s ruling. The appeals court’s decision came in a case filed back in 2018 by a payday lending trade group, which sought to invalidate a CFPB rule that put restrictions on small-dollar consumer loans.
If the Supreme Court upholds the 5th Circuit’s ruling, the CFPB could be subjected to the annual appropriations process, which can result in fluctuating budgets depending on the partisan makeup of Congress. That would be an outcome that Democratic members of Congress have long sought to avoid.
The Democratic lawmakers who signed the court brief include Senate Majority Leader Chuck Schumer, House Minority Leader Hakeem Jeffries, Senate Banking Committee Chair Sherrod Brown and Rep. Maxine Waters, the top Democrat on the House Financial Services Committee.
Other signers included the two namesakes of the law that created the CFPB — former Sen. Christopher Dodd and former Rep. Barney Frank.
Federal Reserve Gov. Michelle Bowman said in a speech Friday in Frankfurt, Germany that calls for “fundamental” reforms in the banking system following the collapse of Silicon Valley Bank, Signature Bank and First Republic Bank “are incompatible with the fundamental strength of the banking system.”
“This would be a logical next step in holding ourselves accountable and would help to eliminate the doubts that may naturally accompany any self-assessment prepared and reviewed by a single member of the Board of Governors,” Bowman said in a speech Friday morning during a closed event hosted by the Program on International Financial Systems in Frankfurt, Germany.
Bowman said the bank runs that toppled Silicon Valley Bank, Signature Bank and First Republic Bank were caused by poor bank management and insufficient supervisory oversight. Because of this, she said, the Fed should focus its efforts on ensuring its supervisors identify critical risks within banks and take the appropriate steps to compel bank executives to address them.
She also supported targeted changes to regulation if further review identifies specific shortcomings, noting deposit insurance and treatment of uninsured deposits as potential areas of change. But she said that the banking system is well capitalized and any changes to standards should be capital-neutral, arguing that recent failures should not be used as a “pretext to push for other, unrelated changes to banking regulation.”
“The unique nature and business models of the banks that recently failed, in my view, do not justify imposing new, overly complex regulatory and supervisory expectations on a broad range of banks,” Bowman said. “If we allow this to occur, we will end up with a system of significantly fewer banks serving significantly fewer customers. Those who will likely bear the burden of this new banking system are those at the lower end of the economic spectrum, both individuals and businesses.”
In her speech, Bowman made scant mention of Fed Vice Chair for Supervision Michael Barr’s report on the failure of Silicon Valley Bank, which was completed at the end of last month and released broadly two weeks ago. But her remarks were, in many ways, a rebuttal to his review.
Barr’s report cites both regulatory changes enacted by the Fed in 2019 and an overall shift in supervisory sentiment under the leadership of former Vice Chair for Supervision Randal Quarles as factors contributing to Silicon Valley Bank’s demise.
Barr’s report, which was compiled by the Fed’s top regulatory advisor Kevin Stiroh and included interviews with supervisory staffers, does not propose new policy changes but suggests that several preexisting proposals could be beneficial moving forward. These include changes to stress testing, a long-term debt requirement for large regional banks and a revision of capital standards.
While Bowman did not address Barr’s findings directly, she noted that there has been a “drumbeat calling for broad, fundamental reforms for the past several years.” She added that any efforts to shift away from the tailored approach to regulation — which reserves the strictest standard for the largest, most complex banks — or risk-based supervision is “the wrong direction for any conversation about banking reform.”
“Calls for radical reform of the bank regulatory framework — as opposed to targeted changes to address identified root causes of banking system stress — are incompatible with the fundamental strength of the banking system,” she said. “I am extremely concerned about calls for casting aside tiering expectations for less-complex institutions, given the clear statutory direction to provide for appropriately calibrated requirements for these banks.”
During her speech, Bowman also highlighted changes to banking culture to which supervisors must adapt. The emphasis on innovation in the banking space and the rise of banking-as-a-service, she said, led to an influx of “non-bankers” from less regulated industries, namely tech.
Bowman, the former banking commissioner of Kansas, said some of these new entrants do not regard the shared risk management relationship of banks and supervisors as highly as those who have spent their whole careers in banking. Many, she said, “espouse an ‘ask for forgiveness, not permission’ mentality when it comes to regulation and compliance.”
Moving forward, she said, supervisors should use all their tools to make sure these newcomers understand the risks they are taking, especially if they are core issues that could threaten a bank’s solvency.
“These include concentration risk, liquidity risk and interest rate risk,” Bowman said. “We have the tools to address these issues, but we need to ensure that examiners focus on these core risks and are not distracted by novel activity or concepts.”
Bowman also said the recent crisis and speed at which it played out are reasons for reevaluating the technology at its disposal to mitigate bank runs. She said tools, such as the discount window, are “important but not effective mechanisms to rescue troubled institutions.” She noted that such tools are not available 24 hours a day, seven days a week and in some cases rely on outdated technology.
“These tools must be nimble and flexible to support the banking system during times of stress,” she said. “I think it is important that we understand how well these tools functioned in early March as two U.S. banks experienced stress and ultimately failed, and what can be improved regarding timeliness or effectiveness of fulfilling the lender-of-last-resort function.”
Policies enacted under former Federal Reserve Vice Chair for Supervision Randal Quarles took center stage in the Fed’s recent report on the failures of its supervisory practices. But he and experts say the issues date back much further.
Anna Moneymaker/Bloomberg
Last month’s Federal Reserve report on the failure of Silicon Valley Bank has put the policy objectives of former Vice Chair for Supervision Randal Quarles back under the microscope.
Many factors contributed to what was then the second-largest bank failure in U.S. history, according to the report, but one finding, in particular, places blame directly at Quarles’s feet. Though he is not named in the report, it states that his office directed a shift in supervisory practices that made supervisors reluctant to elevate issues and take decisive action against banks.
“In the interviews for this report, staff repeatedly mentioned changes in expectations and practices, including pressure to reduce burden on firms, meet a higher burden of proof for a supervisory conclusion, and demonstrate due process when considering supervisory actions,” the report states. “There was no formal or specific policy that required this, but staff felt a shift in culture and expectations from internal discussions and observed behavior that changed how supervision was executed.”
But former Fed officials, supervisory policy experts and bank lawyers say the cultural deficiencies at play in the supervision of Silicon Valley Bank are nothing new for the central bank. They say the heavy focus on gathering evidence and building “consensus” before taking decisive action on lingering issues has been endemic in the institution for years.
There are differing opinions on why this is the case. Some say it is tied to supervision being a secondary consideration for the monetary policy-focused institution. Others call it a focus on the wrong issues.
Quarles argues the Fed’s long-running modus operandi has been to cast a wide net in its supervision, a practice that he said prioritizes the volume of citations over the risk they present to individual banks or financial stability broadly.
Quarles said he tried to do away with this manner of supervision, insisting that his directive was for supervisors to forgo small infractions in favor of hitting hard on major issues. He said the report on Silicon Valley Bank — which notes that 31 supervisory findings were issued to the bank — is evidence that his advice was not heeded.
“I wasn’t able to do much on supervision and it’s evident that I really didn’t get much done on changing the culture, because the objective was to stop distracting both the institutions and ourselves with excessive attention to routine administrative matters and focus on what’s really important – like interest rate and liquidity risk,” he said. “I would often use the phrase, ‘And if they won’t do what’s really important, smite them hip and thigh.’”
The 31 matters requiring attention and matters requiring immediate attention, commonly known as MRAs and MRIAs, raised with Silicon Valley Bank touched on a wide range of issues, according to the supervisory documents released alongside the report last month. These included matters that played no apparent role in the bank’s collapse, including the management of third-party vendors, the granularity of its loan risk rating system and its governance around lending procedures.
Some MRAs and MRIAs focused on broad topics relevant to the bank’s ultimate demise, including funding concentration, deposit segmentation, liquidity management and interest rate modeling for internal stress tests. Still, the two central factors in Silicon Valley Bank’s collapse, a reliance on uninsured deposits and a lack of hedges on its long-dated bond investments, were not singled out in the materials released.
“Where’s the specific MRA about SVB’s excessive exposure to uninsured deposits? Where’s the MRA about SVB’s specific interest rate risk?” Randall Guynn, a bank regulatory lawyer with Davis Polk, said. “They had 31 supervisory findings, but they couldn’t have raised those issues in the 15 months after Quarles left or eight months after Barr got on the job? Unless there’s more that hasn’t been disclosed, it just doesn’t make any sense.”
Clifford Stanford, a regulatory lawyer with Alston & Bird and a former attorney in the Federal Reserve Bank of Atlanta’s supervision division, said the matter speaks to a long-running complaint by many bankers that having to address a litany of minor issues saps them of time and resources needed to remedy major concerns.
“There is a sense that when a bank’s chief risk officer is looking at dedicating resources and they are inundated with dozens of MRAs, the impact of the emphasis on any one MRA could be diluted,” he said.
Yet, Stanford said, supervision is largely a matter of judgment and it is difficult to know which potential threats will ultimately play out. Had another issue proved ruinous for Silicon Valley Bank, he said, the issues highlighted by the Fed could have proven more prescient.
The Silicon Valley Report report, commissioned by Quarles’s successor Michael Barr, notes that it is difficult to pinpoint a specific catalyst for the culture shift. But it points to a 2018 “guidance on guidance” and a 2021 rule spelling out appropriate activities for supervisors as key moments. Others have said Quarles’s focus on transparency and consistency in the supervisory process carried the implication that bank examiners would have their actions held to a higher standard.
At face value, these efforts were all aimed at making bank supervision more effective, but the report states that they “also led to slower action by supervisory staff and a reluctance to escalate issues.”
Last month, a senior Fed official told reporters that Barr had undertaken efforts to change the culture of supervision in the Federal Reserve System, including meeting with supervisors and holding town halls and conferences to encourage them to be more aggressive in their oversight. But implementing changes across the entirety of the Fed’s supervisory apparatus — which includes thousands of staffers spread through the 12 regional reserve banks and the Board of Governors in Washington — is no simple task.
Quarles had a similar experience when he joined the Fed. In 2018 and 2019, he held town halls at each reserve bank in hopes of spelling out his vision to every supervisor directly. Still, he said, there seems to have been a disconnect between what he wanted and what those beneath him thought he wanted.
“There are changes to supervisory culture that need to be made,” he said. “My message to the supervisors was that they needed to be focused on stuff that really matters, and that they needed to draw the attention of the institutions to stuff that really matters. No doubt with the best of intentions, they clearly did the exact opposite of that here.”
Supervisory culture at the Fed has been a work in progress for more than a decade. After the subprime mortgage crisis of 2008 and the passage of the Dodd-Frank Act in 2010, Fed leadership sought to consolidate supervisory standards to the board, particularly for large institutions. Previously, each reserve bank had more discretion over how they supervised the banks in their regions, leading to discrepancies from one district to another in terms of supervisory priorities and outcomes.
Brookings Institution fellow and former Treasury official Aaron Klein said the cultural issues around supervision are deeply ingrained in the institution. He has argued in favor of stripping the Fed of its regulatory mandate.
The emphasis on forming a consensus before acting stems from the Fed’s approach to monetary policy, he said, noting that the Fed has had unanimity on all of its rate-setting decisions for 18 years straight. He added that while this aversion to dissent has advanced an agenda of lighter regulation in recent years, it is only the latest episode in a long-running saga.
“Did the Trump-appointed Governors promote a culture of deregulation? Yes. Did they create a culture of consensus? No,” he said. “That culture stems from monetary policy which is the Fed’s telos, its core objective.”
Karen Petrou, managing partner of Federal Financial Analytics, has a less hardlined view on the Fed’s future as a regulator, but she agrees that the primacy of monetary policy making within the organization has contributed to its supervisory weaknesses.
Petrou said supervisors are rarely blindsided by failures; it’s more the case that the regulators identify critical issues that go unchecked. For Fed-supervised banks, she blames this disconnect on supervisors receiving insufficient support from leadership.
“Supervisors need to be rewarded for and given the tools, which they don’t have, to cut problematic action short,” she said. “What we see constantly in supervision is a negative feedback loop in which banks fail to do what they’re told and sometimes even double down to try and do as much of what’s making them money as fast as they can before they think they have to stop.”
