BPInsights: Sept 21, 2024

Barr Unveils Basel Reproposal

• On Sept. 10, Federal Reserve Vice Chair for Supervision Michael Barr previewed a Basel reproposal that was widely understood to constitute an interagency agreement. It was reported that the FDIC and Federal Reserve Board would each meet as early as Sept. 19, but no meeting has occurred and none is scheduled.
• Disagreements among FDIC board members, however, have scuttled that plan, according to POLITICO this week. One roadblock is clear: the bipartisan "wall of resistance" at the FDIC, according to a Bloomberg article on Friday. "At least three of five FDIC directors oppose the latest overhaul previewed by the Federal Reserve last week, according to people familiar with their thinking," Bloomberg reported. "Democrat Rohit Chopra has joined the two Republican board members, including Vice Chairman Travis Hill, against the changes, the people said." Capitol Account also reported this week that "Chopra and Hill also have concerns about the plan and may balk at backing it, according to people familiar with their thinking. Neither has said publicly how he will vote."
• The FDIC is the primary supervisor of less than 5% of the assets of the banks subject to the proposal; there is no legal requirement that the agencies act jointly; and there is precedent for doing so. Asked about whether the other banking agencies are aligned with the Fed at his FOMC press conference, Chairman Powell said, "The idea is that we're all moving together."

Five Key Things

1. Regulators Aren't Enabling Risk by Reproposing Basel - They're Following the Law.

A recent Bloomberg editorial criticized U.S. regulators' effort to repropose their Basel Endgame rule, characterizing it as a retreat from necessary capital increases. The editorial argues that banks do not have enough capital, pointing out that banks historically held much higher equity ratios and that academics recommend funding at least 15 percent of assets with equity. BPI's new post breaks down key misconceptions and false premises in the editorial.

1. Risk-based capital ratios - the heart of the Basel proposal - are different from leverage ratios, which treat all assets as having equal levels of risk.
2. Current capital levels aren't insufficient; they are well within the optimal range of capital demonstrated in academic studies.
3. The industry opposes the Basel proposal not because of a reflexive hostility to capital increases, but because regulators failed to justify it with economic analysis or follow legal requirements.
4. The Basel proposal isn't about the spring 2023 bank failures or their causes; the one small piece that could be connected to Silicon Valley Bank is a provision that the industry supports.

2. How is U.S. Regulation Affecting Foreign Bank Participation in Capital Markets?

Foreign banks play an important role in financing American businesses, infrastructure and housing through U.S. capital markets. But post-Global Financial Crisis regulatory changes have decreased these banks' U.S. capital markets participation. A new BPI post explains how regulatory requirements for large foreign banks with U.S. operations have affected foreign banks' U.S. capital markets activity. Two key requirements have raised barriers to entry for foreign banks' participation in U.S. markets:

1. Capital trapped within borders: Large foreign banks doing business in the U.S. must establish intermediate holding companies, or IHCs. The interaction between the IHC requirement and other regulatory changes has led to the segregation of bank capital by jurisdiction. The Fed's supervisory practices have led to extremely high levels of capital being held in IHCs, which reduces foreign banks' ability to deploy capital efficiently across international borders. This dynamic also leads to weakened market liquidity under stress and discourages foreign banks from injecting capital into their U.S. subsidiaries.
2. Fee-income business model: The Fed's stress capital buffer requirements disproportionately affect IHCs because of their greater reliance on fee income. The Fed's pre-provision net revenue modeling approach in the stress tests may underestimate trading revenues and other sources of fee income while inaccurately forecasting expenses. This results in lower projections of net revenues and, consequently, higher capital requirements for IHCs compared to domestic U.S. banks.

BPI's analysis: This post explores how these factors have led to declining foreign-bank market share across capital markets business lines. This reduced participation has harmful consequences for U.S. capital markets efficiency and liquidity, especially under stress.

Looking ahead: The finalization of the U.S. Basel Endgame operational risk framework would exacerbate these issues because it is expected to be punitive to banks with fee-based businesses, including many foreign banks in the U.S.

3. A New Survey Reveals Consumer Sentiment About Debit Card Interchange

BPI released new Morning Consult survey results this week that reveal Americans overwhelmingly value the convenience, security and widespread acceptance of debit cards, with many expressing concerns about government interference in fixing prices in private markets. The survey also found that a large majority of consumers believe it is fair for retailers to pay for the goods and services they use to operate, even if doing so cuts into their bottom line. Nine-in-10 (90%) consumers with an opinion agree that large retail chain stores should be responsible for paying for the goods and services they use to operate, and a further 79% believe interchange fees are fair compared to the benefits that retailers receive from accepting debit card payments.

"We have done the research, and consumer preference is clear: they support competitive marketplaces and believe that giant chain stores pay a fair price to process debit cards compared to the benefits earned in return," stated Greg Baer, BPI President and CEO. "Americans overwhelmingly find debit cards to be safe and convenient, and the reality is that debit card transactions benefit both consumers and merchants. We encourage the Federal Reserve to resist pressure from giant chain stores and remain focused on matters that affect consumers' pocketbooks rather than entertaining retailers' attempts to evade their bills."

4. What's New in Bank M&A Policy

Several new developments emerged in bank merger policy this week, some of them the culminations of years-long proposals.

Bank Policy Institute President and CEO Greg Baer issued the following statement in response to the OCC's and FDIC's policy changes on bank M&A, which were finalized this week:

"The bank M&A market is already mired in regulatory uncertainty, and this week's agency policy changes exacerbate it. Merger policy should ensure that applications are processed on a timely and predictable basis consistent with standards established by statute. Rather than sticking to the law, the FDIC and OCC chose to improvise new, subjective standards to evaluate bank mergers. The agencies' merger approval process needs a shot clock; instead they give us the Four Corners, extend the time for the game and create strange new rules.

The FDIC and OCC policies start with a presumption against timely approval for many mergers that would drive banks to avoid pro-competitive, healthy deals: mergers and acquisitions entail a high-cost, high-risk process that would not be worthwhile if the chances of approval are remote or if the process is a black box. Banks and consumers alike would suffer from an opaque and uncertain process. Unfortunately, the final policy measures entrench that uncertainty."

The background: At an open board meeting on Tuesday, the FDIC finalized a policy statement on bank M&A that would make the bank merger review process even more complex, slow and subjective. The OCC also finalized a separate, but very similar, rule the same day. The measures would introduce new standards for merger evaluation and set an unreasonably high bar for approval of a transaction.

• In a comment on the FDIC proposal, BPI urged the FDIC to withdraw it, and otherwise to substantially revise it to align with statutory standards and sound merger policy, including by avoiding artificial constraints in the review process.
• BPI similarly expressed concern about the OCC proposal, which would set an unjustifiably high bar for merger approval.
• BPI also emphasized the tangible costs of delayed merger reviews, such as departing employees and customers.

What's at stake: Banks' ability to shoulder overlapping regulatory requirements, maintain costly cyber defenses, meet customer demand for innovative technology, and compete with less regulated fintechs depends on scale. Policy measures such as the FDIC and OCC's recent actions ignore that reality and put this necessary scale out of reach. Instead of making rational business decisions to pursue M&A, banks may choose to avoid the convoluted process and forgo deals that would benefit their customers and the economy.

Bottom line: These policies depart from the law and set a concerning precedent of presuming that all bank combinations are bad. It would pose harmful consequences for consumers and the vitality of the banking system.

In other M&A news, the Department of Justice this week withdrew from its bank-specific merger guidelines in favor of its generally applicable 2023 merger guidelines. This marks another major change in how bank deals are evaluated by federal agencies. "[I]t looks at things - narrowly - like branch overlaps [and] deposits," DOJ antitrust chief Jonathan Kanter said of the previous bank M&A approach. "I don't believe that is the appropriate, most state-of-the-art, effective way to think about concentration in banking."

'Perverse consequences': The FDIC's policy statement will result in a de facto ban on "all but the simplest and smallest bank mergers," which will "bring an onslaught of perverse consequences," according to a research paper released this week by Federal Financial Analytics. The FDIC's move and other M&A proposals will "exacerbate industry concentration, incite more bank failures, perpetuate migration of core services to nonbanks and stunt national macroeconomic growth," the paper argues. The paper also posits that such regulatory actions make banks uninvestable. "Banks that do not make money are banks no more because investors will not put their money in banks with poor long-term prospects for robust profitability-they have lots of options and banks will only be among them if investors receive market rates of return," Federal Financial Analytics Managing Partner Karen Petrou said.

5. FDIC Proposes New Rules Affecting Fintech-Bank Partnerships

The FDIC at its open board meeting this week proposed new restrictions on so-called custodial deposit accounts aimed at addressing growth in bank-fintech partnerships. The FDIC has placed priority on the issue after the collapse of fintech firm Synapse. The proposal would require banks holding custodial deposit accounts with transactional features to maintain records identifying the beneficial owner of the account deposits and reconcile those accounts each business day. The recordkeeping measure is meant to prevent confusion over who owns what account when a fintech partnering with a bank pools customer deposits into a single bank account for that fintech's customers. The measure received bipartisan support on the FDIC board.

In Case You Missed It

FDIC's Hill on Discount Window Stigma, Deposit Conundrums

In a recent episode of the Mercatus Center podcast Macro Musings, FDIC Vice Chair Travis Hill discussed the challenging balance that regulators must strike when requiring banks to pre-position collateral at the Fed's discount window. He described how Silicon Valley Bank's failure raised the question of why it couldn't have borrowed from the discount window. According to Hill, two key questions are: "[H]ow do we ensure that banks are prepared to use the discount window and that the discount window is usable? Then, a second is, can we make banks more resilient to these types of runs?"

• Pawnbroker for all seasons: Those questions have led to a concept of a discount window pre-positioning rule, Hill said - a derivation of a proposal from former Bank of England Governor Mervyn King, who said the central bank must be a "pawnbroker for all seasons." Notably, King's proposal was intended to replace deposit insurance, liquidity requirements, and capital requirements, not as a supplement to them.
• Delicate balance: Hill observed the tension in setting a hardwired ratio below 100 percent for covering deposits in a pre-positioning rule. "[T]he problem with that is that if you impose that type of rule, you're basically announcing to the world that the banks are not going to be able to cover all of their uninsured deposits, which maybe is fine today, but if you're ever in a panic-type situation, like the SVB situation- if the SVB depositors all look and say, 'Oh, they have a 40% coverage ratio. That means that we better make sure that we're in that 40%, and we get out before they run out of capacity.'"
• Counting capacity: "You don't get credit in the LCR for capacity at the discount window," Hill said. "I personally think that it is worth considering amending the LCR to allow capacity at the discount window to count for the high-quality liquid asset piece of it." Last spring's bank failures demonstrated that "even in a 30-day period, being able to sell that volume of securities is not realistic without having a major impact on markets and on other banks that own securities in those markets," Hill said. "So, I think that having the discount window as some piece of the solution for the deposit run problem makes sense, and rather than creating all of these different rules for each potential scenario, I think that it makes more sense to just have one primary liquidity rule that envisions a bank having multiple options, given that we're not going to know exactly how this is going to unfold."

The Crypto Ledger

Here's the latest in crypto.

• Airdrop clarity: House Financial Services Committee Chair Patrick McHenry (R-NC) and House Majority Whip Tom Emmer (R-MN) asked the SEC for clarity on digital asset "airdrops" in a recent letter to Chair Gary Gensler. "We write to better understand the Securities and Exchange Commission's (SEC) consideration of the status of distributions of digital assets via 'airdrops,'" the lawmakers wrote. "Airdrops in this context are distributions of a digital asset to early users of a blockchain protocol. … We are concerned that a misapplication of the securities laws will prevent this technology from achieving decentralization and its full potential."
• eToro settles with SEC: Crypto brokerage eToro will pay $1.5 million to the SEC over alleged violations of securities laws. The firm will also significantly retreat from the crypto markets, according to POLITICO.
• FTX auditor hit with penalty: Accounting firm Prager Metis agreed to pay $745,000 to the SEC to resolve negligence-based fraud charges over audits of crypto platform FTX.

Dimon: Basel Endgame Needs an Endgame

In comments at the Georgetown University Psaros Center for Financial Markets and Policy conference this week, JPMorgan Chase CEO Jamie Dimon emphasized the need for the Basel Endgame proposal to finally reach a conclusion after a decade. "It's been going on for 10 years and now we've got another six months," he said, according to Capitol Account. "I find it unbelievable." But regulators need to end it the right way - and that includes a reproposal based on robust data and analysis, he said. "The work should be done to justify what they want to do," he said. "It isn't that the banks won relief, I don't care about relief - I want the work to be done properly, that it's an honest assessment."