BPInsights: Nov. 23, 2024

What's Next for Prudential Regulators?

Federal Reserve Vice Chair for Supervision Michael Barr, OCC Acting Comptroller Michael Hsu and FDIC Chair Martin Gruenberg testified before the House Financial Services Committee this week for a prudential regulator oversight hearing. Here are some key moments from the hearing.

• Hitting pause: The banking agencies plan to wait until the presidential transition next year before acting on any significant rulemakings such as the capital, liquidity and long-term debt proposals, regulators said at the hearing. "Given…the importance of making sure this rule is durable and is lasting in serving the American public, my view is that it's appropriate to wait until my new colleagues come in from the OCC and the FDIC [and] we have an opportunity to look at that together, and I get their policy input, they get my input, and we have a conversation about it," Vice Chair Barr said. BPI issued a statement ahead of the hearing urging regulators to pause action on pending rules until all the new agency principals are in place in the new Administration. Gruenberg, whose tenure atop the FDIC has been marked by a workplace culture scandal and allegations of abusive behavior, announced this week that he will resign on Jan. 19, the day before the new President takes office.
• Addressing public input on Basel: Committee Chair Patrick McHenry (R-NC) asked Vice Chair Barr about the Latham & Watkins analysis released this week indicating that only 24% of material substantive issues raised by public commenters would be addressed by the draft Basel Endgame reproposal previewed in Barr's Sept. 10 speech. Barr responded that the changes described in the speech "take on the major issues in the comment letters that have the most material impact" and that "they're not designed to be comprehensive. There are additional changes that I would expect would be appropriate prior to finalizing the Basel III Endgame rule, but they address the most material comments that we got across the full range of suggestions from commenters."
• Personnel: When asked by Ranking Member Maxine Waters (D-CA) if he would leave his position if fired by the President or his Administration, Vice Chair Barr responded: "We serve fixed terms of office, and I intend to serve my fixed term of office." Barr's term as vice chair for supervision runs until July 2026.
• Data sharing: Referring to the CFPB's recently finalized Section 1033 data sharing rule, Rep. Bill Foster (D-IL) asked Vice Chair Barr if the Fed has considered how liability should be distributed if a third party experiences a data breach in a data-sharing scenario. "We have been consulting with the Consumer Financial Protection Bureau on its open banking rule, and I agree with you that it would be useful for the prudential regulators to help provide clarity regarding the circumstances under which a bank, for safety and soundness reasons, for BSA/AML reasons, protecting the financial system, can choose to not share that information," Barr said. "That would be a useful thing for us to do, and we are working on that kind of issue now." In response to Rep. John Rose (R-TN), the officials agreed that prudential regulators would work with the CFPB to provide additional guidance on risk management for open banking under the rule.
• Brokered deposits: Rep. Mike Lawler (R-NY) questioned Gruenberg on whether the FDIC would be able to digest public input on its brokered deposits proposal and a related request for information on deposits by the time Gruenberg resigns. Gruenberg said "we don't anticipate acting on it prior to the end of the President's term."
• Red light, green light: When asked by Rep. Roger Williams (R-TX) if the OCC's bank M&A restrictions would discourage de novo banks from pursuing beneficial mergers, Hsu said the agency's recent policy statement on M&A "was not intended to provide either a red light or a green light on mergers. It really was to provide clarity and transparency as to how we evaluate the statutory factors for an appropriate merger." He said he views new, or de novo, bank formation as healthy and dynamic for the financial system.

Five Key Things

1. FDIC Brokered Deposits Proposal Violates the APA, Would Raise Costs for Consumers

The FDIC's proposal on brokered deposits violates the Administrative Procedure Act, a cornerstone of federal rulemaking that requires agencies to justify their rules and allow public input, a coalition of trade associations said in a comment letter this week.

"The proposed rule, if adopted without significant changes, would be arbitrary and capricious on several grounds," the American Bankers Association, Bank Policy Institute, U.S. Chamber of Commerce, Financial Services Forum, Financial Technology Association, Independent Community Bankers of America and SIFMA said. "The proposal fails to justify the agency's change in position since 2021, consider the costs imposed on businesses that have built themselves around the existing rules or explore obvious alternatives. The FDIC also fails to assess the economic or legal effects of the proposal. And, without justification, the proposal lumps together different types of deposits as 'brokered' without any meaningful analysis of the very different underlying business models of third parties who place their customers' deposits with banks. These flaws make the proposal illegal, and the FDIC should withdraw it."

What's happening: The FDIC has proposed new changes to its brokered deposits rule that would broaden the range of deposits considered "brokered," reversing constructive changes the agency made in 2020-2021 and flouting the intent of the underlying statute, which was aimed at banks that are not well capitalized. The proposal would:

• significantly expand the definition of deposit broker
• significantly narrow the primary-purpose exclusion
• rescind the agency's approval of existing deposit arrangements that are currently treated as non-brokered.

Costly consequences: While the statute was intended to restrict weak banks from gathering deposits at excessively high rates through third parties, the FDIC's proposal would inappropriately encompass many lower-risk deposits. This would raise costs for banks and could make financial services more costly and difficult for customers to access.

What should happen: In the absence of data and analysis justifying the proposal, it should be withdrawn.

• BPI response: In addition to filing a joint trades letter on the proposal's legal deficiencies, BPI filed its own comment letter expressing substantive concerns. The FDIC's proposed changes to its brokered deposits rule would increase costs and reduce the availability of products for consumers, making major changes without compelling justification, BPI said in the letter.
• New research: BPI's empirical analysis casts doubt on the justification for the FDIC's proposal to broaden the definition of brokered deposits. The analysis shows that reclassifying sweep deposits from brokered to non-brokered status likely accounts for most of the observed $350 billion decline in reported brokered deposits following the implementation of the 2020 final rule. It also finds that during the March 2023 banking turmoil, non-brokered sweep deposits demonstrated markedly different risk characteristics compared to brokered deposits. Smaller banks with higher concentrations of brokered deposits experienced significant negative excess returns during stress, but there is no statistically significant link between non-brokered sweep deposit concentrations and bank risk when controlling for relevant bank characteristics among banks of any size. These empirical findings raise substantive questions about the FDIC's proposed regulatory changes, which seek to use anecdotal evidence from the March 2023 bank failures to justify reversing 2021 changes that tailored the brokered deposits framework. BPI's analysis indicates that maintaining the changes adopted in the 2021 final rule better reflect the underlying risk characteristics of brokered and sweep deposits.

2. The Federal Reserve's Incredible Supervision Report: Elevating Process Over Substance

The Federal Reserve's latest report on supervision and regulation paints a paradoxical picture. While it asserts the banking system is "sound and resilient," it also asserts that two-thirds of large financial institutions were rated less than satisfactory in the first half of 2024 - despite these firms holding 85% of bank assets under Fed supervision.

What's happening:

• The unsatisfactory ratings stem primarily from governance and control deficiencies - not capital or liquidity issues - which are often subjective and lack clear, measurable standards.
• The report highlights weaknesses in operational resiliency, cybersecurity and risk management, yet fails to provide enough information to explain the nature of their findings and whether these deficiencies actually pose a threat to safety and soundness.
• While governance and control failures can rise to the level of posing a real threat to safety and soundness, such threats cannot currently be the case for two-thirds of large financial institutions.
• The opaque and subjective nature of supervisory findings leaves banks vulnerable to inconsistent examiner demands and unsubstantiated downgrades.

Why it matters:

• Governance and control issues alone don't necessarily indicate unsafe banks, and supervisory ratings that hinge on vague criteria harm banks' reputations and limit their ability to serve customers, even when their financial health is strong.
• The report raises serious questions about whether the current standards serve as accurate assessments of a bank's risk level.
• Greater transparency in the Fed's reporting - such as detailed data on supervisory findings by category - could enhance public trust and understanding.
• The Federal Reserve should also identify opportunities to better inform the public regarding the activities, accomplishments and shortcomings of supervisory efforts.

The bottom line: With two-thirds of LFIs rated unsatisfactory - and therefore not "well-managed" - apparently based on governance and controls component downgrades, it is time to consider whether this is truly the intended outcome under the rating system. If it's not, it is time for the Federal Reserve to consider appropriate adjustments. The Fed's supervisory ratings need clearer standards and disclosures to ensure they reflect genuine risks to the financial system. The troubled federal banking examination regime is a Matter Requiring Immediate Attention.

Explore our explainer: To better understand why bank supervision is broken, and how to fix it, please click here

Also in supervision: The GAO this week released a report that flagged weaknesses in Fed and FDIC supervision. The Fed could improve its ability to take early, proactive steps to address flawed bank practices, the report suggested. The GAO also identified flaws in "escalation procedures" at the FDIC. For example, the agency lacks a centralized system for tracking examiner recommendations, limiting its ability to identify emerging risks across the banks it oversees. The OCC generally adheres to its escalation procedures, said the report, which arose in response to the 2023 bank failures.

3. Report: Basel Redo Outlined by Barr Would Only Address a Quarter of Public Concerns

An analysis published this week by Latham & Watkins found that only 24 percent of material concerns raised in public comments to the Basel Endgame proposal would be addressed by the changes to the proposal previewed in Vice Chair for Supervision Michael Barr's Sept. 10 speech. Unaddressed concerns include overlaps between Basel and stress tests; legal and process issues with the rulemaking; and effects on minority and underrepresented communities, according to the report. These gaps reflect concerns raised by bipartisan members of Congress, farmers, manufacturers and small businesses, among other commenters. In comments at this week's prudential regulator Congressional hearing, Barr said that the speech was not meant to be comprehensive and that "there are additional changes that I would expect would be appropriate prior to finalizing the Basel III Endgame rule."

4. Op-Ed: The CFPB's 'Open Banking' Rule is a Solution in Search of a Problem

Banks and the market have developed an innovative framework enabling millions of consumers to safely link their financial data to external accounts and apps. This framework relies on APIs, a more secure platform for data sharing than the older method of screen scraping. But the CFPB's new "open banking" rule, known as Section 1033, threatens to upend this thriving ecosystem and expose consumers to fraud and other risks. Rather than regulating financial data sharing, the rule would make it less safe and make consumers more vulnerable. Read more in Greg Baer's BankThink op-ed published this week.

5. FDIC Proposal Oversteps Legal Authority, Introduces Needless Complexity

The FDIC's recent proposal to amend its regulations under the Change in Bank Control Act (CBCA) would exceed the agency's statutory authority and create unnecessary complexity in how the government reviews investments in banks, BPI said in a comment letter filed this week. The FDIC should withdraw the proposal.

"The FDIC aims to regulate 10% investments by index funds in a number of bank holding companies already subject to Federal Reserve scrutiny, but this proposal is a solution in search of a problem. It's unclear why the agency sees index funds as a threat justifying an unnecessary regulatory requirement when these investors are motivated to prioritize long-term shareholder value, are unable to sell shares quickly as a means of influence and are already restricted from exercising active control of banks. In fact, the proposal may threaten a stable source of bank equity funding and elevate the voting power of activist investors. The FDIC should avoid unintended consequences and abide by the statute." - Gregg Rozansky, BPI senior vice president and senior associate general counsel

To learn more, click here.

Paige Pidano Paridon Breaks Down the CFPB's Section 1033 Rule

The CFPB's Section 1033 rule jeopardizes the security and privacy of consumer financial data. Hear from Paige Pidano Paridon, BPI's Co-Head of Regulatory Affairs, on the shortcomings of this rule and learn more at KeepBankingSafe.com.

In Case You Missed It

Fed's Bowman Calls for 'Pragmatic' Approach to Regulation

In a speech this week, Federal Reserve Governor Michelle Bowman emphasized the benefits of a "pragmatic approach" to banking regulation that considers costs and benefits of proposed changes. "It also means that we must consider the limits of regulatory responsibility-grounded by our statutory objectives-when taking regulatory action," she said. The Supreme Court's overturning of Chevron deference "has the potential to transform agency rulemakings positively-in a way that promotes the pragmatic approach I outlined in this discussion," Bowman said. "The same considerations we follow in the pursuit of our statutory objectives could help support rulemakings that are built upon a stronger factual and analytical basis, with a thorough and more comprehensive explanation of an agency's policy approach."

• Unprecedented response: The unprecedented public outpouring in response to the Basel Endgame proposal revealed an "uncomfortable truth: the regulatory approach we took failed to consider or deliver a reasonable proposal, one aligned with the original Basel agreement yet suited to the particulars of the U.S. banking system," Bowman said. "[T]his level of public engagement and debate was also a byproduct of the rulemaking process. While regulatory overreach can threaten the credibility of agency action in the eyes of the public, a transparent process allows public commenters to pressure test and pushback on agency action."
• Unintended consequences: Bowman also drew attention to the unintended consequences of certain regulations, such as regulatory constraints (supplementary leverage ratio, GSIB surcharge and liquidity coverage ratio) on Treasury market functioning. Regulators must ensure they are striking the right balance between economic growth and safeguarding the banking system, she said. This requires a reviewing and updating of regulations as conditions change.
• Transparency throughout: Regulators should maintain transparency in their actions even when it is not legally required, Bowman said, giving the example of bank supervision. "Supervision by its nature involves confidential and detailed inquiries into bank operations, with examiners evaluating quantitative measures like capital and liquidity, while making judgmental assessments of the activities and risks of the institution, and its risk-management approach," Bowman said. "Supervisory expectations should not surprise regulated firms, and yet transparency of these expectations is often challenging to achieve. In fact, since the failure of SVB supervisory surprises have become more common in bank examinations."

Associations Representing Banks and Credit Unions of All Sizes Call on Congress to Reject New Credit Card Mandates

Any legislative initiatives to expand the power of the federal government to intervene in the U.S. credit card market would harm small businesses and consumers across the country, the American Bankers Association, America's Credit Unions, Bank Policy Institute, Consumer Bankers Association, Electronic Payments Coalition, Independent Community Bankers of America, Mid-Size Bank Coalition of America, and National Bankers Association told members of the Senate Judiciary Committee in a letter sent to lawmakers this week.

The letter, sent in advance of Tuesday's Senate Judiciary Committee hearing on the subject, expressed the groups' strong opposition to the Credit Card Competition Act (S. 1838 Durbin-Marshall bill) or any other expansion of the Durbin amendment. The groups also expressed their "deep disappointment" with the committee's decision to hold the hearing during the lame duck session of Congress and not invite testimony from a community bank or credit union harmed by the proposal.

CFPB Finalizes Rule Taking Aim at Big Tech

The CFPB this week finalized a rule to supervise large nonbank firms with digital payment apps. The rule, issued pursuant to the agency's "larger participant" rulemaking authority, would subject Big Tech firms with digital payment businesses to closer scrutiny like the type applied to banks. The rule will allow the CFPB to more closely monitor how tech firms handle consumer data, fraud and account access. It is the latest development in the Bureau's scrutiny of Big Tech and fintech companies. The Washington Post reported recently that the CFPB has taken steps to subject Google to direct supervision.

ECB Report Comparing EU and US Capital Requirements on Ice, FT Reports

The European Central Bank is debating whether to publish an analysis finished last year showing that capital requirements for large EU banks would rise by a double-digit percentage if they were subjected to the same requirements as U.S. banks, according to an article in the Financial Times this week citing unnamed sources. The report comes amid uncertainty on the Basel proposal in the U.S. as banking regulators wait until the new presidential Administration to move forward on the rule. One factor mentioned in the FT story that results in diverging capital requirements between the U.S. and EU is the use of banks' internal models, which are more granular than the one-size-fits-all government models that U.S. banks are required to use.

FSB Chair Sets out Priorities in Latest G20 Message

Financial Stability Board Chair Klaas Knot laid out various policy priorities in his latest letter to G20 leaders, sent on Nov. 15. The letter looks back at the Global Financial Crisis and the 2023 bank failures and puts current regulatory goals in the context of needing to address the issues underpinning those episodes. Knot emphasized the importance of bank risk management, governance and proactive supervision, and said more work remains to be done on issues surrounding the 2023 turmoil. He also called for finalization of the Basel Endgame revisions in full, "consistently and as soon as possible," echoing recent sentiments from Erik Thedeen, new Chair of the Basel Committee on Banking Supervision, and other international regulatory officials. On policy development, the letter stated: "Knot also flags nonbank financial institution oversight, artificial intelligence and payments improvements as priority issues. On climate risk, Knot said there is an increasing need for high-quality, consistent, and comparable firm-level disclosures.

Basel Committee on Banking Supervision Issues Meeting Statement

The Basel Committee on Banking Supervision, a standard-setting organization of global financial regulators, published its most recent meeting statement this week. The statement unanimously reaffirmed expectations to implement Basel III in full, consistently and as soon as possible, echoing the commitment reiterated recently by G20 finance ministers and central bank governors. The Committee also finalized guidelines for strengthening banks' counterparty credit risk management and advanced work to strengthen supervisory effectiveness after the 2023 bank failures, according to the statement. The latter effort covers the supervision of liquidity risk and interest rate risk in the banking book, assessment of sustainability of banks' business models and importance of effective supervisory judgment. The work will be updated in early 2025.

• Nonbank financial firms: The Committee also discussed banks' connections with nonbank financial intermediaries and potential data gaps and risks surrounding these firms.
• CcyB: The Committee plans to publish a report next month on countercyclical capital buffer practices to support jurisdictions seeking to apply "positive cycle-neutral rates."
• Climate: The Committee continued to review its proposed Pillar 3 disclosure framework for climate-related financial risks, and it anticipates the finalization of this work in the first half of 2025.

The Crypto Ledger

Here's what's new in crypto.

• Scattered Spider: U.S. prosecutors accused five members of the so-called Scattered Spider hacking gang of a fraud spree targeting dozens of companies and people, ultimately resulting in the theft of at least $11 million in cryptocurrency. The accused hackers allegedly used text phishing, SIM swapping and other fraudulent techniques to break into company accounts and networks and access digital currency accounts and wallets, according to prosecutors.
• Final FTX sentencing: Former FTX chief technology officer Gary Wang, the last FTX executive to be sentenced, was spared prison time due to his cooperation with prosecutors.
• This price is bananas: At this week's Sotheby's auction, Chinese-born crypto entrepreneur Justin Sun paid $6.2m for Maurizio Cattelan's viral artwork that consisted of a banana duct-taped to a canvas. While the price seemed high, it has been noted that the artwork has more intrinsic value than bitcoin.

FSB Publishes Report on Compensation Incentives and Risk Management

The Financial Stability Board this week published a progress report on legal and regulatory challenges to the use of compensation tools, such as clawback provisions, to manage risk at banks. The report offered observations in light of the 2023 bank failures. Here are some key highlights.

• 2023 lessons: The bank failures of last year reinforced the notion from the Global Financial Crisis that compensation should be aligned with prudent risk-taking, according to the FSB. Compensation linked to short-term profits can lead to poor alignment between compensation and risk, the report suggested. Good governance and board oversight is crucial for effective compensation practices, the report stated.
• Carrots and sticks: Compensation tools can provide incentives for good conduct, while some deterrent-oriented compensation tools like clawback provisions can elicit prolonged legal battles and be challenging to enforce, the report said.
• Progress update: The report examines the progress made by FSB member jurisdictions in implementing compensation tools, offering a summary by jurisdiction of the changes each has made.
• Role of regulators: An effective board of directors, a standard of transparency and a sound organizational culture are essential ingredients for addressing the challenges around compensation tools, according to the report. In addition, regulators and supervisors play an important role through setting expectations and monitoring the use of such tools through guidance, examination and standards.

PNC Announces $500 Million Increase in Branch Investment, More than 100 New Branches

PNC recently announced it is increasing its branch investment by $500 million to open more than 100 new branches and renovate 200 more locations across the country. PNC will expand its branch network throughout Atlanta, Charlotte, Orlando, Phoenix, Raleigh and Tampa. This announcement builds on previously announced investments to expand the bank's branch network throughout the U.S.

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