The Basel Committee’s oversight body, the Group of Central Bank Governors and Heads of Supervision, finalized reforms to the Basel III international capital standards. The reforms’ key elements include revisions to (i) the standardized approach for credit risk, (ii) the standardized approach for operational risk, (iii) the internal ratings-based approach for credit risk, (iv) the credit valuation system framework, and (v) the measurement of the leverage ratio and a leverage ratio buffer for global systemically important institutions. In addition, the reforms will modify the floor for calculating banks’ risk-weighted assets that are generated by their internal models. The final standards text detailing the reforms and a summary document containing short descriptions were made available by the Basel Committee.
In an interagency release, U.S. banking agencies (the Board of Governors of the Federal Reserve Board, the FDIC, and the Office of the Comptroller of the Currency) expressed support for the final reforms. The agencies explained that the reforms “are intended to improve risk sensitivity, reduce regulatory capital variability, and level the playing field among internationally active banks.” The agencies will assess how to appropriately apply the reforms in the United States and propose any changes through the standard rulemaking process.
A bipartisan group of congressional representatives introduced a resolution to overturn the Consumer Financial Protection Bureau’s (“CFPB”) recently adopted “Payday, Vehicle Title, and Certain High-Cost Installment Loans” rule. The rule limits certain “payday” loans by requiring lenders to test a borrower’s ability to repay before providing a loan that would obligate the borrower to repay all or most of the debt at once, among other requirements.
The bill is sponsored by Representative Dennis Ross (R-FL) and co-sponsored by Representatives Alcee Hastings (D-FL), Tom Graves (R-GA), Henry Cueller (D-TX), Steve Stivers (R-OH) and Collin Peterson (D-MN). The resolution attempts to stop the rule using the same Congressional Review Act authority (recently used to block the implementation of the CFPB’s mandatory arbitration rule, see previous coverage). Under the Congressional Review Act, if the relevant committee in either chamber of Congress submits a joint resolution disapproving of an agency rule, then the rule can be overturned by a simple majority vote in Congress within 60 legislative days of finalization.
Representative Ross said that the rule will detrimentally impact citizens who rely on small-dollar lending “to make ends meet” and claimed that the CFPB usurped state authority by adopting the rule:
“I and my colleagues in Congress cannot stand by while an unaccountable federal agency deprives our constituents of a lifeline in times of need, all while usurping state authority. Today, we are taking bipartisan action to stop this harmful bureaucratic overreach dead in its tracks.”
Lofchie Comment: The CFPB’s payday rules are of the type that sound good in theory, but may injure borrowers that the rules were meant to protect. For example, while it sounds perfectly reasonable to say that the interest rate on payday loans is too high, it is necessary for lenders to take into account the costs of making very small loans and the high potential for loss. Given these costs, a low interest rate likely makes the business unprofitable. It is reasonable to ask, therefore, whether the intent of the CFPB rule was to bring down the rate of interest on CFPB lending (which is likely to fail) or to shut down payday lending altogether (a goal unlikely to be appreciated by borrowers).
In remarks at the Federal Reserve Board of New York (“NY Fed”) Third Annual Conference on the Evolving Structure of the U.S. Treasury Market, NY Fed President and CEO William C. Dudley shared regulatory progress and identified focus areas for the U.S. Treasury Market. Mr. Dudley framed his remarks around the priorities identified in the Joint Staff Report on the extreme market volatility issued by the Treasury, the Board of Governors of the Federal Reserve System, the SEC and the CFTC on October 15, 2014.
With regard to the treasury market, Mr. Dudley expressed that improved transaction data reporting has helped to “clos[e] the data gap,” but acknowledged that there is significant work to be done to make sure that data collection is sufficient in light of expanding intermediaries and market participants. Going forward, Mr. Dudley stated, efforts will include an FRB plan to collect transaction data from depository institutions, and a focus on improving data transparency for market participants without negatively affecting market liquidity and integrity.
Mr. Dudley also identified market infrastructure as an area of focus for the Treasury market. He pointed to the clearing and settlement practices of the cash market as a particular issue that has plagued the Treasury market. Mr. Dudley said that Treasury transactions are often bilaterally cleared, which includes the involvement of several market participants and contributes to “opaque” practices. He highlighted the Treasury Markets Practice Group’s efforts in this area, suggesting that its market research can help to increase market integrity by facilitating a greater understanding of risk throughout the clearing and settlement process. Mr. Dudley further identified efforts to improve the resiliency of the repo market infrastructure, and urged a continued focus on moving towards a safer centrally cleared repo market.
Finally, Mr. Dudley reflected on the necessity of collaborative regulatory efforts to monitor the Treasury market. He asserted that the constantly evolving nature of the market demands cooperation between regulators and the public to ensure that it is appropriately and effectively regulated.
Lofchie Comment: The regulators have recently pushed the FICC to substantially increase liquidity requirements with respect to cleared swaps. This will (i) materially raise costs to firms that centrally clear swaps, and (ii) encourage firms to move back to bilateral clearing. Order Approving a Proposed Rule Change To Implement the Capped Contingency Liquidity Facility in the Government Securities Division Rulebook. In the case of the clearing of government securities, there is a flight to quality during a time of financial crisis. Consequently, there would seem to be no need for increased regulation (that is, in a crisis, liquidity will flow into governments and out of other products). So isn’t this a case where rules intended to make the markets safer by requiring firms to maintain liquidity that they won’t need, in fact, make the markets more dangerous by needlessly increasing the costs of central clearing?
Joseph M. Otting was sworn in as the 31st Comptroller of the Currency. Mr. Otting was nominated by President Donald J. Trump in June 2017, and confirmed by the U.S. Senate on November 16, 2017. He will serve a five-year term as Comptroller.
Mr. Otting succeeds Keith A. Noreika, who has served as Acting Comptroller of the Currency since Thomas J. Curry stepped down in May 2017. Before joining the OCC, Mr. Otting was a longtime banking executive, having served as President of CIT Bank, Co-President of CIT Group and Vice Chair of U.S. Bank.
In a statement, Mr. Otting said that his experiences have informed his commitment to implementing effective regulation:
“As a career banker, I know firsthand the importance of effective supervision and the value that OCC examiners and other professionals provide. I also know the challenges bankers face as they work to meet customer needs while coping with unnecessary regulatory burden that makes it more difficult and complicated than necessary. In my experience, bankers support regulation, but effective regulation evolves with the changing needs of the nation and should be reviewed and modified as those needs change.”
The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System and the FDIC (collectively, the “agencies”) issued a final rule extending current transitional provisions under the capital rules for certain capital deductions, risk weights and minority interest requirements. The final rule extends provisions that were set to relinquish at the end of the year. The extension is only applicable to banks that are not subject to the capital rules’ advanced approaches (institutions with total assets under $1 billion).
As previously covered, the agencies in 2013 adopted more stringent capital requirements for banking entities and organizations. These rules established certain limits on minority interests (i.e. on including assets owned by subsidiaries in regulatory capital calculations), as well as other mandates for deducting certain assets from an organization’s regulatory capital. The rules were subject to transitional provisions that allowed organizations to make appropriate preparations for the new requirements. In September 2017, the agencies proposed related capital rule simplifications that would make changes related to the treatment of certain loans, items subject to threshold deduction, and minority interest requirements. As stated in the Financial Institution Letter FIL-60-2017, the final rule extends the 2017 transition provisions for “Mortgage servicing assets; Deferred tax assets arising from differences that could not be realized through net operating loss carrybacks; Significant investments in the capital of unconsolidated financial institutions in the form of common stock; Non-significant investments in the capital of unconsolidated financial institutions; and Significant investments in the capital of unconsolidated financial institutions that are not in the form of common stock.”
The U.S. Department of the Treasury (“Treasury”) reviewed the Financial Stability Oversight Council’s (“FSOC”) processes for non-bank financial company and financial market utility designations (“FMUs”). FSOC’s memorandum included commentary and recommendations for improvements of the process (see memorandum and fact sheet on memorandum).
Treasury outlined five policy goals for FSOC processes: (i) leverage expertise of primary financial regulatory agencies, (ii) promote market discipline, (iii) maintain a level playing field for firms, (iv) tailor regulations to minimize burdens, and (v) ensure rigorous, clear and transparent designation analyses.
Specific to the non-bank financial company determination process, Treasury recommended that FSOC prioritize an activities-based, industry-wide approach to financial stability risk management. Implementing this approach would consist of (i) identifying potential risks of activities and products, (ii) collaborating with financial regulators to address identified risks, and (iii) evaluating firms for designation in consultation with regulators. Further, Treasury recommended that FSOC take a firm’s likelihood of material stress into account and conduct a detailed cost-benefit analysis before making a designation. Treasury also suggested that FSOC improve transparency and more clearly communicate the risks that led to a designation and steps to take to appropriately “off-ramp.”
Regarding FMUs, Treasury recommended that FSOC enhance its designation process to more appropriately tailor it to individual firms. Treasury suggested that FSOC conduct further studies related to FMU operation, designation and resolution (e.g., potential access to Federal Reserve emergency facilities). Treasury also encouraged regulatory agencies to cooperate in order to develop effective strategies to enhance resilience and improve the resolution process. Further, Treasury recommended that FSOC integrate a cost-benefit analysis into the designation analysis process, enhance transparency and engagement with FMUs, and leverage expertise of primary regulators to inform regulatory and supervisory strategies.
Lofchie Comment: While improving the transparency of the FSOC process would be a significant improvement on FSOC’s operations to date, it would be better still to rethink (and to some extent junk) the discretionary designation process. The government should not have broad discretion to pick and choose on a subjective basis the firms that are to be subject to regulation. It should be easy enough to draft legislation that provided specifically for the regulation of large financial market utilities. Likewise, if Congress believes it necessary to regulate insurance companies over a certain size, then Congress should adopt legislation to that effect. Establishing and maintaining this precedent of subject determination of entities that are to be regulated is a bad idea, even if it is carried out less badly.
Consumer Financial Protection Bureau (“CFPB”) Director Richard Cordray announced his resignation.
In a memo sent to CFPB colleagues, Mr. Cordray touted achievements during his tenure including (i) $12 billion in relief for consumers, (ii) stronger safeguards against certain mortgage practices, (iii) the processing of 1.3 million consumer complaints, and (iv) new financial education and literacy initiatives.
House Financial Services Committee Chair Jeb Hensarling (R-TX) expressed his view that Mr. Cordray’s resignation represents an opportunity to rein in the authority of the CFPB:
“We are long overdue for new leadership at the CFPB, a rogue agency that has done more to hurt consumers than help them. . . . The extreme overregulation it imposes on our economy leads to higher costs and less access to financial products and services, particularly for Americans with lower and middle incomes.”
In contrast, Committee Ranking Member Maxine Waters (D-CA) thanked Mr. Cordray for his efforts and praised the work accomplished during his tenure:
“Under his outstanding leadership, the Consumer Bureau has made the financial marketplace stronger and fairer for hardworking Americans across the country. As the first Director of the Consumer Bureau, he has overseen the implementation of much needed rules on mortgages, prepaid cards, and payday and auto title loans, clamping down on unfair practices and ensuring that consumers are not ripped off.”
Mr. Cordray was nominated to serve as the first Director of the CFPB by President Barack Obama in 2011.
Lofchie Comment: Mr. Cordray’s resignation presents an opportunity to restructure the CFPB in a manner that is consistent (i) with the bipartisan structure of other agencies, and (ii) that gives Congress and the President authority over the agency, including budgetary authority.
The existing regulatory structure now gives President Trump the ability to appoint a new head of the CFPB to serve a five year term. Without a change in structure, the new appointee will serve regardless of whether the President is re-elected or there is a new President that has different priorities. That simply makes no sense.
Likewise, the degree of authority given to the head of the CFPB is not prudent. The position is not directly accountable to the President and any appointee cannot be fired except in extraordinary circumstances. Either the head of the CFPB should be subject to dismissal by the President or the CFPB should be run by a five-person commission that would include persons who could provide some check on the director’s power.
The Office of the Comptroller of the Currency (“OCC”) updated two documents providing guidance for OCC-supervised branches of foreign banking organizations (“FBOs”): (i) a paper titled The OCC’s Approach to Federal Branch and Agency Supervision (the “paper”), and (ii) the “Federal Branches and Agencies” booklet of the Comptroller’s Licensing Manual. The paper replaces a document from October 8, 2014, while the booklet is an update of a document previously issued in July 2015.
With the passage of the International Banking Act (“IBA”) of 1978, FBOs could opt to conduct banking operations through a branch or agency licensed by the OCC. Such licensed entities are known as “federal branches and agencies.” FBOs acting through federal branches and agencies generally have the same rights and responsibilities as national banks operating at the same locations and are subject to the same laws, regulations, policies and procedures that apply to national banks. There are important differences, however, between an FBO and a full-service bank with respect to OCC supervision.
The paper gives an overview of OCC regulatory practices with regard to FBOs. The OCC International Bank Supervision group of the Large Bank Supervision Department is responsible for the supervision program for these entities. The paper explains the supervisory approach for federal branches and agencies, including a “multifaceted” risk assessment process that takes into account the impact of the parent bank on each supervised entity. Supervision also includes onsite and offsite monitoring, cross-border coordination with home country regulators, and clear communication of examination results. The paper also includes a discussion of resolution and recovery planning, as well as of licensing processes.
The booklet includes all OCC policies and procedures for establishment, operations, and other activities for the federal branches and agencies of FBOs. It provides information regarding establishing branches or agencies, acquisitions, the conversion or contraction of operations, relocations, fiduciary powers, voluntary liquidation, and other relevant topics.
The U.S. Senate voted on a resolution to overturn the Consumer Financial Protection Bureau’s (“CFPB”) arbitration rule. Republican senators Lindsey Graham of South Carolina and John Kennedy of Louisiana opposed the resolution, and Vice President Mike Pence cast the deciding vote in favor of striking down the rule to break a 50-50 tie.
The CFPB arbitration rule restricts mandatory arbitration clauses in certain consumer financial contracts. The rule has been subject to criticism from various sources who allege that the rule will greatly increase the number of class-action lawsuits, thereby benefiting the plaintiff’s bar and increasing costs to consumers. The U.S. Department of the Treasury recently released a report criticizing the rule and the CFPB’s review process in adopting the rule.
In July, Republicans in the House of Representatives and the Senate introduced joint resolutions to nullify the rule using the authority granted under the Congressional Review Act. Under the Congressional Review Act, a rule can be repealed by simple majority votes in both the House and the Senate within 60 legislative days of its finalization. The House promptly voted to block the rule in July and, by a narrow margin, the Senate has now voted to do the same. The resolution now will be put in front of President Trump, who is expected to sign it into law and block the rule from taking effect.
Lofchie Comment: The need for Congress and the President to undo the actions of the CFPB illustrates what an odd regulatory structure Dodd-Frank created in establishing the CFPB. The agency operates independently of, and now in opposition to, both the Executive and Legislative branches of government. While there are undoubtedly those who favor the rulemakings of the CFPB on a policy basis, that does not change the fact that the CFPB is, from a Constitutional standpoint, operationally unsound. Should a Democrat win in the next Presidential election, presumably the CFPB would be headed by a Republican and appointed by President Trump. Undoubtedly, such an appointee would seek to frustrate the goals of the next President. That is simply not the way that the government should work.
In an op-ed published by Bloomberg, Senator Elizabeth Warren (D-MA) argued against any measures to reduce the regulation of banks with more than $50 billion in assets.
Senator Warren explained that Dodd-Frank mandates the Board of Governors of the Federal Reserve System (“FRB”) to impose stricter rules and apply more careful oversight to banks with more than $50 billion in assets. According to Senator Warren, the FRB has done a good job of “aggressively tailor[ing]” rules to ensure that banks with just over $50 billion in assets are not treated the same as banks with more than $250 billion in assets. This tailoring process is “ongoing,” and includes recent efforts to lower stress-testing requirements for banks with less than $250 billion in assets.
Senator Warren contended that big banks continue to advocate and lobby for raising the $50 billion threshold to $250 billion, or to have it replaced with a “multi-factor test.” She criticized both approaches, arguing that even banks at the lower end of the threshold pose significant risks to the financial system. Senator Warren posited that the correlated nature of these banks’ portfolios could lead to several of them failing at once. Lowering the threshold would only provide “negligible” benefit, she argued. Senator Warren suggested that changing the threshold would lead not to increased lending, but rather to “additional stock buybacks, mergers, and executive bonuses.”
Lofchie Comment: Senator Warren’s arguments might be more compelling if she tried to fit them more closely to particular facts or concerns. Because she chooses to argue in generalities, her claims have the appearance of generic political statements as opposed to attempts to discuss better financial regulation. As a result, the Senator remains consistent in her views on regulation: more is always better.
Given the authority that the Federal Reserve Board has over banks, it is an overstatement to suggest that banks might escape the Fed’s scrutiny. No one is suggesting that the Fed would not regulate bank holding companies. Further, the federal banking regulators have substantial authority over executive compensation and stock buybacks. That authority is not going to disappear. Lastly, it is not clear why Senator Warren believes that some reduction in regulation would lead to an increase in bank mergers. Heavy regulation results in increased fixed costs, which favors the very largest entities. One need not look far for proof. Since the adoption of Dodd-Frank, there has been increased financial industry consolidation (particularly in areas regulated by the CFTC, where the regulatory increases have been greatest; e.g., the number of FCMs is approximately halved).
Perhaps there are good arguments for maintaining the regulations that Senator Warren supports. If that is the case, Senator Warren would do better, to the extent that her interest is regulatory policy, to make those arguments with a good bit more specificity.