Sandor on “Creation and Evolution of New Markets: The Case of Interest Rate Benchmarks”

Dr. Richard Sandor – CFS Advisory Board Member and CEO of the American Financial Exchange (AFX) delivered remarks “Creation and Evolution of New Markets: The Case of Interest Rate Benchmarks” at a recent CFS roundtable.

Richard discussed the new Secured Overnight Financing Rate (SOFR) and American Interbank Offering Rate (Ameribor) – which is a new transaction-based interest rate based on actual overnight, unsecured transactions. As a perennial financial entrepreneur, his comments on LIBOR, financial innovation and the seven stages of market creation were especially noteworthy.

For the presentation: http://centerforfinancialstability.org/research/Sandor-11-16-18.pdf

For more on the AFX and Ameribor, please request a briefing pack from Rafael Marques at rmarques@theafex.com.

FRB Vice Chair Considers Proposed Amendments to Stress Testing Program

Federal Reserve Board (“FRB”) Vice Chair for Supervision Randal K. Quarles considered proposed changes to the FRB’s large bank stress testing regime that would increase transparency and efficiency.

In a speech at the Brookings Institution, Mr. Quarles said that the FRB is seeking to improve the measurement of trading book-related risks, and that a “single market shock” approach in existing stress testing practice does not adequately capture risks in firms’ trading books. He said that the proposed changes “are not intended to alter materially the overall level of capital in the system or the stringency of the regime.”

Mr. Quarles discussed changes to the Comprehensive Capital Analysis Review (“CCAR”) indicating that the FRB will reconsider whether any part of the regulatory capital rule (the stress capital buffer or “SCB”) proposal will remain for the 2019 CCAR. He said that he intends to request that the FRB exempt firms with less than $250 billion in assets from the 2019 CCAR quantitative assessment and supervisory stress testing in light of the FRB’s recent tailoring proposal. In addition, Mr. Quarles expressed his support for “normaliz[ing] the CCAR qualitative assessment” by (i) removing the public objection tool and (ii) evaluating firms’ stress testing practices through “normal supervision.”

Mr. Quarles stated that elements of the proposal to integrate stress testing with the stress capital buffer will be amended after receiving public comment. As a result, the SCB, which was scheduled for the 2019 stress test cycle, will be delayed. Mr. Quarles said that the first SCB may go into effect after 2020.

FRB to Implement New Supervisory Rating System

The Federal Reserve Board (“FRB”) will implement a new supervisory rating system for large financial institutions.

Effective February 1, 2019, the FRB will enforce a new rating system for large financial institutions (“LFI”). The new system is intended to (i) better reflect current FRB supervisory programs and practices, (ii) enhance the supervisory assessments and communications of supervisory findings and implications and (iii) improve “transparency related to the supervisory consequences of a given rating.” The new LFI rating system will apply to (i) all domestic bank holding companies and non-insurance, non-commercial savings and loan holding companies (“SLHCs”) with $100 billion or more in total consolidated assets and (ii) U.S. intermediate holding companies of foreign banking organizations with $50 billion or more in total consolidated assets.

The existing RFI/C(D) rating system will continue to be applied to community and regional bank holding companies with less than $100 billion in consolidated assets. In addition, the RFI/C(D) rating system will be expanded to apply to certain SLHCs with less than $100 billion in total consolidated assets on February 1, 2019.

Banking Agencies Propose Updating Calculation of Derivative Contract Exposure Amounts

The Comptroller of the Currency, the Federal Reserve Board and the Federal Deposit Insurance Corporation proposed allowing “advanced-approaches” banking organizations (i.e., those with $250 billion or more in total consolidated assets, or $10 billion or more in on-balance sheet foreign exposure) to use an alternative approach for calculating derivative exposures under regulatory capital rules.

The proposed approach – the standardized approach for counterparty credit risk (“SA-CCR”) – would replace the current exposure methodology (“CEM”). If adopted, the proposal would (i) require advanced-approaches banking organizations to use SA-CCR to calculate their standardized total risk-weighted assets by July 1, 2020 and (ii) allow non-advanced-approaches banking organizations to use either CEM or SA-CCR when calculating standardized total risk-weighted assets.

In addition, the proposal would require advanced-approaches banking organizations to use SA-CCR to determine the exposure amount of derivative contracts for calculating total leverage exposure and would amend the cleared transactions framework to include SA-CCR.

Comments on the proposal must be submitted within 60 days from the date of publication in the Federal Register.

FRB Governor Says FinTech Innovation Offers Solutions for Financial Inclusion

Federal Reserve Board (“FRB”) Governor Lael Brainard argued that more needs to be done to encourage financial inclusion and to improve access to credit for underserved families and small businesses. She stated that FinTech developments “may be combined in powerful ways to bring end-to-end solutions to financial inclusion.”

In a speech at the FinTech, Financial Inclusion Conference, Ms. Brainard stated that while access to accounts and credit are lowering transaction costs, such developments are not sufficient. She argued that continued progress toward financial inclusion is likely to require solutions that are designed with an understanding of issues that the underserved face (e.g., many unbanked or underbanked people in the U.S. are deliberately choosing not to maintain a bank account). According to Ms. Brainard, access to credit is important in mitigating financial vulnerability.

Ms. Brainard said that policymakers and financial services providers are assessing “financial inclusion” in a more holistic and nuanced manner, with a greater emphasis on “financial health.” In particular, she said that innovative platforms, such as faster payment services, can be combined with other technological developments (e.g., cheap access to cloud computing) to establish a more robust solution to fostering financial inclusion. Ms. Brainard said that the FRB has “a role and, potentially, a responsibility” to help build an “infrastructure that facilitates safe, innovative, and ubiquitous faster payment services.” For those who are struggling financially, she observed, the “difference between waiting for a payment to clear and receiving a payment in real time is not merely an inconvenience; it could tip the balance toward overdraft fees, bounced checks, or collection fees.”

 

Bank Regulators Testify on Bank Deregulation Act

Federal banking regulators testified before the U.S. Senate Committee on Banking, Housing and Urban Affairs on progress toward implementing the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Act”). As previously covered, the Act makes targeted changes to key areas of Dodd-Frank, which will primarily benefit smaller banking organizations with simpler business models. Testimony was provided by Comptroller of the Currency Joseph M. Otting; Federal Reserve Board (“FRB”) Vice Chair for Supervision Randal K. Quarles; FDIC Chair Jelena McWilliams; and National Credit Union Administration (“NCUA”) Chair J. Mark McWatters.

Mr. Otting, Mr. Quarles and Ms. McWilliams described various agency initiatives, including (i) the issuance of a notice of proposed rulemaking (“NPR”) that grants federal savings associations greater flexibility to exercise national bank powers without changing their charters, (ii) the issuance of a joint NPR to revise the statutory definition of a high-volatility commercial real estate exposure acquisition, development and construction loan, (iii) the adoption of interim final rules modifying the liquidity coverage ratio rule and (iv) the issuance of a joint agency proposal to raise the total asset threshold from $1 billion to $3 billion to allow well-capitalized insured depository institutions to be eligible for an 18-month examination cycle.

Mr. Otting noted that the Office of the Comptroller of the Currency also intends to:

  • implement an exemption from appraisal requirements for certain rural real estate transactions;
  • reduce the regulatory burden on banks for calculating and reporting regulatory capital;
  • reduce reporting requirements on Call Reports;
  • increase the required frequency of stress testing and reduce the required number of scenarios; and
  • revise the leverage ratio requirements for the largest U.S. banking organizations.

Mr. Quarles stated that the FRB prioritized:

  • issuing a proposed rule tailoring enhanced prudential standards for banks with assets between $100 billion and $250 billion;
  • reviewing requirements for firms with assets between $250 billion and the globally systemic important bank threshold; and
  • revisiting the threshold for the application of enhanced prudential standards to foreign banks.

Ms. McWilliams outlined the FDIC’s plans, which include:

  • rule amendments to reflect the exemption for certain loans secured by real property;
  • a proposed rule as to the community bank leverage ratio;
  • updates to Call Report Instructions to reflect the reporting change from brokered to non-brokered treatment of specified reciprocal deposits; and
  • reductions in reporting requirements for “covered depository institutions” with less than $5 billion total assets in the first and third quarter Call Reports.

Mr. McWatters discussed the NCUA’s recent actions and noted that the agency began to (i) update its examiner guidance and examination procedures, (ii) review credit union compliance in line with its risk-focused examination program and (iii) work with state supervisory authorities and other federal regulators to implement regulatory amendments.

Senator Sanders Proposes Big Bank Breakup

Senator Bernie Sanders (D-VT) introduced legislation that would break up the biggest U.S. banking and financial institutions. The bill is sponsored in the U.S. House of Representatives by Representative Brad Sherman (D-CA).

The bill, titled the Too Big to Fail, Too Big to Exist Act, would, among other things, require:

  • the restructuring of certain covered financial institutions (including banking organizations, insurance firms, broker-dealers and investment advisers) with a total exposure greater than three percent of the GDP of the U.S.;
  • insurance companies with more than $50 billion in assets to report total exposure to federal financial regulators; and
  • the Federal Reserve Board Vice Chair of Supervision and the Financial Stability Oversight Council to submit written reports on the status of financially significant institutions.

Entities that exceed the three percent cap (i.e., “too big to fail” institutions) would be given two years to restructure. According to the bill, these “too big to exist” institutions would not be eligible for a taxpayer bailout from the Federal Reserve Board and could not use customers’ bank deposits to engage in “risky financial activities.”

Lofchie Comment: Like some Cabinet newsletters, nice title, not much substance.

Senator Introduces Draft Bill Expanding the Community Reinvestment Act

Senator Elizabeth Warren (D-MA) introduced legislation intended to increase the supply of lower- and middle-income housing, incentivize communities to revise their zoning laws to facilitate housing construction, and provide substantial grants to first time home buyers with an emphasis on loans in formerly segregated neighborhoods. The bill would materially expand the scope of the Community Reinvestment Act of 1977 (the “CRA”). The CRA requires depository institutions to help meet the credit needs of the communities in which they operate, including low- and moderate-income neighborhoods, consistent with safe and sound operations.

Senator Warren’s bill, titled the American Housing and Economic Mobility Act, would among other things:

  • Expand the Scope of Covered Institutions – The CRA currently applies to insured banks and thrifts. Under the bill, the scope of the CRA would be broadened to include U.S. non-bank mortgage originators, bank holding companies, savings and loan holding companies, and credit unions.
  • Revise the “Assessment Area” – Currently, a bank’s CRA performance is assessed on activities that occur in or that serve the institution’s assessment areas. An assessment area is generally limited to the area or areas surrounding a bank’s main office, branches and deposit-taking ATMs. Under the bill, the term “assessment area” would be expanded to include each community, including a state, metropolitan area and urban or rural county in which the institution: (i) maintains deposit-taking branches, ATMs or retail offices; (ii) is represented by an agent; (iii) issues a significant number of loans or other products relative to the total number of loans or other products made by the institution; (iv) has issued not less than 75% of the loans of the institution; or (v) has conducted not less than 75% of the business of the institution.
  • Require the Submission of “Community Benefits Plans” – The CRA does not currently require an applicant to a merger or other expansionary proposal to submit a community benefits plan, nor is such a plan required by the Federal Reserve under the Bank Holding Company Act or by any of the federal banking agencies under the Bank Merger Act. However, the CRA would, if amended by Ms. Warren’s bill, explicitly require the adoption of a community benefits plan and consultation with “community-based organizations and other community stakeholders” in developing such a plan.
  • Significantly Alter Procedures Applicable to Financial Holding Companies – The bill would amend notification procedures under Section 4(k)(6) of the Bank Holding Company Act to require prior notice filings and opportunities for public comment on certain acquisitions. In reviewing any prior notice filing, the Federal Reserve would be required to consider, among other things, the overall CRA rating of the financial holding company and any improvement plans.

Lofchie Comment: In her latest bill, Senator Warren takes aim at restrictive zoning policies that diminish the housing supply. (See Section 101(b).) San Francisco is commonly pointed to as a paradigm for such policies. The bill also provides for housing grants in areas where there is a shortage of housing and where rents have risen particularly fast over the last three years. (See Section 102(e) of the bill.) So what zoning policies should San Francisco adopt to be awarded some of the benefits provided for under the proposal? The bill could reward San Francisco by directing subsidies to ameliorate problems that – according to the bill – were created in the first place by the San Francisco zoning laws.

CFS Financial Crisis Timeline

As the 10-year anniversary of the global financial crisis approaches, assessment of key events before, during, and since is essential for understanding varying dimensions of the crisis.

The CFS Financial Timeline, created and managed by senior fellow Yubo Wang, seamlessly links financial markets, financial institutions, and public policies. It:

  • Covers more than 1,100 international events from early 2007 to the present.
  • Provides an actively maintained, free, and easy-to-use resource to help track developments in markets, the financial system, and forces that impact financial stability.
  • Curates essential inputs on a real time basis from established public sources.

Since 2010, the Timeline has become an integral part of the work done by scholars, students, government officials, and market analysts. View the Timeline.

We hope you find it of use and interest.

FRB Vice Chair Discusses Lessening Regulatory Burden on Community Banks

Federal Reserve Board (“FRB”) Vice Chair for Supervision Randal K. Quarles outlined the agency’s recent efforts to review and improve its regulatory framework now that implementation of major post-crisis reforms is largely complete.

In a speech before the 110th Annual Convention of the Utah Bankers Association, Mr. Quarles emphasized the importance of U.S. participation in the Financial Stability Board (“FSB”). He highlighted two supervisory improvements that the FSB and other agencies applied to reduce the regulatory burden on community and regional banks: (i) the FRB “Bank Exams Tailored to Risk” program and (ii) a joint action taken with other agencies to simplify the reporting responsibilities of smaller banks.

Mr. Quarles discussed the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Act”), which was recently signed into law. According to Mr. Quarles, the Act retains the most important post-crisis reforms while directing the FRB to make necessary changes to reduce the regulatory burden on regional banks. Additionally, Mr. Quarles said that raising the asset threshold for bank holding companies that are eligible for the Small Bank Holding Company Policy Statement allows the FRB to “tailor its rules for these firms moving forward while retaining the ability to protect the safety and soundness of the system.”

Mr. Quarles also underscored the importance of international regulatory communications, standard setting and assuming a comprehensive perspective on financial vulnerabilities when addressing global issues. Mr. Quarles argued that more accurate risk assessment in the broader financial system is integral to reducing the regulatory burden on community banks.