Fed Signals Continued Focus on Banking Sector Exposures to Nonbank Financial Institutions
Also: exploratory market shocks, and the FDIC's plan for bank merger and deposit insurance application briefings
Today the Federal Reserve Board published a draft Federal Register notice about proposed updates to its FR Y-14 series of reporting forms, which are used by the Board to collect certain information from large U.S. banking organizations, as well as the U.S. operations of certain foreign banks.1 In addition to being used for general supervisory purposes, these forms are also the vehicle the Board uses to collect information in connection with its supervisory stress test.
The notice describes a number of proposed updates; this post will discuss two of them.
Exposures to Nondepository Financial Institutions (NDFIs)
The Board observes that “U.S. bank exposures to NDFIs have grown rapidly over the past five years.” Because certain of these NDFIs “operate with very high leverage and are dependent on credit from the banking sector,” this increased exposure “poses risks to banks.”
This makes the Board uneasy, particularly because the FR Y-14 has a “material data gap” when it comes to NDFIs, which “hinders staff’s ability to consistently measure, monitor, and model the risks stemming from these exposures under stress.”
In particular, the FR Y-14 “currently does not require firms to report certain financial information (such as total assets, total liabilities, short term debt or net income) on NDFI obligors.” The Board worries that this means “stress test models may not accurately capture risks associated with loans” and that measurement and monitoring of these exposures for supervisory purposes may be inconsistent.
To address this concern, first, firms would be required to report an additional 30 or so data items2 about their NDFI borrowers, including total assets of the borrower, net income of the borrower, and so on.
Second, firms would need to identify their NDFI borrowers by entity type, “e.g., credit fund, broker-dealer, special purpose entity, etc.” The Board explains that it is proposing this because “various business types of NDFIs pose different types of risks to banks,” and therefore “these data are necessary to consistently measure and monitor the risks NDFIs pose to firms and to ensure that the supervisory stress test is appropriately calibrated for loans to NDFIs.”
Third, because the Board believes the changes described above, on their own, “would not increase insight into equity investments in the corporate sector where NDFIs are increasing their activities,” the Board proposes to also collect more data on financial sponsors.3 Specifically, firms will be required to report those of their borrowers that are “controlled by a financial sponsor” and if so will need to provide the identity of the financial sponsor. This is intended to “inform the Board of lending to companies controlled by a NDFI, a noted gap of insights into firm activities with NDFIs.”
These proposed changes are thematically consistent with, though not identical to, changes the Board, FDIC and OCC made to the call report earlier this year.
Continued Use of Exploratory Market Shocks
Under the Board’s supervisory stress test, certain banking organizations are subject to a global market shock (GMS), which is intended to stress those organizations’ trading, private equity and certain other fair-valued positions. Results of the GMS component feed into, and can be a significant driver of, a firm’s stress test losses, which are used to calculate the firm’s stress capital buffer.
Last year the Board’s supervisory stress test featured, in addition to the GMS, an “exploratory market shock” meant to test the U.S. GSIBs against a different set of risks than those posed by the GMS.4
The 2024 supervisory stress test, the results of which are set to be announced next week, expands a little further on this concept, testing the U.S. GSIBs against two exploratory market shocks, one “characterized by a sudden dislocation to financial markets stemming from expectations of reduced global economic activity and tighter financial conditions” and the other “characterized by a sudden dislocation to financial markets stemming from expectations of severe recessions in the United States and other countries.”
Currently only the GMS, and not any exploratory market shock(s), factors into a calculation of a firm’s stress capital buffer requirement. In the reporting form proposal published today, the Board says that “the use of a single GMS limits the Board’s ability to capture and test a firm’s resilience to a range of risks, which is the purpose of the supervisory stress test.” Accordingly, in order to “expand risk identification beyond the current GMS framework” the Board is proposing to require firms5 to “submit relevant data with respect to all market shocks that the Board may conduct in a given year, including any exploratory market shocks.”
So, though not really surprising in light of the stated desire of Vice Chair for Supervision Michael Barr to build additional scenarios into the Board’s stress testing program, the reporting form update proposed today seems to signal that the Board intends to continue to feature exploratory scenarios in future supervisory stress tests.
How many exploratory scenarios? The Board is keeping its options open. For purposes of the burden estimate required to be published along with the proposal, the Board assumes that it “would conduct two exploratory market shocks per year. However, the number of exploratory market shocks conducted may vary from year to year.”
The reporting form proposal says that “[c]onsistent with the nature of exploratory market shocks and their information-serving purposes, the losses associated with any exploratory market shocks would not contribute to firms’ capital requirements.”
FDIC Board Briefings re: Long-Delayed Merger and Deposit Insurance Applications
At a public meeting today the FDIC’s board of directors voted unanimously to adopt a proposed resolution offered by Vice Chair Travis Hill. The text of the resolution itself does not appear to be publicly available, but as described in a memo from Vice Chair Hill the resolution will require the FDIC staff to provide a briefing to the FDIC’s board of directors on any merger or deposit insurance application that has been outstanding for more than 270 days.
To avoid mischief, the 270-day clock will start running on the date of initial receipt of the application by the FDIC, and not the date the application is deemed by the FDIC staff to be complete. Staff briefings to the FDIC’s board will be required to include, among other things, “a timeline of steps that have been taken and expected timeframes for steps that still need to be taken.” Quarterly follow-up briefings will be required until final action is taken on the application.
ILC Applications
Some of the coverage of today’s vote has focused on the effect on bank mergers. This is obviously fair enough, and more on this below, but the resolution’s inclusion of long-pending deposit insurance applications is pretty interesting in its own right, particularly with respect to the industrial bank applications that the FDIC has had pending for roughly forever. These applications include:
An application from Ford, filed in July 2022
An application from Thrivent, filed in July 2021
An application from GM, filed in December 2020
Interestingly, though, the website of the Utah Department of Financial Institutions suggests that there may have been movement on some of these applications recently, at least at the state level if not at the FDIC.6 The Utah DFI’s application status page, last updated today, says that Thrivent’s application was “Approved 6/14/24.”
Even more interestingly, the same Utah DFI site lists GM’s application as “Approved 6/14/24,” but goes on to say that GM’s application was then “Subsequently Withdrawn 6/19/24.”
It is not immediately clear what this means or what (if anything) it suggests about the status of the FDIC’s own review of these applications.
Expected Effects on FDIC Bank Merger Reviews
In his statement in support of the proposal, Vice Chair Hill wrote:
A long application review process is costly in a variety of ways. In the case of mergers, it adds uncertainty for employees and customers, it makes post-merger integration more challenging, and it can be dangerous if one of the merging entities is in a vulnerable condition. . . .
The purpose of [the briefing] requirement is, in part, to give the Board more regular and rigorous insight into the review process, but more fundamentally it is intended to motivate faster processing of applications. 270 days is an extremely long time; we need to find ways to move faster.
As noted above, the FDIC’s vote on the proposal was unanimous, with all five directors voting in favor. CFPB Director Chopra’s statement on the proposal, however, suggests he has a different view from Vice Chair Hill as to the effects of this proposal (emphasis added throughout):7
. . . I think there can be a sense that the banking agencies are not willing to deny applications. And I think the result of this is an endless game of footsie between the agencies and the applicants. Often we hear this over and over and over again, where there are clear concerns that are communicated by the staff. Rather than putting the application through for the [FDIC] Board or leadership to issue a denial, we go through an endless iteration to determine how we can all twist ourselves into a pretzel to get to yes for sometimes facially deficient applications. We have denied the public with any real benefit about the reasons for those denials, and have not been willing in some cases to stand up to judicial scrutiny of it.
So I really think this is good. I think this is a way we can get applications processed and have those denials be public. That will provide a lot of benefit to the public about how we are looking at this, where the concerns are, so that future applicants can know what should be expected of them.
There is almost no litigated caselaw with respect to much of the application disposition, and I think there is a reputation that the agencies approve every single application, and that’s actually not true. We see a number of withdrawals that do occur and those withdrawals come with almost no transparency about what the agencies’ concerns are.
. . . I do think hopefully this will get us to a place of a policy where we can swiftly deny applications that are facially deficient or not substantially complete.
*****
The FR Y-14A report collects detailed data on bank holding companies’ (BHCs), savings and loan holding companies’ (SLHCs), and intermediate holding companies’ (IHCs) quantitative projections of balance sheet assets and liabilities, income, losses, and capital across a range of macroeconomic scenarios and qualitative information on methodologies used to develop internal projections of capital across scenarios. The FR Y-14Q collects detailed data on BHCs', IHCs', and SLHCs’ various asset classes, capital components, and categories of pre-provision net revenue (PPNR). The FR Y-14M report collects monthly detailed data on BHCs’, IHCs’, and SLHCs’ loan portfolios.
Specifically firms would be required to report “fields 52 through 82 on Schedule H.1, the ‘Obligor Financial Data Section’.”
The release describes a financial sponsor for these purposes as an entity “whose principal business activity is acquiring, holding, and selling investments in otherwise unrelated companies that each are distinct legal entities with separate management, books, records, and bank accounts, whose operations are not integrated with one another and whose financial condition and creditworthiness are independent of the other companies so owned by such person.”
The custody bank U.S. GSIBs were subject only to a portion of the exploratory market shock. See page 2:
As in the supervisory stress test, the exploratory market shock for The Bank of New York Mellon Corporation and State Street Corporation will only include the counterparty default component. Their exploratory market shock component will not include mark-to-market losses on their trading or credit valuation adjustments exposures.
The proposal seems to say that this new reporting requirement would apply to all firms currently subject to the GMS component of the supervisory stress test, rather than only applying to the U.S. GSIBs that have been subject to the 2023 and 2024 exploratory market shocks. See the bottom of page 6: “Firms currently subject to the GMS component of the supervisory stress test would be required to report FR Y-14 information related to any exploratory market shocks.”
This could be read to suggest that exploratory market shocks in future years will apply to a broader range of firms. If the same group as the GMS, this would scope in the U.S. operations of foreign banks with significant trading operations such as Barclays, Deutsche Bank and Credit Suisse (now UBS).
The way these applications work is that the company needs to get Utah DFI approval to charter the industrial bank, and also separately needs to get FDIC approval for deposit insurance for the new industrial bank.
This statement starts at the 45:29 mark of the recording of the FDIC’s public board meeting.