Whatever Happened With...
In the middle of a mostly sleepy August, this post offers a brief look at four issues where it has been a while since a public update from the federal banking regulators, along with some speculation as to what might be happening behind the scenes.
SLR Revisions
Background: In April 2020 the Federal Reserve Board announced a temporary change to the supplementary leverage ratio to exclude U.S. Treasury securities and deposits at Federal Reserve Banks from the denominator of the SLR. On March 19, 2021, the Board announced that the temporary change would expire on March 31, 2021 as scheduled. As part of that announcement the Board also, however, noted the following:
[B]ecause of recent growth in the supply of central bank reserves and the issuance of Treasury securities, the Board may need to address the current design and calibration of the SLR over time to prevent strains from developing that could both constrain economic growth and undermine financial stability.
To ensure that the SLR—which was established in 2014 as an additional capital requirement—remains effective in an environment of higher reserves, the Board will soon be inviting public comment on several potential SLR modifications. The proposal and comments will contribute to ongoing discussions with the Department of the Treasury and other regulators on future work to ensure the resiliency of the Treasury market.
Status: No proposals have been released and no public comment has been invited following the March 2021 statement.
In his nomination hearing this past May, now-confirmed Vice Chair for Supervision Michael Bar had the following exchange with Senator Rounds:
Rounds: … It sounds like you are agreeing to considering permanent modifications to the SLR. When do you think we could expect to see action on that? …
Barr: … As I said to Senator Toomey, what I’d like to do is to come in to this position if confirmed and wrap my arms around the whole capital and liquidity picture - that includes the SLR, the Basel III endgame, and stress testing and the like - and make sure I understand the full package of potential issues. I want to make sure that I understand how the institutions are doing with respect to emergent risks as well…
Rounds: … I guess what I’m asking is that you would move forward fairly quickly to address the SLR issue.
Barr: … What I’d really like to do, and what I think makes sense, is not to think about the capital rules piecemeal but to understand them as a group.
Rounds: You’re talking about a long-term study, an extended period of time. I just want to clarify that this isn’t going to take years to get done.
Barr: Senator, it will not take years.
Rounds: Will it take months to get done?
Barr: I can’t specify the exact time period, Senator. I promise that I take the issue seriously. …
VCS Barr left himself a good deal of room to maneuver there in terms of timing, but given that he mentioned the Basel III endgame, I wonder if that forthcoming rule proposal might be the vehicle the Board uses to solicit comment on the potential SLR changes first previewed in March 2021.
The timeline for a Basel III endgame rule proposal is uncertain, but for what it is worth the OCC and FDIC in their latest non-binding and very much aspirational1 regulatory agendas say that they expect to release proposals by this December. The Board’s own agenda does not list a Basel III endgame proposal, but the OCC and FDIC agendas each indicate that they are anticipating a typical FRB/OCC/FDIC joint rulemaking.2
HHI Thresholds in Bank Merger Competitive Review
Background: In September 2020 the Department of Justice’s Antitrust Division sought public comments on potential changes to its framework for evaluating the competitive aspects of bank mergers, last revised in 1995. Among the topics on which the Division solicited comment was whether the deposit-based Herfindahl-Hirschman Index (HHI) “screening thresholds in the 1995 Banking Guidelines [should] be updated to reflect the HHI thresholds in the 2010 Horizontal Merger Guidelines.”
An overview of the context can be found in a Wachtell Lipton comment letter:
Presently, as a “screening test” for competitive considerations under the Banking Guidelines, the Division and FRB traditionally conclude that a merger presents no competitive concerns and warrants no further investigation if either (a) the post-merger HHI (computed by summing the squares of deposit-based market shares of all FDIC-reporting firms in affected geographic markets) is less than 1800 or (b) the increase in the HHI as a result of the merger is less than 200 points. If a proposed transaction does not exceed this 1800/200 screen, “the banking agencies are unlikely to further review the competitive effects of the merger.”
When the 1800/200 standards in the Banking Guidelines were adopted, they were more relaxed than the HHI thresholds applied to industrial mergers (1800/50), residing at the upper limit of the Industrial Guidelines’ category of moderate concentration with a greater permissible HHI change. … In 2010, however, when the Industrial Guidelines were revised to relax HHIs for industrial mergers, the Banking Guidelines were not similarly revised …
Of course, the Antitrust Division is now under new management and in December 2021 the Division sought “additional comments” on the 1995 guidelines. This time, the Division asked commenters to focus on “whether bank merger review is currently sufficient to prevent harmful mergers and whether it accounts for the full range of competitive factors appropriate under the laws.”
Status: The comment period for the DOJ’s most recent request closed in February 2022. The comment letters the DOJ received are available here, including a letter submitted by FTC Chair Lina M. Khan in her personal capacity. Among other things, Chair Khan’s letter calls for the HHI screens used in bank merger review to be made more restrictive:
Deposit-based HHI screens at the current thresholds appear to have permitted consolidation that reduced competition in consumer banking. Accordingly, adjustments to those thresholds should be considered to strengthen enforcement.
Separately, the DOJ and FTC are also in the process of reviewing their more general horizontal merger guidelines, and although there is no formal deadline Chair Khan has stated that draft new guidelines may be released late this summer or early this fall, with a view to finalizing them before the end of the year. It is not clear what will come from the DOJ’s review, and even if the DOJ does make revisions to its competitive analysis framework for bank mergers those revisions may not necessarily be mirrored by the federal banking agencies in their own frameworks.
As for what the banking agencies are doing, the FDIC’s request for information on bank mergers has received a lot of attention, as have Acting Comptroller Hsu’s speeches regarding the potential imposition of certain conditions in connection with large regional bank mergers.
Less remarked upon, though, has been the Federal Reserve Board’s own review of its competitive analysis framework, which a speech by Governor Bowman in February 2021 (that is, prior to President Biden’s July 2021 executive order on bank mergers and prior to the FDIC’s March 2022 RFI) seemed to suggest was independently underway:
Technological developments and financial market evolution are quickly escalating competition in the banking industry, and our approach to analyzing the competitive effects of mergers and acquisitions needs to keep pace. The Board's framework for banking antitrust analysis hasn't changed substantially over the past couple of decades. I believe we should consider revisions to that framework that would better reflect the competition that smaller banks face in an industry quickly being transformed by technology and non-bank financial companies. As part of this effort, we have engaged in conversations and received feedback from community banks about the Board's competitive analysis framework and its impact on their business strategies and long-term growth plans. We are in the process of reviewing our approach, and we are specifically considering the unique market dynamics faced by small community banks in rural and underserved areas.
There have been no real public updates from the Board since then, although perhaps you could discern from another Governor Bowman speech, this one delivered just last week, some hints as to which faction currently has the upper hand behind the scenes:
Earlier this year, the Justice Department requested comment on whether to revise their 1995 Bank Merger Competitive Review guidelines, seeking input on a wide range of issues. The FDIC also issued a request for information on the Bank Merger Act framework. I expect this review will be a focus across the banking agencies, and I will be very interested to see how the framework for small and regional banks is affected by any proposed change. I would be concerned about any changes that would result in making mergers among these institutions more difficult or would not address some of the longstanding issues with the existing framework. Among those are that the framework doesn't account for new technologies or overwhelming competition posed by credit unions, internet based financial services, and non-bank financial companies. Another concern is that overly strict criteria for mergers could have the unintended consequence of depriving consumers in some areas of access to any banking services. "Banking deserts" in rural and underserved areas are a real problem and regulators should guard against this outcome when proposing or evaluating rules.
Greater Clarity for Crypto-Asset Related Activities
Background: In November 2021 the Board, FDIC and OCC announced that they had recently completed a review and analysis of “a number of crypto-asset activities in which banking organizations may be interested in engaging.” The agencies also promised further action:
Throughout 2022, the agencies plan to provide greater clarity on whether certain activities related to crypto-assets conducted by banking organizations are legally permissible, and expectations for safety and soundness, consumer protection, and compliance with existing laws and regulations related to:
Crypto-asset safekeeping and traditional custody services.
Ancillary custody services.
Facilitation of customer purchases and sales of crypto-assets.
Loans collateralized by crypto-assets.
Issuance and distribution of stablecoins.
Activities involving the holding of crypto-assets on balance sheet.
Status: The agencies have not in 2022 provided guidance on any of the matters described above. And from the few public details about the process that have trickled out, signs are that things have not gone smoothly this year.
First, Politico reported in May that the FDIC had paused its work with the other agencies on these matters.3
In June, testimony from Chair Powell suggested that the agencies may have been caught off guard by actions taken by other federal financial regulators.
U.S. Federal Reserve Chairman Jerome Powell said on Wednesday that a recent, much-debated move by the Securities and Exchange Commission (SEC) has thrown a potential wrench into common practice for how the U.S. central bank and banking regulators view digital assets held by lenders. Powell's remarks came in testimony on monetary policy before the Senate Banking Committee.
In an accounting directive – the innocuous-sounding Staff Accounting Bulletin No. 121 – to public companies, the SEC had advised firms holding customers’ digital assets that they’d need to consider those assets as belonging to the companies’ own balance sheets. …
"Custody assets are off balance sheet, have always been,” Powell told the Senate Banking Committee. “The SEC made a different decision as it relates to digital assets for reasons it explained, and now we have to consider those.”
As it relates to the banks the Fed oversees in the U.S., Powell said the SEC’s interpretation is “certainly something we're focusing on very closely right now,” adding that his agency is working with other banking regulators to figure out how it might change the way they assess lenders that keep cryptocurrencies.
Finally, last week a group of Democratic Senators led by Senator Warren sent a letter to the OCC taking issue with interpretive letters issued by the OCC in 2020 and 2021 which, according to the Senators, provided banks with essentially “unfettered opportunity to engage in certain crypto activities.” The Senators acknowledge that the OCC under Acting Comptroller Hsu revised certain of these interpretive letters, but say that the letters as revised continue to raise concerns and thus should be withdrawn.
Somewhat confusingly in light of the above-quoted November 2021 announcement from the agencies that they are doing exactly this, the letter also calls for the Board, OCC and FDIC to work together to “develop a comprehensive approach that adequately protects consumers and the safety and soundness of the banking system.” One way to read this in context of the previously-reported FDIC withdrawal from the process is as a sign that the letter writers do not like where the Board and OCC are heading with their existing review. It is also possible, though, that the letter just lapsed into a boilerplate call for coordination, without intending that anyone read too much into it.
Industrial Bank Applications
Background: Six applications seeking either deposit insurance for a de novo industrial bank or seeking to convert an existing bank to an industrial bank are currently pending with the FDIC. Industrial banks are attractive to certain applicants (and strongly disliked by other stakeholders) because a company that owns an industrial bank generally is not subject to the Bank Holding Company Act.
The most recent of the six pending industrial bank applications was filed by Ford a few weeks ago, but the others have been pending for some time:4
Rakuten Bank America, first filed in July 2019
Edward Jones Bank, first filed in July 2020
GM Financial Bank, first filed in December 2020
Thrivent Bank, first filed in February 2021
Ameriprise Bank, first filed in June 2021
Status: Unclear. A bill to restrict the types of companies that would be permitted to control industrial banks passed the House Financial Services Committee earlier this year, but the bill’s prospects beyond that are uncertain.
The current FDIC is understood to be highly skeptical of industrial bank applications, and a few applicants other than those listed above have withdrawn their applications without refiling, apparently deciding not to bother any longer.5
Many both in the banking industry and at the banking regulators would not be disappointed to see the other applicants make the same decision, but assuming the pending applications are not withdrawn, at some point the time-honored FDIC tradition of simply ignoring industrial bank applications in the hope that they will go away is going to prove untenable,6 and action will need to be taken one way or the other.
The FDIC’s agenda from Spring 2021, for instance, said that the FRB/OCC/FDIC intended by August 2021 to issue a “proposal to comprehensively revise the Agencies’ risk-based capital rules, including revisions to the current standardized and advanced approaches capital rules.”
An additional interesting thing about the agenda items is that the FDIC’s description of the forthcoming proposal says that the revisions would apply only to firms subject to Category I and Category II prudential standards, or with significant trading activity. The OCC’s description, on the other hand, says more generically that the proposal will include “revisions to the current standardized and advanced approaches capital rules.” These statements are not necessarily inconsistent with each other, and even if they were I would be cautious about reading too much into them, but still maybe notable.
The reasons for the pause are not completely clear, particularly in light of the “FDIC Priorities for 2022” in this area, announced by Acting FDIC Chairman Gruenberg in February:
It is imperative that the federal banking agencies carefully consider the risks posed by these products and determine the extent to which banking organizations can safely engage in crypto-asset-related activities. To the extent such activities can be conducted in a safe and sound manner, the agencies will need to provide robust guidance to the banking industry on the management of prudential and consumer protection risks raised by crypto-asset activities.
The list in the main text reflects when the applications were first filed. It is not uncommon for a deposit insurance application to be withdrawn and refiled with revisions based on initial FDIC feedback, and a few of the applicants on this list have done so. Particularly notable is Rakuten, which filed in July 2019, withdrew in March 2020, re-filed in May 2020, withdrew in July 2020, and re-filed in January 2021.
A charter application by discount brokerage platform Interactive Brokers was filed in October 2019 and withdrawn in May 2020, while Brex filed in February 2021 and withdrew in August 2021.
Most notable, though, might be the proposed GreatAmerica Bank, which filed in March 2020 and withdrew in March 2022. The company’s CEO said his firm initially had “great discussions” with the FDIC regarding the filing, but things later shifted: “Going into the process, we also knew that the industrial bank charter was a controversial charter in the minds of some politicians. And when the political tension in Washington spilled over to cause changes in the leadership at the FDIC, it was clear that this would affect our ability to obtain the industrial bank charter in this window.”
To be fair to the current FDIC leadership and senior staff, even with an FDIC under former Chairman Jelena McWilliams that was much more inclined to be open to industrial bank applications, the process still a took a while. The two applications approved under Chairman McWilliams had the following timelines:
Square Financial Services - first filed September 2017, withdrawn April 2018, re-filed December 2018, approved March 2020.
Nelnet Bank - first filed June 2018, withdrawn September 2018, re-filed November 2019, approved March 2020.
Thus, viewed in light of these recent precedents, you could argue that the current applications have not (yet) been pending for an unusual amount of time.