BPInsights: Jan. 11, 2025

Fed's Barr Resigns from Supervision Job

Michael Barr will step down from the position of Federal Reserve Vice Chair for Supervision as of Feb. 28, 2025, the Fed announced on Monday. The action avoids a potential legal dispute if President-elect Trump had tried to remove or demote Barr. The Fed does not plan to engage in any major rulemakings until a successor to Barr is confirmed, according to the central bank's announcement. Barr will remain a member of the Fed's Board of Governors.

• Upshot: Barr's decision to remain a Fed governor may complicate President-elect Trump's options for replacing him. To replace Barr as supervision chief, he would either have to wait until there is a vacant governor's seat or elevate a current governor, Axios reported this week.
• Potential successor: A likely candidate for successor is Fed Governor Michelle "Miki" Bowman, Capitol Account reported this week. Bowman's family founded Kansas community bank Farmers and Drovers Bank, and she previously worked there and later as a state banking regulator. She has the support of community bankers, and during the Biden administration has "often played the loyal opposition, blasting [Barr's] Basel capital plan and regularly reminding audiences about the thousands of pages of complex rule text that the Fed has published."

Five Key Things

1. How Stress Tests Started, and Where They Stand Now

The Federal Reserve's stress test evaluates whether large banks in the U.S. can withstand economic shocks. A new BPI factsheet offers a quick look at stress tests' past, present and future. Read it to find out:

• How did stress testing start, and how has it evolved?
• How are stress tests connected to banks' capital requirements?
• What are the challenges, inaccuracies and weaknesses of the stress tests?

The factsheet corrects common misconceptions about the stress test and explains why BPI and its partners are challenging the opacity of the Fed's stress test models in court.

2. Silvergate Bank: A Discount Window Success Story

Silvergate Bank's actions leading up to its liquidation show how the discount window can prevent bailouts.

What happened: In the fourth quarter of 2022, Silvergate Bank, a $16 billion California bank with a concentration in the crypto industry, experienced a depositor run after the crypto firm FTX collapsed. In total, nearly 70 percent of the bank's deposits fled in that quarter, totaling $8.1 billion.

• This situation resembled the runs on SVB and Signature Bank the following March, but its outcome differed in one key way: Silvergate was prepared to borrow from the discount window.
• When Silvergate liquidated itself, it repaid all its depositors, and there was no loss to the FDIC.

The alternative: The day after Silvergate announced it would self-liquidate, Silicon Valley Bank closed its doors amid a massive run. SVB attempted to shift collateral to the discount window but was unable to do so because it had not taken steps to prepare to borrow. Signature Bank encountered similar difficulties. To stanch the run and prevent broader contagion in the banking system, the Treasury, Fed and FDIC invoked the systemic risk exception to least cost resolution to enable the FDIC to bail out uninsured depositors.

Key point: The discount window operated the way it was supposed to do in the case of Silvergate, preventing a disorderly failure. If SVB and Signature had been prepared to borrow, they could have wound down safely, obviating a government bailout.

Missed opportunity: Despite the clear benefits of being prepared to borrow from the discount window, banking regulations still do not recognize that a bank that is prepared to borrow is more liquid than one that is not. There is a missed opportunity to give banks incentives to borrow and to address longstanding stigma surrounding the window. The Fed has taken some constructive steps recently such as seeking public input on discount window operations.

• In response to the Fed's request for comment, BPI emphasized the importance of being able to move collateral to the window rapidly.
• The Fed published an FAQ in August that stated that banks are now allowed to point to the discount window in their required internal liquidity stress tests as the means by which they would monetize their liquid assets.
• A recent BPI survey found that the FAQ had been an effective step in reducing, although not eliminating, stigma.

Nevertheless, a bank with prepositioned collateral at the Fed is still not allowed to count on the window as a source of liquidity in its internal tests, nor does the capacity count toward the bank's liquidity coverage ratio. Banks are also not allowed to count on the window as a source of liquidity in resolution for more than a few days. Addressing these outstanding vulnerabilities could bolster the chances that the discount window once again fulfills its intended purpose.

3. Will OIG's Supervision Scrutiny Make MRAs Better or Worse?

The Office of Inspector General overseeing the Federal Reserve and CFPB recently issued an updated work plan that previews an assessment of the Fed's supervision practices. It specifically previews OIG evaluation of how the Fed follows up on Matters Requiring Attention and Matters Requiring Immediate Attention. "The Board expects examiners to follow up on MRAs and MRIAs to assess a banking organization's progress and to validate that the organization has implemented satisfactory corrective actions," the report says. "We plan to assess the effectiveness of the Board's and the Reserve Banks' practices for following up on supervisory findings that address safety and soundness issues."

• Addressing the substance: It seems unlikely that the OIG would address the core substantive problem with MRAs and MRIAs - their issuance to force compliance with examiner preferences that lack any clear nexus to bank safety and soundness. Until this core substantive problem is addressed, an emphasis on speedy follow-up is likely to reduce the efficiency and competitiveness of the banking system without improving bank safety and soundness.

4. Supervision, Tailoring and Stress Tests: Highlights from Bowman's Remarks

Federal Reserve Governor Michelle Bowman remarked on several significant regulatory topics in a speech this week at a California Bankers Association event. Her remarks recommended a "pragmatic approach" to policymaking and a renewed commitment to tailoring regulation. Here are a few key takeaways.

• Supervision: Bowman suggested examiners should "prioritize safety and soundness and deprioritize matters that are not essential to-or that are tangential to-our statutory obligations." Bowman warned that the 2023 bank failures sparked many regulatory and supervisory proposals that swept unrelated, perhaps unjustified changes into the "crisis response." Such responses "included finding supervisory deficiencies in the management of well-capitalized and financially sound firms and considering widespread changes to the funding and liquidity requirements and expectations that apply to all banks." In addition, the "wide range of information being categorized as confidential supervisory information (CSI)" in supervision prevents banks from deepening their understanding of supervisory expectations, she said.

• Tailoring: Bowman views tailoring as essential for maintaining an effective regulatory framework that can appropriately address risks while supporting economic growth. She argues that a one-size-fits-all approach could harm medium-sized banks and lead to unnecessary consolidation in the banking sector.
• Stress tests: Bowman expressed support for the Fed's recently announced effort to revisit the stress testing framework to increase transparency and reduce volatility in the test results.

5. Quarles on Basel: 'Maybe We Go Back to Totally Capital-Neutral'

Former Fed Vice Chair for Supervision Randal Quarles suggested capital neutrality - a net change that neither raises nor lowers the aggregate amount of capital in the banking system - could be the future of the U.S. Basel Endgame measure as the banking agencies consider revisions to the proposal. "Maybe we go back to totally capital neutral now," Quarles said in a Risk.net interview published late last week. "I think it's in the interest of the U.S. and the banking industry to implement this in a way that's closer to what I left on the shelf." When Quarles left his position at the Fed, he envisioned a Basel Endgame plan that would have led to a 3 percent or 4 percent aggregate capital increase. He also said that "acting Comptroller of the Currency Michael Hsu was the stumbling block in 2021" that prevented Quarles' 2021 proposal from seeing the light of day.

• The face of Basel revamp? Quarles suggested that Fed Governor Michelle Bowman or the FDIC's Travis Hill could play a leading role in shepherding Basel revisions under a Republican Administration. In a comment before Barr's resignation was announced, Quarles said: "[T]he majority party in Washington may not trust Michael Barr on capital regulation and may want to move it to another governor or agency. That is very doable, exactly as we did with CRA while I was there."

In Case You Missed It

Judge Affirms NY Fed's Right to Close Puerto Rico Bank's Master Account

A federal judge in New York this week reaffirmed a previous ruling that denied a Puerto Rico bank's request to block closure of its Federal Reserve master account. The bank, Banco San Juan Internacional Inc., had sought a preliminary injunction to stop the Fed's closure of its master account, a privilege that comes with access to the federal payments system. The Fed had terminated the bank's account based on concerns about compliance with U.S. sanctions and anti-money laundering rules, particularly in connection to Venezuela. The judge ruled that the bank does not have a statutory right to a master account.

• Bigger picture: Fed master accounts have emerged in recent years as a coveted goal for crypto-focused firms such as Custodia in Wyoming, which sued the Fed over master account access.

FDIC's Hill on Crypto, Supervision, Debanking

FDIC Vice Chair Travis Hill, who is slated to take over as Acting Chair when Martin Gruenberg steps down ahead of the presidential inauguration, previewed several priorities in a speech Friday at an American Bar Association event. Here are some highlights.

• Substance over process: FDIC examiners should strive to move away from a focus on "process-related issues" and focus more on core safety and soundness issues, Hill said in prepared remarks. The process-centered approach may have distracted examiners from the issues that led to Silicon Valley Bank's failure, he suggested. He also said regulators should revisit the CAMELS supervisory rating system and reform examination, including by retraining examiners and revising exam manuals.

• Debanking: Hill also addressed a topic that has attracted significant attention in public discourse lately - "debanking." "There is no place at the FDIC for anyone who has pushed-explicitly or implicitly-banks to stop serving law-abiding customers," Hill said in the remarks.

• Technology: Hill's remarks describe the current FDIC approach to digital assets as one that has "stifled innovation and contributed to a public perception that the FDIC is closed for business" if banks are interested in such technologies. The agency should provide clear guidance on what activities are permitted, he said.

• Capital: Hill said in the remarks that he supports a "roughly capital-neutral" revision of the Basel capital proposal. He cited the Fed's recent announcement on stress testing that said that "proposed changes are not designed to materially affect overall capital requirements," noting that if that is the case, then the Basel overhaul will need to take that into account.

• M&A: The length of bank M&A application processing is a "huge problem," Hill said. He said he is focused on process improvements that will expedite the application process, which can take well over a year currently. He is seeking to move together with the other banking agencies on a consolidated approach to M&A but it's "too soon to say if that is a realistic possibility in the short term." He added that the FDIC is "thinking through the options" on what to do about the 2024 policy statement, which laid out a prescriptive and restrictive approach to M&A.

CFPB Finalizes Rule Barring Medical Debt from Credit Reports

The CFPB this week finalized a rule banning medical debt from being included in credit reports. The rule also prohibits lenders from considering medical information in lending decisions. Critics of the rule have expressed concern that it could artificially inflate consumers' credit scores, leading vulnerable consumers to take on more debt than they can handle.

• Compared to proposal: The proposal was limited to debt owed directly to medical providers and did not include third-party debt.
• Future in flux: The rule comes as President-elect Trump prepares to enter office on Jan. 20; his Administration is expected to oppose CFPB policies enacted under Director Rohit Chopra. The rule would fall within the Congressional Review Act window, when Congress could eliminate it through a legislative vote. If the rule is not published in the Federal Register before the inauguration, the new Administration could preclude it from being published. The rule faces a legal challenge by the Consumer Data Industry Association.
• Other CFPB actions: The CFPB has showed no sign of slowing its pace of activity even as the inauguration approaches. The bureau took several other actions this week, including recognizing the Financial Data Exchange as a standard-setter under the Section 1033 data sharing rule; agreeing to launch a rulemaking on nonbank firms providing personal consumer loans in response to a petition for rulemaking by the Consumer Bankers Association and Center for Responsible Lending; and agreeing to initiate a rulemaking to shorten maximum permissible hold times for checks and funds deposited by customers in response to a 2024 petition filed by Aaron Klein and Miriam Carliner of The Brookings Institution. The CFPB also reinstituted policies on compliance assistance sandbox approval and no-action letters.

Fact Check: Hsu on Basel, Supervision, Liquidity

OCC Acting Comptroller Michael Hsu weighed in on liquidity, capital and other key topics in a recent Q&A with POLITICO.

• Basel 3 finalization: Hsu said it is needed to prevent a "race to the bottom" among international banks, but Hsu's example of variability in risk-weighted assets across jurisdictions is flawed, as shown by BPI's prior research. For example, variability can be driven by jurisdiction-specific discretion in estimating loss given default, especially how LGDs during a downturn are calculated.
• Capital neutral: The net effect of any changes in the stress tests, Basel Endgame proposal and GSIB surcharge should be "comprehensive capital neutrality," Hsu said. "There's enough capital in the system," he said. "If everyone can commit to comprehensive capital neutrality … then we get the best of both worlds … We get some of that recalibration which banks are searching for, and you can still walk away and say there's enough capital in the system." But he emphasized that the result shouldn't be less capital: "If all you do is turn the dials for each of these, and you get less than that, then we have a problem." This comment rests on a false premise that banks are undercapitalized - banks are at or above optimal levels of capital, according to BPI research. The most reliable and highest-quality form of bank capital has increased nearly 3.5x since the Global Financial Crisis.
• Black box: It was hard for regulators to show the public they were doing due diligence on banks' liquidity in the wake of Silicon Valley Bank's failure, Hsu said, because "it's confidential supervisory information … it's hard for us to be transparent about all of that." That challenge is why Hsu and the Fed's Michael Barr were contemplating a new liquidity rule, he said. "A rule would essentially lock in those gains, and do it through a transparent mechanism, with notice and comment and make it clear to everyone, we've got consistency across banks and across time, that those improvements that were made are essentially locked in, and they're transparent." The fact is, if regulators wanted examination to be transparent, they wouldn't cloak so much information into the black box of "CSI." This rationale also distracts from the supervisory failure that missed the biggest risks at SVB.
• No surprises: In the context of whether SVB's failure was the fault of examiners, Hsu said, "I'm in the camp of, supervisors are not the fourth line of defense for banks, right? We don't get paid to prevent banks from failing, period. That's not the role of a supervisor. It is to minimize surprise." Again, SVB was a complete failure of supervisory oversight - SVB's examiners were surprised because they weren't paying attention to the most important risks.
• Forgiveness or permission: Hsu was asked about regulators' posture on banks and crypto. He referred to a joint statement from the banking agencies in 2023 advising banks on how they should proceed in crypto activities. "Most banks who were crypto-curious said, 'OK, this is more trouble than it's worth. We're not going to do it,'" he said. "And some banks said, 'Well, we really want to get into this, and so we have to just do the work to take care, to manage these risks.' Totally fine. That's a choice. We just want to be really clear as to what that choice is." Just how much of a choice banks have is unclear. The OCC has imposed through interpretive letter an examiner "non-objection" process on banks seeking to engage in crypto-related activities. Relatedly, over two dozen FDIC "pause letters" to banks on crypto activities, recently released as part of a court case, show how the hidden supervisory process stifles banks' choices when it comes to the businesses they engage in.

Competition, Economic Growth, Tech Impacts and Nonbanks: Bank of England Flags Research Priorities

The Bank of England this week published its research agenda for 2025-2028, highlighting a range of priorities from macroeconomics to prudential policy. Here are a few takeaways.

• Prudential: The BoE will examine how prudential policies can "promote the competitiveness and growth of the UK economy while continuing to ensure the safety and soundness of regulated financial institutions." The central bank will also investigate the optimal level of capital for insurers, how nonbank and market-based finance firms affect the spread of shocks across the financial system and how prudential policies affect risk-taking and financial sector resilience.
• CBDC: The BoE plans to study how different design choices for central bank digital currency would affect monetary transmission, financial stability and innovation. This is part of an ongoing CBDC project at the Bank; other areas for research include the resilience of core markets, the economic effects of AI and machine learning by market participants and other work on fintech.
• Balance sheet: The central bank will also research potential effects of new counterparties such as stablecoin issuers and CBDC holders gaining access to central bank balance sheets.
• Other priorities: The Bank also plans to study the implications of fragmentation; international spillovers; implications of climate change, digitalization and other major shifts. In addition, it flagged the roles of nonbanks, banks, market-based finance and "new forms of financial intermediation" in originating and propagating shocks internationally; and the effects of leveraged nonbanks on the financial system.

The Crypto Ledger

Here's the latest in crypto.

• Coinbase in court: A federal judge granted crypto exchange Coinbase's request for a special, narrow appeal to the U.S. Court of Appeals for the Second Circuit in a legal battle between the firm and the SEC. Coinbase seeks to rebut allegations from the SEC that the exchange improperly handled trading of unregistered securities.
• Give up the passcodes: A U.S. District Court judge ordered an early bitcoin investor accused of crypto-related tax fraud to disclose his secret passcodes so the U.S. government can unlock his crypto accounts. The U.S. officials are seeking access to digital assets now valued at about $124 million, according to Bloomberg. The case centers on Frank Richard Ahlgren III, who owes the government about $1 million in restitution in the case.

PNC Supports Low-Income Housing Investment Effort

PNC Bank recently announced a $128 million investment in affordable housing across the U.S., supported by a Low-Income Housing Tax Credit Fund that includes investments from PNC and other financial institutions and insurers. The housing funds will provide up to $128 million in financing for more than 1,400 affordable housing units across eight states.

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