FEDERAL GOVERNMENT RELATIONS
Fed Stress Tests Show Large Banks Can Weather Severe Recession
The Federal Reserve indicated Wednesday that large banks are well positioned to weather a severe recession and continue to lend to households and businesses even during an economic downturn, according to the results of Dodd-Frank Act-mandated stress tests.
According to the Fed, all 23 banks above $100 billion in assets tested remained above their minimum capital requirements during the hypothetical recession, despite total projected losses of $541 billion. Under stress, the aggregate common equity risk-based capital ratio – which provides a cushion against losses – is projected to decline by 2.3 percentage points to a minimum of 10.1%. This year's test modeled a severe global recession with a 40% decline in commercial real estate prices, a substantial increase in office vacancies, a 38% decline in house prices and an unemployment rate peaking at 10%.
For the first time this year, the Fed conducted an exploratory market shock on the trading books of the largest banks, testing them against greater inflationary pressures and rising interest rates. The Fed indicated the exploratory market shock would not contribute to banks' capital requirements but was used to further understand the risks with their trading activities and to assess the potential for testing banks against multiple scenarios in the future. The results showed that the largest banks' trading books were resilient to the rising rate environment tested.
Rep. Mooney Introduces Bill to Help Small Banks Raise Capital
This week, Rep. Alex Mooney, R-W.Va., introduced a bill that would raise the threshold for small bank holding companies from $3 billion to $10 billion. H.R. 4346 would enable more banks to operate at higher debt levels, allowing them to raise capital more cheaply. The bill does not change capital rules and regulations for subsidiary banks. Five House Republicans also co-sponsored the bill, which is endorsed by both the American Bankers Association and the Independent Community Bankers of America.
Indiana Communities Could Benefit From Young Bill
U.S. Sen. Todd Young is pushing bipartisan legislation that could entice investors to revitalize blighted areas and bring in more affordable housing. The Neighborhood Homes Investment Act would create a federal tax credit for investments into developing and renovating single-family housing in distressed urban, suburban and rural neighborhoods.
Agencies Finalize Updated Statement on CRE Loan Accommodations
The Office of the Comptroller of the Currency, Federal Deposit Insurance Corp. and National Credit Union Administration Thursday issued an updated policy statement regarding accommodations and workouts for commercial real estate loans whose borrowers are experiencing financial difficulty. The policy statement – which supersedes a previous statement adopted in 2009 – recognizes the recent elimination of accounting for troubled debt restructurings.
The statement also builds on existing supervisory guidance calling for financial institutions to work prudently and constructively with borrowers during times of financial stress, updates interagency supervisor guidance on commercial real estate loan workouts and adds a section on short-term loan accommodations.
Regulators reaffirmed two key principles from the 2009 statement with regard to safety and soundness standards. First, financial institutions that implement prudent CRE loan accommodations and workout arrangements following a comprehensive review of a borrower's financial condition will not be subject to criticism for engaging in these efforts, even if these arrangements that result in modified loans with weaknesses that result in adverse classification. Second, modified loans to borrowers who have the ability to repay their debts according to reasonable terms will not be subject to adverse classification solely because the value of the underlying collateral has declined to an amount that is less than the outstanding loan balance.
Fed Certifies First Round of FedNow Adopters
The Federal Reserve announced that 57 early adopter organizations have completed formal testing and certification in advance of FedNow's launch planned for late July. Many of the organizations will be live when the FedNow program launches or shortly after, with financial institutions ready to send and receive transactions and service providers ready to support transaction activity.
The Fed indicated that the early adopters are currently performing final trial runs on the service to confirm their readiness to support live transactions over the instant payments infrastructure. The early adopters include 41 financial institutions participating as senders, receivers or correspondents supporting settlement; 15 service providers processing on behalf of participants; and the Treasury Department.
Over time, financial institutions are expected to adopt and build on FedNow with the goal of offering instant payment services to customers, the agency said. The Fed added that it will continue to work with and onboard financial institutions planning to join later in 2023 and beyond, with the goal of reaching all 10,000 U.S. financial institutions.
Powell Sees Lessons Learned from Recent Bank Closures
In a speech Thursday at an economic conference in Spain, Federal Reserve Chairman Jerome Powell said the recent bank runs and failures were "painful reminders" that there is no way to predict all of the stresses that come with time and chance, so regulators and policymakers must not grow complacent about the financial system's resilience. Powell also said regulators are committed to learning lessons from the failures and shared three broad observations.
First, Fed stress tests use scenarios that produce losses on banks' books, including outsized credit losses, but that did not sink Silicon Valley Bank. "SVB's vulnerability came not from credit risk, but from excessive interest rate risk exposure and a business model that was vulnerable in ways its management did not fully appreciate, including a heavy reliance on uninsured deposits," Powell said.
Second, there is value in recognizing when a crisis is building and responding decisively, particularly after the unprecedently fast collapse of SVB. "Notably, bank runs were no longer a matter of days or weeks – they could now be nearly instantaneous," Powell said. "Fortunately, in concert with other parts of the government, we were able to act decisively to meet the liquidity needs of the banking system, protect depositors and limit contagion."
Third, there is value in having the largest banks be very resilient. The safeguards enacted after the 2008 financial crisis made the fallout from the recent failures easier to deal with. "[Global systemically important banks] are subject to capital surcharges, required to be highly liquid and held to the highest supervisory standards," he said. "The events of the past couple of months would have been much more difficult to manage had the largest banks been undercapitalized or illiquid."
Powell: More Rate Hikes Likely Needed to Fight Inflation
Federal Reserve Chairman Jerome Powell said Wednesday that the Federal Open Market Committee may raise the federal funds rate at least twice as it continues the fight against inflation. The heads of other central banks joined Powell as part of a panel on monetary policy organized by the European Central Bank. Asked by the moderator about the FOMC's decision to pause its recent spate of rate hikes at its last meeting, the chairman said the rate has not been in the restrictive territory for very long and that a strong labor market is continuing to put upward pressure on inflation. Most FOMC members believe two or more hikes will be needed, he added.
"When you look at the data over the last quarter, what you see is stronger-than-expected growth, a tighter-than-expected labor market and higher-than-expected inflation," Powell said. "So that tells us that although the policy is restrictive, it may not be restrictive enough, and it has not been restrictive for long enough." The chairman later said he does not expect core inflation to return to the Fed's 2% target until at least 2025.
Powell was also asked about new capital requirements in the works for U.S. banks, particularly their potential effects on small and regional banks. He said that he saw the size and diversity of the U.S. banking system as a core strength.
"We think it's a real benefit to have banks of different sizes and business models that serve local communities and offer different products, as well as having the large banks," Powell said. "And the large banks in the United States are very strong, well-capitalized [with] a lot of liquidity, and they've been a source of strength through the last couple of events. So it's important that whatever changes we make keep in mind the need to preserve the business models of these smaller banks and not just the largest banks."
Fed's Bowman Questions Need for Higher Capital Requirements for Banks
Federal Reserve Governor Michelle Bowman said Sunday during a financial conference in Austria that new capital requirements for financial institutions could unnecessarily hinder bank lending and diminish competition. In her remarks, Bowman expressed skepticism about calls for tougher capital standards following the recent bank failures. Her comments came a few days after Federal Deposit Insurance Corp. Chairman Martin Gruenberg suggested the failures may lead to stronger capital requirements for banks between $100 billion to $250 billion in size. He also dismissed criticism that higher standards could potentially drag the U.S. economy.
Regulators are expected to soon propose rulemaking on a new framework finalizing the Basel III capital standards. Bowman said she plans to approach the proposal with an open mind. "When policymakers raise capital requirements, the tendency can be to singularly focus on the perceived benefits – higher capital implies greater resiliency of the banking system," she said. "But there's a tradeoff. Resiliency, in terms of higher capital, comes at a cost – namely, decreased credit availability and increased cost of credit in normal times – and can have broad impacts on banks, the broader financial system and the economy."
At the same time, she noted that the U.S. banking system is strong and resilient, which raises questions about the need for higher capital requirements. "We need to consider whether examiners have the appropriate tools and support to identify important issues and demand prompt remediation," she said. "Increasing capital requirements simply does not get at this underlying concern about the effectiveness of supervision."
Still, Bowman stressed that her remarks should not be interpreted as a categorical rejection of reform efforts. "Some reform efforts – to both regulation and supervision – are a natural part of the evolution of the regulatory framework, and some would address weaknesses revealed by the recent bank failures…but these reform efforts should be both informed by an impartial and independent review of what led to the failures and healthy public debate, which should take into account the unintended consequences of reform."