How Basel Negotiations Got Stuck

The banking agencies’ negotiations on the Basel reproposal have reached a stalemate, according to a report from Capitol Account this week. “The impasse is particularly puzzling given that two weeks ago, Fed Vice Chair for Supervision Michael Barr gave a high-profile speech strongly suggesting (if not quite stating) that the opposite was true: After months of silence, the Fed, FDIC and OCC appeared to have ‘jointly’ agreed on a path forward for the capital rule,” the article stated.

• Capitol Hill pushback: House lawmakers expressed dismay at the logjam at a regulatory-themed Financial Services subcommittee hearing this week. “The result has been lingering uncertainty about the future rules of the road for financial institutions and consumers of financial services,” Rep. Andy Barr (R-KY) said.
• Background: The original Basel proposal sparked significant concerns both within the banking agencies and across the business and consumer community. Many commenters and members of Congress have urged the agencies to fully repropose the rule and start from scratch. The reproposal seemed close to emerging when it garnered opposition from three out of five members of the FDIC , according to media reports.
• The most uncertain variable: The FDIC disagreements appear to be the defining variable in the process. “Republicans Jonathan McKernan and Travis Hill and Democrat Rohit Chopra are unwilling to support the changes – despite what sources say has been intensified effort in recent days to persuade them,” Capitol Account reported.
• Knock-on effects: A delay in the Basel rule could have a ripple effect on other regulations, such as the long-term debt proposal, which policymakers have indicated they will only address after Basel is resolved.
• What’s possible: It is possible and precedented for the Federal Reserve to move on its own to repropose Basel.

1. House Lawmakers Take Aim at ‘Politicized’ Banking Rules

The House Financial Services Committee’s Subcommittee on Financial Institutions and Monetary Policy discussed the harmful consequences of certain banking regulations at a hearing this week. Witnesses at the hearing were Jonathan Gould, a partner at Jones Day and former OCC official; Kenneth Bentsen, president and CEO of SIFMA; and Marc Jarsulic, chief economist at the Center for American Progress. The Basel Endgame proposal was a central theme of the hearing, but other regulations such as the long-term debt proposal also garnered criticism. Here are a few key highlights.

• State of play: Lawmakers expressed consternation about the uncertainty and process failures surrounding Basel Endgame. “The future of the Endgame proposal is unclear, and administrative procedures followed by the agencies continue to be clumsy at best and politicized at worst,” Rep. Andy Barr (R-KY), the subcommittee’s chairman, said at the hearing. The changes previewed by the Fed Vice Chair for Supervision’s recent speech are encouraging, but “Barr's speech suggests that considerable work still remains, particularly to the market risk component of the Endgame proposal,” Rep. Barr indicated.
• ‘Partisan horse trading’: Rep. Barr also pointed out the discrepancy between Vice Chair Michael Barr’s remarks that the Basel reproposal is a joint effort between the banking agencies, and regulators’ lack of movement on it. “Instead of seeing progress after Mr. Barr’s speech, there have been numerous reports of partisan horse trading among disgraced FDIC Chairman Gruenberg, [FDIC board member and] CFPB Director Chopra and others,” Rep. Barr said. “Partisanship at regulatory agencies” and procedural failures weigh on American small businesses and families, Barr said.
• Regulatory ‘onslaught’: Rep. Barr and colleagues decried the “onslaught” of regulations from the banking agencies, including “significant proposals” on long-term debt, brokered deposits and M&A. Such a deluge “amplifies uncertainty” and threatens the independent posture of regulatory agencies, according to Rep. Barr.
• More details needed: Rep. Bill Foster (D-IL), ranking member of the subcommittee, said he is “encouraged to hear” that Michael Barr mentioned in his preview speech many of the issues that lawmakers raised, including mortgages and investments in green energy. However, he described the House hearing as “premature” because “the text of the proposal has not been seen by any member of this committee or the public.” He urged regulators to avoid unnecessary delays.
• Capital markets impact: High market risk capital requirements threaten to raise costs for capital markets, an engine for U.S. businesses to grow, Kenneth Bentsen of SIFMA emphasized at the hearing.
• Tailoring in danger: Rep. Barr cautioned that the undoing of regulatory tailoring – rules that are tiered based on banks’ size and risk profile – is “circumventing Congressional intent.” He referred to Acting Comptroller Michael Hsu’s recent suggestion to designate domestic systemically important banks, or DSIBs, as an example of these efforts.

2. Fed’s Bowman: Regulators’ Lack of Business Experience is a Blind Spot

Federal banking regulators without experience in the business world may not have clear insight into the real-world implications of their rules, Federal Reserve Governor Michelle Bowman said this week at a Kentucky Bankers’ Association event. "They don't understand what those implications are, both intended and unintended," said Bowman, a former community banker. Bowman cited the example of recent M&A policy changes finalized by the OCC and FDIC. The Fed has not formally changed its M&A approach, but it has amended its application form to require more estimates about the projected impacts of a proposed deal, according to Bowman. Bank mergers are often the best outcome for smaller banks and the communities they serve, Bowman said, noting the increased costs of delayed merger reviews.

• Lack of transparency: An underappreciated aspect of bank-fintech partnerships is banks’ lack of visibility into supervisory issues with fintech companies, Bowman said. Banks may not know that their fintech partner is on a supervisory watchlist; agencies cannot warn banks about such problems because of prohibitions on sharing confidential supervisory information. "We don't have guardrails for banks to work with validated, confirmed partners that supervisors think are legit," Bowman said.
• Liquidity: Bowman also suggested that some liquidity changes under consideration could deny banks the ability to make their own choices about funding sources. Such potential changes include those that may shift banks away from using the Federal Home Loan banks as a funding source.
• Legal shift: The Supreme Court’s overturning of Chevron deference has introduced a heightened risk of litigation against regulators, which serves as a check on agencies’ rulemaking, Bowman suggested. "The risk of litigation is already chilling the way agencies are thinking about new regulation," she said. "In my mind, that's an excellent influence on our regulatory process and will help moving forward."

3.?Barr Previews Potential Liquidity Changes Ahead

Federal Reserve Vice Chair for Supervision Michael Barr this week outlined changes to liquidity regulations that the Fed is “exploring.” In a speech Thursday, Barr said the Fed may consider?a requirement for larger banks to maintain a minimum amount of readily available liquidity with a pool of reserves and pre-positioned collateral at the discount window, based on a fraction of their uninsured deposits. He described such a requirement as a “complement to existing liquidity regulations” such as the internal liquidity stress tests and the liquidity coverage ratio. “Incorporating the discount window into a readiness requirement would also reemphasize that supervisors and examiners view use of the discount window as appropriate under both normal and stressed market conditions,” Barr said.

• Limit on held-to-maturity: In the banking turmoil of spring 2023, banks faced constraints converting held-to-maturity assets with large unrealized losses to cash, Barr said. “To address these gaps, we are considering a partial limit on the extent of reliance on HTM assets in larger banks' liquidity buffers, such as those held under the LCR and ILST requirements,” Barr said. “These adjustments would address the known challenges of banks being able to use these assets in stress conditions.”
• Deposit treatment: The Fed is also reviewing the treatment of certain types of deposits in the liquidity framework, he said. This reconsideration may include recalibrating deposit outflow assumptions for certain types of depositors.
• Scope of liquidity regulation: The Fed is also considering “revisiting the scope of application of our current liquidity framework for large banks.” It remains unclear what form this or other changes might take as discussions move forward.
• Reiterating the answer: Barr also emphasized a point that the Fed clarified about the discount window in August. “We had been hearing that some were confused about how banks could incorporate ready access to the discount window and the SRF into their contingency funding plans and internal liquidity stress tests,” Barr said. “Supervisors have a role in assessing the viability of large banks' plans to meet stressed outflows in their stress scenarios, and we have been asked whether the discount window, the SRF, and also Federal Home Loan Bank advances can play a role in those scenarios. The answer to this question is ‘yes.’”
• Potential pitfalls: As they explore these issues, the Fed should keep in mind 10 pitfalls to avoid.

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