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  • Hsu notes a “trip wire approach” for FSOC review of payments, private equity systemic risk

    On February 21, Acting Comptroller of the Currency Michael Hsu delivered remarks at Vanderbilt University, discussing banking and commerce, regulatory effectiveness, and financial stability. Hsu further discussed the “blurring of the line” between banking and private credit/equity, its relevance to different market crashes, and how it can create risk. Hsu mentioned the potential to fill a regulatory gap regarding payments.

    Hsu highlighted that the FSOC’s recent analytic framework indicated vulnerable points that can commonly contribute to financial stability risks and discussed how FSOC may address the risks. The framework also established how the council determines whether a given nonbank should be under the Fed’s supervision and prudential standards (covered by InfoBytes here). In his speech, Hsu defines banking as “institutions that take deposits, make loans, and facilitate payments” and commerce as “everything else” including nonbank finance. 

    He added that the FSOC should use its macro-prudential tools to address risk and develop metrics and thresholds to identify when a payments or private equity firm may need an assessment of systemic risk. This “trip wire approach” would leverage the FSOC’s framework, moving a firm from the identification phase to the assessment phase of the FSOC’s analytic framework, and the assessment would inform if there was a need for FSOC response. Because of the rise in cash managed by nonbanks on behalf of consumers, Hsu said that could serve as a metric for the trip wire for payments-focused fintechs and other nonbank companies. “The standardization, scalars, and level at which an FSOC assessment would be triggered would be informed by public comment,” he added. Finally, Hsu highlighted how the trip wire approach offered a transparent and proactive method for identifying and addressing systemic risks before they escalate. 

    Bank Regulatory Federal Issues FSOC OCC Payments Nonbank Risk Management

  • Yellen testifies on FSOC Annual Report, key areas of focus

    Federal Issues

    On February 8, the U.S. Senate Committee on Banking, Housing, and Urban Affairs held a hearing titled “The Financial Stability Oversight Council Annual Report to Congress” with testimony provided by U.S. Treasury Secretary Janet Yellen. Secretary Yellen discussed progress, and continued focus, related to five topics addressed in FSOC’s 2023 Annual Report (covered by InfoBytes here): capital risks posed by nonbank financial institutions; climate-related financial stability risks; cybersecurity risks; monitoring artificial intelligence (AI) use in financial services; and digital asset oversight. In response to questioning from Senator Cortez Masto (D-NV), Yellen discussed how FSOC highlighted that about 70 percent of single-family mortgages were originated by nonbank mortgage originators during the first half of 2023. When Secretary Yellen was asked if the shift from banks to nonbanks in the mortgage space poses a financial stability risk “due to non-banks’ lack of access to deposits,” she responded that FSOC is “very focused” on the issue since non-banks are reliant on short-term financing. In addition, Yellen spoke about AI and learning its impact on vulnerabilities and risk, as well as the Basel III proposal, urging regulators to “finalize these rules as quickly as possible.”

    Federal Issues FSOC Department of Treasury U.S. Senate Basel Mortgage Lenders

  • FSOC report highlights AI, climate, banking, and fintech risks; CFPB comments

    Privacy, Cyber Risk & Data Security

    On December 14, the Financial Stability Oversight Counsel released its 2023 Annual Report on vulnerabilities in financial stability risks and recommendations to mitigate those risks. The report was cited in a statement by the Director of the CFPB, Rohit Chopra, to the Secretary of the Treasury. In his statement, Chopra said “[i]t is not enough to draft reports [on cloud infrastructure and artificial intelligence], we must also act” on plans to focus on ensuring financial stability with respect to digital technology in the upcoming year. In its report, the FSOC notes the U.S. banking system “remains resilient overall” despite several banking issues earlier this year. The FSOC’s analysis breaks down the health of the banking system for large and regional banks through review of a bank’s capital and profitability, credit quality and lending standards, and liquidity and funding. On regional banks specifically, the FSOC highlights how regional banks carry higher exposure rates to all commercial real estate loans over large banks due to the higher interest rates.

    In addition, the FSOC views climate-related financial risks as a threat to U.S. financial stability, presenting both physical and transitional risks. Physical risks are acute events such as floods, droughts, wildfires, or hurricanes, which can lead to additional costs required to reduce risks, firm relocations, or can threaten access to fair credit. Transition risks include technological changes, policy shifts, or changes in consumer preference which can all force firms to take on additional costs. The FSOC notes that, as of September 2023, the U.S. experienced 24 climate disaster events featuring losses that exceed $1 billion, which is more than the past five-year annual average of 18 events (2018 to 2022). The FSOC also notes that member agencies should be engaged in monitoring how third-party service providers, like fintech firms, address risks in core processing, payment services, and cloud computing. To support this need for oversight over these partnerships, the FSOC cites a study on how 95 percent of cloud breaches occur due to human error. The FSOC highlights how fintech firms face risks such as compliance, financial, operational, and reputational risks, specifically when fintech firms are not subject to the same compliance standards as banks.

    Notably, the FSOC is the first top regulator to state that the use of Artificial Intelligence (AI) technology presents an “emerging vulnerability” in the U.S. financial system. The report notes that firms may use AI for fraud detection and prevention, as well as for customer service. The FSOC notes that AI has benefits for financial instruction, including reducing costs, improving inefficiencies, identifying complex relationships, and improving performance. The FSOC states that while “AI has the potential to spur innovation and drive efficiency,” it requires “thoughtful implementation and supervision” to mitigate potential risks.

    Privacy, Cyber Risk & Data Security Bank Regulatory FSOC CFPB Artificial Intelligence Banks Fintech

  • FSOC approves analytic framework for financial stability risks and guidance on nonbank financial company determinations

    Agency Rule-Making & Guidance

    On November 3, the Financial Stability Oversight Council (FSOC) announced that it unanimously voted to issue the final versions of a new analytic framework regarding financial stability risks, in addition to updated interpretive guidance on the council’s nonbank designation guidance. The analytic framework indicates vulnerable points that commonly contribute to financial stability risks, and it explains how FSOC may address the risks, including interagency coordination, recommendations to regulators, or the designation of certain entities. The nonbank designation guidance establishes how the council determines whether a given nonbank should be under the Fed’s supervision and prudential standards under Section 113 of Dodd-Frank. In April, FSOC released the proposed analytic framework and the proposed nonbank designation guidance (as covered by InfoBytes here) and opened a comment period on the proposals.

    FSOC adopted key changes in consideration of public comments on the proposed framework, including (i) clarifications to the interpretation of “threat to financial stability”; (ii) more examples of quantitative metrics considered in its analysis; (iii) expanded discussion of transmission channels; and (iv) additional emphasis on FSOC’s engagement with state and federal financial regulatory agencies regarding risk. Comments directed at the interpretive guidance were addressed, and some changes are reflected in the framework. Both CFPB Director Rohit Chopra and OCC Acting Comptroller Michael J. Hsu issued statements supporting the issuance of the interpretive guidance and the framework. Chopra commented that FSOC’s actions to evaluate whether any “shadow bank” meets the statutory threshold for enhanced oversight are essential in preventing potential threats to financial stability. Hsu also noted the significance of leveraging Dodd-Frank's tools for “monitoring and mitigating risks to U.S. financial stability.”

    The analytic framework will be effective upon publication in the Federal Register, and the nonbank designations guidance will be effective 60 days after publication in the Federal Register.

    Agency Rule-Making & Guidance Federal Issues Fintech FSOC Federal Reserve Supervision Nonbank

  • FDIC's chairman addresses CRA rulemaking, unbanked households, and nonbank payment services

    Federal Issues

    On September 20, FDIC Chairman Martin J. Gruenberg delivered prepared remarks at the Exchequer Club, discussing the risks posed by nonbank financial institutions (nonbanks) to the U.S. financial system. He noted that nonbanks hold a significant share of the financial sector, with assets totaling around $20.5 trillion in 2021, emphasizing their importance alongside traditional banks. Gruenberg highlighted the financial stability concerns associated with nonbanks, especially their limited regulation and supervision compared to traditional banks. He further mentioned the interconnectedness between nonbanks and banks, and the potential for nonbanks to transmit risk during market shocks, which underscores the need for attention to these issues. Specifically, Gruenberg stated that the “information about the risks undertaken by a variety of nonbanks is severely lacking”, and transparency about these issues will ensure a safer financial system. Gruenberg also pointed out that nonbanks are becoming increasingly active in mortgage finance, business lending, and consumer financial services. He discussed some risks associated with hedge funds and leveraged investment vehicles generally, such as their reliance on short-term funding, and their potential to disrupt the stability of financial markets. Gruenberg concluded by advocating for a comprehensive strategy to address the financial stability risks posed by nonbanks, emphasizing the importance of transparency, oversight, and prudential requirements for nonbank financial institutions.

    Federal Issues FDIC CRA Nonbank FSOC Consumer Finance

  • McHenry objects to FSOC’s proposed designation framework

    Agency Rule-Making & Guidance

    On June 15, House Financial Services Committee Chairman Patrick McHenry sent a letter to Treasury Secretary Janet Yellen urging the Financial Stability Oversight Council (FSOC), which Yellen chairs, to “revisit” its proposals on nonbank financial firm risks. As previously covered by InfoBytes, in April, FSOC released a proposed analytic framework for financial stability risks to provide greater public transparency on how it identifies, assesses, and addresses potential risks “regardless of whether the risk stems from activities or firms.” The same day, FSOC also released for public comment proposed interpretive guidance relating to procedures for designating systemically important nonbank financial companies for Federal Reserve supervision and enhanced prudential standards.

    McHenry’s letter raised concerns with FSOC’s decision to evaluate risks based on an entity’s size and not its activities. According to McHenry, FSOC’s April proposals will essentially undo changes it made in 2019, which incorporated principles considering a financial institution’s systematic risk rather than merely its size. In his announcement accompanying the letter, McHenry elaborated on his concerns, stating that “allowing FSOC to extend its supervisory reach beyond prudential institutions to nonbank entities in this way could pose significant regulatory consequences for our financial system.” McHenry claimed these institutions may engage in different activities, thus presenting different risks, and said the proposals do not take this into account. McHenry also argued that expanding the Fed’s oversight jurisdiction is not a “panacea for financial stability.”

    Agency Rule-Making & Guidance Federal Issues FSOC Department of Treasury Nonbank House Financial Services Committee Supervision

  • FSOC seeks feedback on risk framework, nonbank determinations

    Agency Rule-Making & Guidance

    On April 21, the Financial Stability Oversight Council (FSOC) released a proposed analytic framework for financial stability risks, “intended to provide greater transparency to the public about how [FSOC] identifies, assesses, and addresses potential risks to financial stability, regardless of whether the risk stems from activities or firms.” FSOC explained in a fact sheet that the proposed framework would not impose any obligations on any entity, but is instead designed to provide guidance on how FSOC expects to perform certain duties. This includes: (i) identifying potential risks covering a broad range of asset classes, institutions, and activities, including new and evolving financial products and practices as well as developments affecting financial resiliency such as cybersecurity and climate-related financial risks; (ii) assessing certain vulnerabilities that most commonly contribute to financial stability risk and considering how adverse effects stemming from these risks could be transmitted to financial markets/market participants, including what impact this can have on the financial system; and (iii) responding to potential risks to U.S. financial stability, which may involve interagency coordination and information sharing, recommendations to financial regulators or Congress, nonbank financial company determinations, and designations relating to financial market utility/payment, clearing, and settlement activities that are, or are likely to become, systemically important.

    The same day, FSOC also released for public comment proposed interpretive guidance relating to procedures for designating systemically important nonbank financial companies for Federal Reserve supervision and enhanced prudential standards. (See also FSOC fact sheet here.) The guidance would revise and update previous guidance from 2019, and “is intended to enhance [FSOC’s] ability to address risks to financial stability, provide transparency to the public, and ensure a rigorous and clear designation process.” FSOC explained that the proposed guidance would include a two-stage evaluation and analysis process for making a designation, during which time companies under review would engage in significant communication with FSOC and be provided an opportunity to request a hearing, among other things. Designated companies will be subject to annual reevaluations and may have their designations rescinded should FSOC determine that the company no longer meets the statutory standards for designation.

    Comments on both proposals are due 60 days after publication in the Federal Register.

    Both CFPB Director Rohit Chopra and OCC acting Comptroller Michael J. Hsu issued statements supporting the issuance of the proposed interpretive guidance. Chopra commented that, if finalized, the proposed guidance “will create a clear path for the FSOC to identify and designate systemically important nonbank financial institutions” and “will accelerate efforts to identify potential shadow banks to be candidates for designation.” Hsu also noted that sharing additional details to improve the balance and transparency of FSOC’s work “would both make it easier for [FSOC] to explain its analysis of potential risks and create an opportunity for richer public input on the analysis.”

    Agency Rule-Making & Guidance Federal Issues Fintech FSOC Nonbank Federal Reserve Supervision

  • FSOC annual report highlights digital asset, cybersecurity, and climate risks

    Federal Issues

    On December 16, the Financial Stability Oversight Council (FSOC or the Council) released its 2022 annual report. The report reviewed financial market developments, identified emerging risks, and offered recommendations to mitigate threats and enhance financial stability. The report noted that “amid heightened geopolitical and economic shocks and inflation, risks to the U.S. economy and financial stability have increased even as the financial system has exhibited resilience.” The report also noted that significant unaddressed vulnerabilities could potentially disrupt institutions’ ability to provide critical financial services, including payment clearings, liquidity provisions, and credit availability to support economic activity. FSOC identified 14 specific financial vulnerabilities and described mitigation measures. Highlights include:

    • Nonbank financial intermediation. FSOC expressed support for initiatives taken by the SEC and other agencies to address investment fund risks. The Council encouraged banking agencies to continue monitoring banks’ exposure to nonbank financial institutions, including reviewing how banks manage their exposure to leverage in the nonbank financial sector.
    • Digital assets. FSOC emphasized the importance of enforcing existing rules and regulations applicable to the crypto-asset ecosystem, but commented that there are gaps in the regulation of digital asset activities. The Council recommended that legislation be enacted to grant rulemaking authority to the federal banking agencies over crypto-assets that are not securities. The Council said that regulatory arbitrage needs to be addressed as crypto-asset entities offering services similar to those offered by traditional financial institutions do not have to comply with a consistent or comprehensive regulatory framework. FSOC further recommended that “Council members continue to build capacities related to data and the analysis, monitoring, supervision, and regulation of digital asset activities.”
    • Climate-related financial risks. FSOC recommended that state and federal agencies should continue to work to advance appropriately tailored supervisory expectations for regulated entities’ climate-related financial risk management practices. The Council encouraged federal banking agencies “to continue to promote consistent, comparable, and decision-useful disclosures that allow investors and financial institutions to consider climate-related financial risks in their investment and lending decisions.”
    • Treasury market resilience. FSOC recommended that member agencies review Treasury’s market structure and liquidity challenges, and continue to consider policies “for improving data quality and availability, bolstering the resilience of market intermediation, evaluating expanded central clearing, and enhancing trading venue transparency and oversight.” 
    • Cybersecurity. FSOC stated it supports partnerships between state and federal agencies and private firms to assess cyber vulnerabilities and improve cyber resilience. Acknowledging the significant strides made by member agencies this year to improve data collection for managing cyber risk, the Council encouraged agencies to continue gathering any additional information needed to monitor and assess cyber-related financial stability risks. 
    • LIBOR transition. FSOC recommended that firms should “take advantage of any existing contractual terms or opportunities for renegotiation to transition their remaining legacy LIBOR contracts before the publication of USD LIBOR ends.” The Council emphasized that derivatives and capital markets should continue transitioning to the Secured Overnight financing Rate.

    CFPB Director Rohit Chopra issued a statement following the report’s release, flagging risks posed by the financial sector’s growing reliance on big tech cloud service providers. “Financial institutions are looking to move more data and core services to the cloud in coming years,” Chopra said. “The operational resilience of these large technology companies could soon have financial stability implications. A material disruption could one day freeze parts of the payments infrastructure or grind other critical services to a halt.” Chopra also commented that FSOC should determine next year whether to grant the agency regulatory authority over stablecoin activities under Dodd-Frank. He noted that “[t]hrough the stablecoin inquiry, it has become clear that nonbank peer-to-peer payments firms serving millions of American consumers could pose similar financial stability risks” as these “funds may not be protected by deposit insurance and the failure of such a firm could lead to millions of American consumers becoming unsecured creditors of the bankruptcy estate, similar to the experience with [a now recently collapsed crypto exchange].”

    Federal Issues Digital Assets CFPB FSOC Nonbank Department of Treasury Climate-Related Financial Risks Privacy, Cyber Risk & Data Security LIBOR SOFR Fintech

  • NYDFS's Harris to serve as the state banking representative on the FSOC

    State Issues

    On December 13, the Conference of State Bank Supervisors (CSBS) announced that NYDFS Superintendent Adrienne A. Harris will serve as the state banking representative on the Financial Stability Oversight Council (FSOC). According to the announcement, in 2013, Superintendent Harris joined the Obama Administration as a Senior Advisor in the U.S. Department of Treasury prior to being appointed as the Special Assistant to the President for Economic Policy. In this role, she managed the financial services portfolio, focusing on the implementation of Dodd-Frank, and developed strategies for financial reform, consumer protections, cybersecurity and housing finance reform. According to James M. Cooper, president and CEO of CSBS, Harris’s “background and experience at both the federal and state level will be an asset for the council as it manages emerging risk during a time of economic uncertainty.”

    State Issues CSBS NYDFS New York FSOC

  • Chopra discusses SIFI risks

    Federal Issues

    On November 9, CFPB Director and FDIC Board Member Rohit Chopra delivered remarks before the FDIC Systemic Resolution Advisory Committee to discuss challenges facing systemically important financial institutions. Chopra began by raising concerns related to domestic systemically important banks (DSIBs) and the potentially disruptive impact facing consumers and small businesses should one of these bank fail. Chopra explained that, because DSIBs are heavily involved in retail banking with large consumer businesses and carry relatively high levels of uninsured deposits, “DSIB resolutions could pose serious technical challenges for the FDIC” that would necessitate serious consideration. Chopra also pointed out concerns raised by many experts that a large number of nonbank systemically important financial institutions (which have not yet been formally designated by the Financial Stability Oversight Council) pose systemic risk to the financial system. “Absent a designation, these institutions are not required to file a resolution plan,” Chopra said, noting that “[r]esolving these institutions without a plan would be an enormous challenge.” He also emphasized the importance of finding ways to eliminate bailout risks for global systemically important banks.

    Federal Issues Bank Regulatory CFPB FDIC DSIB Nonbank FSOC GSIBs

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