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Financial Services Law Insights and Observations

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  • FDIC Director McKernan suggests phasing ‘underdeveloped’ parts of Basel III

    On December 12, a member of the FDIC Board of Directors, Jonathan McKernan, expressed concerns about its Endgame proposal’s reliance on Basel Committee decisions. In his speech at a conference on trading book capital, he highlighted the lack of explanation behind design choices, leaving banking regulators unable to justify or comprehend certain reform aspects. The board member added that the absence of rationale hindered public feedback and raised doubts about the reform’s legitimacy.

    McKernan suggested an approach to defer less developed areas of the reforms while implementing uncontested aspects—acknowledging the proposal’s goal to address weaknesses in the trading book framework and citing concerns about specific design decisions. McKernan notes certain design decisions like the profit-and-loss attribution test and non-modellable risk factors. McKernan explained that the PLA attribution test assesses the alignment between a bank’s risk management and front office models. McKernan said that for both designs, there is very little public information on the Basel Committee’s threshold formulation and that they are based on simulated data, which is viewed as a preliminary estimate still under development. Finally, McKernan supported enhancing the regulatory capital framework but stressed the need to validate the rationale behind key design decisions in the Basel reforms. 

    Bank Regulatory FDIC Basel Bank Supervision Basel Committee

  • FDIC releases semiannual update on Restoration Plan

    On December 7, the FDIC released its semiannual update on the Restoration Plan for the agency’s Deposit Insurance Fund (DIF). The Federal Deposit Insurance Act (the FDI Act) requires that the FDIC board adopt a Restoration Plan wherein the DIF balance falls below the statutory minimum reserve ratio by the required deadline. The FDIC detailed that after the first half of 2020 and the onset of Covid-19, insured deposit growth caused a steep decline in the reserve ratio—the ratio of the fund balance relative to insured deposit—so the FDIC initiated the Restoration Plan in September 2020 to restore the DIF reserve ratio to 1.35 percent by the anticipated deadline. In 2022, however, the FDIC revised the plan after recognizing the risk of not meeting the required minimum by the deadline. The Amended Restoration Plan (covered by InfoBytes here) raised deposit insurance assessment rates by two basis points for all insured depository institutions, effective from the first quarterly assessment period of 2023.

    The FDIC reported that as of June 30, the DIF balance was $117 billion, and the reserve ratio decreased from 1.25 percent to 1.1 percent due to increased loss provisions, which is on track to meet the statutory threshold ahead of the September 30, 2028, deadline. 

    Bank Regulatory Federal Issues FDIC Deposit Insurance Federal Deposit Insurance Act

  • OCC issues annual federal banking report for 2023

    On December 11, the OCC published its 2023 Annual Report, which provides a comprehensive overview of the current state of the federal banking system, outlines the OCC’s strategic priorities and initiatives, and details the agency’s financial management and condition.

    The OCC restated its supervisory priorities for the year, summarized proposed rules, guidance and other publications issued in FY 2023, reported on its licensing activities and summarized the results of enforcement actions against institutions and individuals, which netted over $100 million in civil money penalties.  The report also highlighted the OCC’s efforts in “guarding against complacency, reducing inequality, adapting to digitalization, and acting on climate-related financial risks—which collectively focus the OCC’s efforts on maintaining the public’s trust in banking.” According to the “comptroller’s viewpoint” within the report, Acting Comptroller Michael J. Hsu proposed an annual survey to gauge the American public’s trust in banks and banking supervision over time. The survey will aim to collect diverse data on consumer trends to aid policymakers, regulators, and community groups in better understanding and enhancing trust in the banking system. Hsu also highlighted some actions he believes will help restore trust in the banking system: (i) bank supervisors acting in a timely and efficient manner; (ii) the strengthening of large bank resilience and resolvability regulations; (iii) updates to deposit insurance coverage; and (iv) preserving “the diversity of the banking system… as the industry evolves.” Among other points of the annual report, as part of its emphasis on climate-related financial risk, the OCC reported that it is conducting exploratory reviews of banks with $100 billion or note in assets, in an attempt to establish a baseline understanding of how banks manage financial risks related to climate change.

    Bank Regulatory Federal Issues OCC Climate-Related Financial Risks Bank Supervision

  • OCC issues guidance on BNPL loans

    On December 6, the OCC posted Bulletin 2023-37 to provide banks with guidance on Buy Now, Pay Later (BNPL) loans. The OCC defined BNPL as point-of-sale or “pay-in-4” installment loan products. The OCC noted that, if BNPL products are used responsibly, they “can provide consumers with a low-cost, short-term, small-dollar financing alternative to manage cash flow.”

    The OCC emphasized that the banks should offer BNPL loans in accordance with standards for safety and soundness, treat customers fairly, provide fair access to financial services, and act in compliance with applicable laws and regulations. In the bulletin, the OCC highlighted the risks to banks associated with offering BNPL lending, including credit, compliance, operational, strategic, and reputational risks to banks. In particular, the bulletin also underscores the risks that borrowers may not fully understand their BNPL repayment obligations, the challenges of underwriting BNPL applicants who have limited or no credit history, the lack of standardized disclosure language, and the risks of merchant disputes, among other risks.

    The OCC recommended banks consider risk management practices, such as maintaining “underwriting, repayment terms, pricing, and safeguards that minimize adverse customer outcomes” tailored to the unique characteristics and risks of BNPL loans. The bulletin also advised banks to pay close attention to “the delivery method, timing, and appropriateness of marketing, advertising, and consumer disclosures,” in particular to ensure that all such documents clearly disclose the borrower’s obligations and any fees that may apply.

    Bank Regulatory Federal Issues Buy Now Pay Later Consumer Finance Lending Banking

  • OCC’s Fall 2023 report highlights risks in banking system

    On December 7, the OCC reported key issues facing the federal banking system in its Semiannual Risk Perspective for Fall 2023. In evaluating the overall soundness of the federal banking system, the OCC emphasized the need for banks to maintain prudent risk management practices. The key themes that the OCC underscored in the report included (i) credit risk due to high interest rates, commercial real estate lending, and inflation; (ii) market risks from rising deposit rates, liquidity contraction, and reliance on wholesale funding; (iii) operational risks from cyber threats, increased digitization, and fraud; and (iv) compliance risks from equal access to credit, fair treatment of consumers, fintech partnerships, and BSA/AML risk. The OCC noted that deposit and liquid asset trends stabilized in the latter half of 2023, and the stability was sustained through a greater dependence on wholesale funding.

    The report included a special discussion of emerging risks linked to artificial intelligence (AI) in banking. The OCC noted the potential benefits of widespread AI adoption, which could reduce costs, improve products, strengthen risk management, and expand access to credit. At the same time, the OCC cautioned that AI use can create risk and banks must manage its use carefully. 

    Bank Regulatory Federal Issues OCC Compliance Cyber Risk & Data Security

  • OCC approves bank to surpass Section 23A thresholds

    The OCC recently published redacted Interpretive Letter #1181, in which the OCC granted a national bank’s application for exemption from the quantitative limits under Section 23A to allow the bank to purchase an affiliate LLC that owns the premises on which the bank’s headquarters and main office are located. According to the letter, the affiliate transaction would exceed ten percent of the bank’s capital stock and surplus and would cause the aggregate amount of the bank's covered transactions with all affiliates beyond 20 percent of the bank’s capital stock and surplus. Exceeding either of these thresholds would requires an exemption, but the OCC believed a waiver was appropriate given the anticipated reduction in the bank's operating costs. Moreover, the OCC reasoned that the exemption would fortify the bank's financial standing, enhancing its ability to improve the services it provides to customers and communities. The FDIC agreed and determined that an exemption would not pose an unacceptable risk to the Deposit Insurance Fund. For these reasons, the OCC approved the exception and permitted the purchase to move forward.

    Bank Regulatory OCC Federal Issues

  • FDIC OIG makes recommendations based on material loss report

    On November 28, the OIG for the FDIC delivered a material loss review report. The report’s objectives were twofold: first, to determine why a bank’s issues led to a material loss to the deposit insurance fund; and second, to review the FDIC’s supervision of the bank and make recommendations to prevent similar losses in the future.

    The report outlined 11 recommendations for the FDIC to implement so it can improve its supervision process over the banking sector. The recommendations include: (i) to evaluate if and why banks may wait to issue CAMELS ratings downgrades until they issue a Report of Examination; (ii) to identify whether the training curriculum should be adjusted to emphasize why timely ratings changes are important; (iii) to review FDIC examination guidance to determine if enhancements are necessary to highlight when a bank’s practices do not align with its policies, and make recommendations; (iv) to evaluate and update examination guidance to require supervisory actions when it violates its risk-appetite statement metrics; (v) to comprehensively review the FDIC manual for any updates to the examination guidance pertinent to evaluating the stability of uninsured deposits; (vi) to comprehensively review the FDIC manual to determine if any updates are required to the examination guidance pertinent to banks’ deposit outflow assumptions for liquidity stress testing; (vii) to revisit examination guidance to determine if any updates are required for monitoring other banks, horizontally, for similar risk characteristics; (viii) to revisit examination guidance to determine if any updates are required regarding incorporating shared risk characteristics that lead to risk in the FDIC’s supervisory approach; (ix) to explore research methods to monitor large bank reputational risk; (x) to evaluate if Chief Risk Officers should place more consideration on unrealized losses and declines in fair value; and (xi) to work with other federal regulators on evaluating necessary rule changes, such as the adoption of noncapital triggers.

    Bank Regulatory Federal Issues OIG FDIC

  • FDIC issues QBP for 3Q 2023

    On November 29, the FDIC released the Third Quarter 2023 Quarterly Banking Profile for FDIC-insured community banks, reporting an aggregate net income of $68.4 billion in the third quarter of 2023, which is down $2.4 billion (3.4 percent) from the previous quarter. The FDIC said higher realized losses on securities and lower noninterest income were among the causes of the decreased net income for the quarter. The FDIC emphasized, among other things, that the banking industry is still facing significant effects from current economic conditions, especially regarding commercial real estate values and other downside risks. According to the remarks provided by FDIC Chairman Gruenberg, such issues will remain areas of attention by the FDIC.

    Bank Regulatory Federal Issues FDIC Community Banks

  • FDIC issues final rule on special assessment, moves to collect $16.3 billion

    On November 16, the FDIC approved a final rule to implement a special assessment to recover Deposit Insurance Fund (DIF) losses from protecting uninsured depositors, following the failure of two banks earlier this year. According to the fact sheet, banks that benefited most from assistance provided under systemic risk determination will pay to recover the losses. The FDIC aims to collect $16.3 billion from 114 financial institutions at a quarterly rate of 3.36 basis points over eight quarterly assessment periods, and an annual rate of 13.4 basis points “an increase from the 12.5 basis point annual rate in the [May] proposal.”

    The FDIC stated that if enough funds were collected to cover actual or estimated losses, it could cease collection efforts early. Alternatively, if losses surpass the collected amount within the initial eight-quarter collection period, the collection period can be extended for additional quarters. The FDIC also added that if actual losses exceed the collected amounts after the receiverships for both banks end, it can impose a one-time final shortfall assessment.

    The special assessment does not apply to any financial institution with less than $5 billion in total assets. The final rule will be effective April 1, 2024, and the first collection for the special assessment is due June 28, 2024. 

    Bank Regulatory FDIC Credit Risk Deposit Insurance Call Report

  • Fed releases paper on debt substitution dynamics

    On November 21, the Fed released a paper concluding that when mortgage rates rise on cash-out refinancings, households do not significantly increase overall borrowing, but instead switch to alternative borrowing options (i.e. credit cards, personal loans, HELOCs, and second liens). Analyzing rate increases and using monetary policy surprises from 2006 to 2021, the paper finds that changes in cash-out refinancing are balanced by shifts to alternative borrowing.

    The paper’s findings further reveal that higher mortgage rates and the amount borrowed through cash-out refinancing have a positive correlation. The parallel showcases a pattern where borrowers are choosing the most cost-effective borrowing option based on the size of their liquidity need, the paper noted. The paper suggests that the way borrowers react to changes in monetary policy, like interest rate adjustments, can depend on whether they have existing mortgages and what interest rates they have on those mortgages. The paper also suggests that while some borrowers might change their mortgage terms when interest rates shift, others might choose different types of loans that don't change their original mortgage rate. This offsets the impact of changing monetary policies on refinancing decisions, the paper explained.

    Bank Regulatory Federal Issues Federal Reserve Mortgages Refinance Consumer Finance

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