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Bowman skeptical about higher capital requirements
On June 25, Federal Reserve Governor Michelle W. Bowman expressed skepticism about calls for higher capital requirements following a string of recent bank failures, warning that stricter capital standards could hinder bank lending and diminish competition. In prepared remarks delivered during a global financial seminar held in Salzburg, Austria, Bowman said that while efforts have been taken to understand what went wrong, which have revealed “some uncomfortable realities about the lead-up to the bank failures,” the majority of the work was prepared internally by Fed supervision staff “relying on a limited number of unattributed source interviews, and completed on an expedited timeframe with a limited scope.” She commented that a necessary next step would be to engage an independent third party to analyze what factors and circumstances contributed to the recent bank failures. Independent reviews, Bowman said, “should play an important role in informing the future path of supervision and regulation.”
Bowman further stressed that banks are currently better capitalized and more closely supervised than before the 2008 financial crisis. The banking system is strong and resilient, Bowman said, which “begs the question—what are the justifications for higher capital requirements?” Instead, regulators should consider whether examiners are armed with the appropriate tools and support to identify material risks and demand prompt remediation. “Increasing capital requirements simply does not get at this underlying concern about the effectiveness of supervision,” she said. She commented that if regulators think about what tools are most effective and efficient in addressing shortcomings, they will find ways to improve supervision, revise liquidity requirements, or improve banks’ preparedness to access liquidity. Bowman cautioned that while “higher capital implies greater resiliency,” this resiliency comes at the cost of decreased credit availability and higher cost of credit in normal times, which “can have broad impacts on banks, the broader financial system, and the economy.” Rising bank capital requirements, Bowman added, may also “exacerbate the competitive dynamics that result in advantages to non-bank competitors and push additional financial activity out of the regulated banking system.”
Agencies release 2023 list of distressed, underserved communities
On June 23, the FDIC, Federal Reserve Board, and the OCC released the 2023 list of distressed or underserved nonmetropolitan middle-income geographies where revitalization or stabilization activities are eligible to receive Community Reinvestment Act (CRA) consideration. According to the joint release, the list of distressed nonmetropolitan middle-income geographies and underserved nonmetropolitan middle-income geographies are designated by the agencies under their CRA regulations and reflect local economic conditions such as unemployment, poverty, and population changes. Under CRA, banks are encouraged to help meet the credit needs of the local communities listed. For any geographies that were designated by the agencies in 2022 but not in 2023, the agencies apply a one-year lag period, so such geographies remain eligible for CRA consideration for another 12 months.
Fed publishes master accounts database
On June 16, the Federal Reserve Board published the Master Account and Services Database, which provides comprehensive, searchable information on which financial institutions have access to Federal Reserve Bank master accounts and financial services. The Fed explained that a master account is an account with a Reserve Bank, in which the Reserve Bank receives deposits for a financial institution. The Reserve Bank also provides financial services to financial institutions, similar to that of banks that provide services for its customers, like collecting checks, electronically transferring funds, and distributing and receiving cash and coin.
In the press release, the Fed explained the two components of the database: “The first component consists of financial institutions that currently have access to Reserve Bank master accounts and services. The second component consists of financial institutions that have requested access to master accounts and services after December 23, 2022, or had a request pending on that date, as well as the status of each request.” Both components of the database—the existing account database and the access requests database—will be updated quarterly.
Agencies propose ROV guidance
On June 8, the CFPB joined the Federal Reserve Board, FDIC, NCUA, and the OCC to request comments on proposed interagency guidance relating to reconsiderations of value (ROV) for residential real estate valuations. The proposed guidance advises financial institutions on policies that would afford consumers an opportunity to introduce evidence that was not previously considered in the original appraisal. The proposal references the occurrence of “deficiencies” in real estate valuations, which can be due to errors or omissions, valuation methods, assumptions, or other factors. According to the proposed guidance, these kind of valuation deficiencies can “prevent individuals, families, and neighborhoods from building wealth through homeownership by potentially preventing homeowners from accessing accumulated equity, preventing prospective buyers from purchasing homes, making it harder for homeowners to sell or refinance their homes, and increasing the risk of default.” Also noted is the risk non-credible valuations pose to financial institutions, which may lead to loan losses, violations of law, fines, civil money penalties, damages, and civil litigation.
The proposed guidance (i) provides direction on how ROVs overlap with appraisal independence requirements and compliance with relative laws and regulations; (ii) identifies how financial institutions can implement and improve existing ROV policies while remaining compliant with regulations, preserving appraiser independence, and being responsive to consumers; (iii) explains how deficiencies can pose risk to financial institutions and describes how ROV policies should be factored into risk management functions; and (iv) provides examples of ROV policies, procedures, control systems, and complaint processes to address deficient valuations.
Comments on the proposed guidance are due within 60 days of publication in the Federal Register.
Agencies finalize guidance on managing third parties
On June 6, the OCC, Federal Reserve Board, and FDIC issued interagency guidance to aid banking organizations in managing risks related to third-party relationships, including relationships with financial technology-focused entities. (See also FDIC FIL-29-2023 and Federal Reserve Board memo here.) The joint guidance, final as of June 6, replaces each agency’s existing general guidance on third-party risk management and is directed to all supervised banking organizations. Designed to streamline government guidance on mitigating risks when working with third parties, the final guidance establishes principles for banking organizations to consider when implementing risks management practices. Banking organizations are advised to consider and account for the level of risk, complexity, and size of the institution, as well as the nature of the third-party relationship, when conducting sound risk management.
After considering public comments received on proposed guidance issued in July 2021 (covered by InfoBytes here), the final guidance provides directions and expectations for oversight at all stages in the life cycle of a third-party relationship, including topics relating to planning, due diligence and third-party selection, contract negotiations, ongoing monitoring, and termination. Guidance on conducting independent reviews, maintaining documentation, and reporting is also included. The agencies advised banking organizations, particularly community banks, to review illustrative examples to help align risk management practices with the scope and risk profile of their third-party relationships. Additionally, banking organizations should maintain a complete inventory of their third-party relationships, identify higher-risk and critical activities, periodically conduct reviews to determine whether risks have changed over time, and update risk management practices accordingly, the agencies said.
The final guidance emphasizes that the agencies will review a banking organization’s third-party risk management practices as part of the standard supervisory process. When assessing whether activities are conducted in a safe and sound manner and in compliance with applicable laws and regulations, examiners will, among other things, (i) evaluate a banking organization’s ability to oversee and manage third party relationships; (ii) assess the effects of those relationships on a banking organization’s risk profile and operational performance; (iii) perform transaction testing to evaluate whether activities performed by a third party comply with applicable laws and regulations; (iv) conduct conversations relating to any identified material risks and deficiencies with senior management and board of directors; (v) review how a banking organization remediates any deficiencies; and (vi) consider supervisory findings when rating a banking organization.
The agencies stressed that they may take corrective measures, including enforcement actions, to address identified violations or unsafe or unsound banking practices by the banking organization or its third party. The agencies further announced that they plan to immediately engage with community banks and will develop additional resources in the future to help these organizations manage relevant third-party risks.
DFPI, Fed to oversee bank’s self-liquidation
On June 1, the California Department of Financial Protection and Innovation (DFPI) announced that it issued a joint cease-and-desist order with the Federal Reserve Board to fulfill the voluntary liquidation of a crypto-friendly bank. Focusing on providing financial services in the crypto-asset industry, the bank began operating in 2013. In 2023, however, the bank announced its voluntary liquidation, following a mass exodus of high-profile clients. In the fourth quarter of 2022, the bank experienced a sudden drop in deposits, triggered by the collapse of a crypto-exchange company in the previous quarter. DFPI noted that in its most recent examinations of the bank, the bank showed deficits in security and compliance with regulations. Within 10 days of the order, the bank must submit a voluntary self-liquidation plan acceptable to DFPI and upon approval, must implement that plan to wind down its operations “in a safe and sound manner and in compliance with all applicable federal and state laws, rules, and regulations.” The bank has advised that the liquidation will include full repayment of all of its deposits.
Agencies propose new standards for AVMs
On June 1, the CFPB joined the Federal Reserve Board, OCC, FDIC, NCUA, and FHFA in issuing a notice of proposed rulemaking (NPRM) to implement quality control standards mandated by the Dodd-Frank Act concerning automated valuation models (AVMs) used by mortgage originators and secondary market issuers. Specifically, institutions that engage in certain credit decisions or make securitization determinations would be required to adopt quality control standards to ensure a high level of confidence that estimates produced by an AVM are fair and nondiscriminatory. Other requirements would necessitate institutions to protect against data manipulation and avoid conflicts of interest. Institutions would also be required to conduct random sample testing and reviews and comply with applicable nondiscrimination laws. The agencies acknowledged that while advances in AVM technology and data availability may contribute to lower costs and reduce loan cycle times, institutions’ reliance on AMV technology must not be used as an excuse to evade the law.
CFPB Director Rohit Chopra explained that, while AVMs rely on mathematical formulas and number crunching to produce estimates (and are often used to “check” human appraisers or used in place of an appraisal), they can still embed the human biases they are meant to correct. This is due in part to the data fed into the AVMs, the algorithms used within the machines, and biases and blind spots attributed to the individuals who develop the models, Chopra warned, commenting that AVMs can actually “make bias harder to eradicate in home valuations because the algorithms used cloak the biased inputs and design in a false mantle of objectivity.”
Chopra went on to explain that inaccurate or biased algorithms can lead to serious harms to consumers, neighborhoods, and the housing market, and may also impact the tax base. A focus common to all the agencies, Chopra said, is ensuring that automated systems and artificial intelligence modeling technologies are developed and used in accordance with federal laws to avert discriminatory outcomes and prevent negative impacts on consumer financial stability.
Comments on the NPRM are due within 60 days of publication in the Federal Register.
Fed and Illinois regulator take action against bank on capital and management
On May 4, the Federal Reserve Board announced an enforcement action against an Illinois state-chartered community bank and its holding company related to alleged deficiencies identified in recent examinations. While the written agreement (entered into by the parties at the end of April) does not outline the specific deficiencies, it notes that the bank and the holding company have started taken corrective action to address the issues identified by the Federal Reserve Bank of St. Louis (FRB) and the Illinois Department of Financial and Professional Regulation (IDFPR). Among other things, the holding company’s board of directors must take appropriate steps to fully use its financial and managerial resources to ensure the bank complies with the written agreement and any other supervisory action taken by the bank’s federal or state regulator. The board is also required to submit a written plan to the FRB and the IDFPR describing actions and measures it intends to take to strengthen board oversight of the management and operations of the bank. The bank is required to submit a written plan outlining its current and future capital requirements and must notify the FRB and the IDFPR within 30 days after the end of any calendar quarter in which its capital ratios fall below the minimum ratios specified within the approved capital plan. Additionally, the bank is prohibited from taking on debt, redeeming its own stock, or paying out dividends or distributions without the prior approval of state and federal regulators.
Oklahoma ties maximum interest on loans to fed funds rate
The Oklahoma governor recently signed SB 794, which increases the maximum loan finance charge for certain loans (i.e., supervised loans under applicable Oklahoma law) by additionally including the federal funds rate published by the Federal Reserve Board. Specifically, a loan finance charge may not exceed the equivalent of the greater of either of the following: the total of (i) 32 percent plus the federal funds rate per year on the part of the unpaid balances of the principal which is $7,000 or less; (ii) 23 percent plus the federal funds rate per year on the part of the unpaid balances of the principal which greater than $7,000 but less than $11,000; and (iii) 20 percent plus the federal funds rate per year on the part of the unpaid balances of the principal which exceeds $11,000; or 25 percent plus the federal funds rate per year on the unpaid balances of the principal. The federal funds rate is defined as the rate published by the Fed that is “in effect as of the first day of each month immediately preceding the month during which the loan is consummated.” Supervised lenders may contract for and receive a loan finance charge not exceeding what is allowed by the Act. The Act is effective November 1.
Republicans say regulators are coordinating on de-banking digital assets
On April 26, House Financial Services Committee Chairman Patrick McHenry (R-NC), Digital Assets, Financial Technology and Inclusion Subcommittee Chairman French Hill (R-AR), and Oversight and Investigations Subcommittee Chairman Bill Huizenga (R-MI) sent separate letters to the Federal Reserve Board Chair Jerome Powell, FDIC Chair Martin J. Gruenberg, and acting Comptroller of the Currency Michael J. Hsu seeking information to help the lawmakers determine whether there exists a “coordinated strategy to de-bank the digital asset ecosystem in the United States” and “suppress innovation.”
The text common to each letter pointed to actions taken by the federal prudential regulators as discouraging banks from offering services to digital asset firms. The lawmakers cited OCC guidance issued in 2021 (Interpretive Letter 1179, covered by InfoBytes here), which stated that banks can engage in certain cryptocurrency activities as long as they are able to “demonstrate, to the satisfaction of its supervisory office, that it has controls in place to conduct the activity in a safe and sound manner” and the banks receive a regulator’s written non-objection. Also discussed were FDIC instructions released in April 2022, which directed banks to promptly notify the agency if they intend to engage in, or are currently engaged in, any digital-asset-related activities, as well as a joint statement issued by the regulators in January that highlighted key risks banks should consider when choosing to engage in cryptocurrency activities. (Covered by InfoBytes here and here.)
Referring to certain recent bank collapses, the lawmakers argued that they do not believe that the underlying problems were caused by digital asset-related customers. The lawmakers requested information related to non-public records and communications between agency employees and supervised banks relating to the aforementioned guidance by May 9.