February 23, 2023
It would hardly be an exaggeration to say that every issue of Cabinet News and Views could be a special issue devoted to crypto-assets. Crypto again dominates our coverage this week, just as it comes up in just about every conversation my colleagues and I have here in DC and with clients across the country.
But let's not let the crypto focus get in the way of other financial regulatory news. This week we also take a look at consumer disclosure and bank regulatory issues in the U.S. and, over in the UK, important Prudential Regulation Authority regulatory priorities for 2023.
We are always happy to talk crypto (or anything else in the financial regulatory space). Just drop us a line here.
Daniel Meade
Editor, Cabinet News and Views
Earlier today, the Federal Reserve Board (“FRB”), Federal Deposit Insurance Corporation (“FDIC”) and Office of the Comptroller of the Currency (“OCC”) issued a “Joint Statement on Liquidity Risks to Banking Organizations Resulting from Crypto-Asset Market Vulnerabilities.”
The joint statement points out the recent liquidity risks that crypto-asset-related entities have presented. The statement notes that “certain sources of funding from crypto-asset-related entities may pose heightened liquidity risks to banking organizations due to the unpredictability of the scale and timing of deposit inflows and outflows.”
The statement went on to remind banking organizations of risk management tools that may be effective to actively monitor such risks. The agencies made sure to note that the statement “does not create new risk management principles … [and that] [b]anking organizations are neither prohibited nor discouraged from providing banking services to customers of any specific class or type, as permitted by law or regulation.”
We have reported previously regarding the FDIC’s efforts to better police representations regarding deposit insurance, including when the FDIC issued an advisory regarding deposit insurance and the crypto industry last summer, and also when the FDIC published an updated rule in May 2022 regarding false advertising and misrepresentations, with support from the Federal Reserve and the Consumer Financial Protection Bureau.
This past week, the FDIC continued its work to ensure that the public is not misled regarding deposit insurance by reporting on a series of cease and desist demands it sent to two financial institutions and two websites that misrepresented the applicability of deposit insurance to their own products and to crypto, in general. One of the recipients of the FDIC letter is a crypto exchange making representations that deposit insurance covered fiat currency amounts held by the exchange, and the other company is a fintech that offers a savings product similar to a certificate of deposit that did not clearly identify the FDIC institution involved to provide deposit insurance and misrepresented the extent to which deposit insurance applies. With respect to the websites receiving the cease and desist letters, each website (see letters here and here) published articles regarding the very crypto exchange that also received a cease and desist letter, thereby perpetuating the impression that the crypto exchange itself was able to provide deposit insurance, even though it is not an insured depository institution.
The State of New York passed a law in December 2020 – the Commercial Finance Disclosure Law (“CFDL”), with an effective date of June 2021 – that prescribed required disclosures for commercial finance transactions that are $2,500,000 or less. The required disclosures are similar in style to those required for consumer financial services, but have specifics that are quite different from the federal Truth In Lending Act (“TILA”). Accordingly, the New York Department of Financial Services (“NY DFS”) finally published regulations implementing the law. In particular, the regulations clarified the available exemptions from the law’s requirements, which include:
- Financial institutions, including federally- and state-chartered banks, credit unions, industrial loan companies;
- Technology services providers providing financing for their products and services, as long as they have no interest in the financing;
- Real-estate secured financing;
- Leases (as defined in the UCC); and
- Providers that make no more than five (5) annual transactions in a rolling 12-month period.
In addition, if the transaction is covered by TILA, then the CFDL does not apply. Importantly, however, the NY DFS did not extend that exemption to cover commercial transactions that provide TILA-compliant disclosures, which has been a popular strategy for small business lenders to appease the Consumer Financial Protection Bureau and the Federal Trade Commission.
When the CFDL does apply to a commercial finance transaction, the breadth of the CFDL is quite broad – drawing in not just closed-end and open-end transactions but also sales-based financing and factoring transactions.
On 10 January, the UK’s Prudential Regulation Authority (“PRA“) wrote to international banks active in the UK to update them on regulatory priorities for 2023.
While these clearly reflect current macroeconomic drivers, they are a useful reminder of the way that global bank regulatory priorities are moving or have in fact moved:
- At the top of the list is financial resilience, with an emphasis on the need for proactivity when it comes to anticipating shocks. The PRA also makes it clear that resilience will be a focus when assessing capital and liquidity positions.
- Risk management and governance is next, with the PRA raising concerns about continuing to find large, concentrated exposures to single counterparties. Referencing lessons learned from the Archegos Capital default, the PRA is emphatic about the need to do comprehensive reviews of onboarding and due diligence practices, to do counterparty pricing and margining, and to stress test counterparties rigorously.
- Under rules now current on operational risk and resilience, firms should have already identified Important Business Services (as defined under those rules), set their impact tolerances and started scenario testing, and the PRA will be engaging with firms on how they have assessed their ability to remain within those identified risk tolerances. The PRA highlights a notable increase in outsourcing and the requirement for firms to maintain that ability even when the Important Business Service has been outsourced.
- On data, it is no surprise that the PRA reemphasises the need for timely, complete and accurate reporting, and they point to a programme of skilled persons reviews that have revealed a number of material deficiencies in regulatory reporting.
- The PRA reiterates its focus on financial risks arising from climate change and reports that while firms have taken “tangible and positive steps,” there is variability in the levels of “embededness” amongst firms.
Federal Reserve Board (“FRB”) Governor Michelle Bowman gave remarks last week to the American Bankers Association (“ABA”) Community Banking Conference. Governor Bowman discussed the role of FRB independence, predictability and tailoring in the FRB’s Bank Regulatory and Supervision function, as opposed to its monetary policy function. Governor Bowman noted that Chair Powell recently discussed FRB independence as it pertains to supervision and regulation in his speech at the Swedish Central Bank in January that we also discussed at the time. She noted that while this independence is important, it is appropriately accompanied by accountability through mechanisms such as Congressional oversight. She noted, however, that accountability to Congress wasn’t enough, and that transparency to the public (including regulated institutions) was also a requirement.
Governor Bowman elaborated on her transparency point by saying that being transparent also means “conducting supervision in a way that is predictable and fair.” She noted that what FRB is “always looking to improve is the publication of clear, appropriate guidance, especially for community banks.” She noted that providing community banks with tools to predict their CECL exposures was an instance where she thought the FRB has “done a pretty good job.” She added that, for larger institutions, the FRB is likely to publish its supervision manual for institutions covered by the FRB’s Large Institution Supervision Coordinating Committee (“LISCC”).
Governor Bowman then turned to an area where she thought FRB transparency had room for improvement: bank mergers. While the factors that go into review of bank merger applications are fairly transparent and set by Congress, she noted her concern that “the increase in average processing times will become the new normal.” She noted that there often are very understandable reasons why an application may take longer than anticipated, including new supervisory issues coming to light or the need for additional information from the applicants. Governor Bowman pointed out that “often, the key difference in processing times is whether the application will be acted on by the Reserve Banks on a delegated basis or will require Board action,” and Board action can be triggered due to a single protest from the public. She summed up her comments on bank merger application processing by saying that she believes there is room for improvement in the process and reiterated her belief that “the application process should not be used as a substitute for rulemaking.”
Governor Bowman concluded her remarks on the “virtues” of the tailored approach to bank supervision that the group of community bankers she was speaking to were presumably happy to hear. She noted that she believes the tailored approach will be present in the shortly forthcoming proposed rulemaking on the regulatory capital framework that should implement the Basel III Endgame rules in the United States. Governor Bowman concluded with her view that the tailoring approach has fostered fairness and efficiency in bank supervision.