BPInsights: Jun 15, 2024

How the Basel Proposal Could Harm Consumer Credit Card Lines

The U.S. banking agencies' Basel capital proposal includes a new capital charge for the unused portion of consumer credit card lines. This charge could harm the financial well-being of low- and middle-income consumers, who depend on unused credit card capacity as a crucial backup source of liquidity to cover unexpected expenses like medical bills or car repairs. This financial "dry powder" would generate new costs under the proposal, which could drive banks to reduce credit limits or close accounts that are used less frequently. Reductions in credit lines not only hurt consumers' ability to handle unexpected expenses, but also increase consumers' credit utilization rates and therefore can lower their credit scores. This capital charge could hurt low- and moderate-income households' ability to cover expenses in the short term and access credit in the long term.

How it works: The proposed 10 percent Credit Conversion Factor essentially works as a risk weight applied to consumers' unused credit lines (the amount remaining between what consumers put on their credit card and their credit limit on that card). This charge overstates risk, and this overstatement exposes consumers to significant credit line reductions, especially on accounts on which they do not revolve balances.

Unique effect: This charge could have a uniquely significant impact on U.S. consumers compared to those in other jurisdictions - about 80 percent of available credit among U.S. bank credit card lines are unused.

BPI's analysis: BPI's analysis shows how the charge on unused credit lines overstates risk and could harm access to credit, particularly for consumers that are "transactors" - those who pay their credit card balance in full every month. This category comprises consumers across the income spectrum, including low- and moderate-income consumers. The analysis is based on a dataset containing anonymized consumer-level characteristics derived from credit card account data, provided by TransUnion, a global information solutions company. The analysis reveals that around half of credit card lines are issued to credit card accounts that are paid off in full every month (Transactors) and that credit card line utilization rates are relatively low for these accounts across all income groups.

What the results support: These results support implementing a lower capital charge for the unused portion of all Transactor accounts. This step is further justified because the 10 percent CCF contained in the U.S. proposal (and the Basel standard) is about double the amount suggested by historical loss experience for this risk parameter, even before considering how the annual stress tests in the United States already account for such risk.

Avoid unintended consequences: Consumers across all income levels and with varying numbers of credit cards consistently maintain substantial amounts of available unused credit lines. As the agencies consider changes to the Basel proposal, it is crucial that they fully assess the risk of disrupting established consumer credit practices. Transactors, in particular, represent a lower-risk segment that could be unduly affected by the proposed changes. At a minimum, the agencies should strongly consider assigning a lower capital risk weight measure to Transactor accounts to reflect their lower credit-risk profile.

Five Key Things

1. FDIC's Toxic Workplace Revelations Front and Center on Capitol Hill

The revelations of a toxic workplace environment roiling the FDIC and Chair Martin Gruenberg were the focus of a House Financial Services Committee hearing this week. Shortly after lawmakers decried sexual harassment and other serious misconduct at the agency and Gruenberg's leadership during these incidents, the White House announced its intent to nominate CFTC Commissioner Christy Goldsmith Romero as Gruenberg's successor. Reuters this week reported that the White House will aim for a nomination hearing the week of July 8.

• Chief witness absent: The most notable witness at the hearing was the one who did not attend: Gruenberg himself, who cited a scheduling conflict. Other witnesses included FDIC board member Jonathan McKernan, OCC Acting Comptroller Michael Hsu and two partners at Cleary Gottlieb, Joon Kim and Abena Mainoo. Cleary published the external report on the FDIC's workplace culture. McKernan and Hsu served as co-chairs of the FDIC's Special Review Committee, tasked with overseeing the independent review of the agency's culture.
• 'Deny, deflect and delay': Gruenberg has agreed to resign when a Senate-confirmed successor takes the helm, but for many lawmakers, that is not soon enough. Financial Services Committee Chair Patrick McHenry (R-NC) called Gruenberg's delay in resignation a "farce," saying that "his approach to a long overdue cultural overhaul of the FDIC seems to be deny, deflect and delay." Rep. Bill Huizenga (R-MI) called Gruenberg a "failed leader who has put politics and a radical progressive agenda over doing what is right."
• Fear, sadness and anger: Cleary partner Joon Kim described the "fear, sadness and anger" expressed by FDIC employees reporting misconduct. "Virtually all of them expressed hope that reporting what they had gone through to us might help to change and make better the agency that they cared about deeply," he said. His colleague Abena Mainoo described "a deep-seated fear of retaliation, as well as a lack of clarity and credibility around internal reporting channels" at the FDIC, as well as "a lack of accountability, insufficient prioritization of workplace culture, risk aversion, abuse of certain power dynamics and insufficient record keeping."
• Change needed: When asked if Gruenberg should immediately step down, the FDIC's McKernan responded "the FDIC urgently needs a fresh start, and the sooner the better." Rep. Bill Foster (D-IL), who has called for Gruenberg's resignation, said "it is appropriate to bring in new leadership at the FDIC that has demonstrated commitment to addressing these issues" and urged the Administration to quickly nominate a replacement.
• Political undercurrents: Ranking Member Maxine Waters (D-CA) criticized the Cleary report as, in her view, narrowly focusing on the accountability of Gruenberg and not on former Chair Jelena McWilliams or on current Vice Chair Travis Hill, both Republican appointees.

2. Late Fees, Funding Structure, Financial Data: CFPB's Chopra on the Hill

The Supreme Court recently ruled that the CFPB's funding structure is constitutional, but for some lawmakers at this week's regular CFPB oversight hearing, the ruling only ignited their concerns. In addition to discussing the impact of AI in financial services and a recent proposal to remove medical debt from credit reports, Chopra expressed concern about the use of financial data in targeted advertising. At the House hearing, he said he is aiming to finalize the Section 1033 rule on financial data sharing by October. Here are some notable exchanges from CFPB Director Rohit Chopra's appearance on Capitol Hill this week.

• 'The bill … always comes due': Senate Banking Committee Ranking Member Tim Scott (R-SC) emphasized the need to examine unintended consequences - and costs - of the CFPB's policies, such as its credit card late fee rule. "With every action taken, there are tradeoffs, and those tradeoffs have consequences," Scott said. "In this case, the administration is trading a punchy headline proclaiming they are saving families money today while actually building higher costs down the road." He named the late fee rule as a key example: "While the rule may save some folks around $20 each time they make a late payment, how much will it cost these same consumers when they no longer qualify for a credit card because they haven't paid their balances on time? How much will it cost them when their credit score drops as a result of these late payments?" he said. "You can't just keep erasing the bad facts to fit your political narrative. The bill always, and unfortunately, always, comes due."
• Electronic fund transfers: Sen. Mike Rounds (R-SD) asked Chopra to clarify if the CFPB believes scam transactions - those authorized by the consumer but under false pretenses, rather than fraud - are considered unauthorized electronic fund transfers under the Electronic Fund Transfer Act and the rule related to that statute, Regulation E. Chopra gave a vague response: "the general sense is that with respect to fraud and scams, the line is a little bit blurry," and later said "there are some places where Regulation E would certainly apply."
• Nonbank oversight: Sen. Chris Van Hollen (D-MD) emphasized the need for the CFPB to oversee nonbank financial firms such as fintechs, which are increasingly dominating the financial services market.
• Flawed analysis: Rep. Andy Barr (R-KY) expressed concern about the economic analysis underpinning the CFPB's proposals. "CFPB analytical work under your tenure has lost credibility and increasingly amounts to junk economics," Barr said to Chopra.
• Funding case: Some Republican lawmakers remained skeptical about the CFPB's funding mechanism despite the Supreme Court's recent ruling in its favor. "You've been operating illegally," Sen. John Kennedy (R-LA) told Chopra. Kennedy was parsing the notion that the CFPB is funded by Federal Reserve "earnings" and said the Fed is no longer transferring money to the Treasury's General Fund. Sen. Mark Warner (D-VA) noted that the Fed operates under distinct rules regarding generating earnings. In the House, Financial Services Committee Chair Patrick McHenry (R-NC) called for lawmakers to enact a "legislative solution" to change the CFPB's funding structure.
• Buy now, pay later: Sen. Jack Reed (D-RI) expressed support for the CFPB's recent interpretive rule saying that buy now, pay later loans qualify as credit card loans. "The CFPB should bring the biggest BNPL lenders under federal supervision in order to spot violations," Reed said.

3. Bloomberg: EU to Delay Part of Basel Implementation by One Year

The European Union will delay implementation of key elements of the Basel Endgame rules by one year, in order to align with likely delays in the U.S., according to Bloomberg this week. The article cited people familiar with the matter, who said the delays will apply to market risk rules in particular, since those activities are global in nature. Implementation of the wider package remains scheduled for the start of next year, according to a European Commission spokesperson, but the Commission "has the power to delay or tweak the application of certain market risk provisions," the spokesperson said. "The exercise of this power would not delay the implementation of all new Basel rules, but only the rules on market risk."

• Competitive perspective: Senior European officials, such as French President Emmanuel Macron, have been reluctant to implement the Basel rules ahead of the U.S., fearing a competitive disadvantage for European banks.

4. A Holistic Look at the Regulatory Deluge on Retail Banking

A recent Oliver Wyman report explores the impact of three major regulatory measures on retail banking and offers a framework for how to evaluate their effects. Regulatory proposals from multiple agencies can result in overlapping impacts on banks or produce complex interactions, the report said. It aims to address the challenge of identifying unintended consequences of such simultaneous proposals. The three policies in focus are the Basel Endgame proposal, the CFPB credit card late fee rule and the Fed debit interchange proposal. Here are some key highlights of the report.

• Knock-on effects: Regulations can affect consumers directly - for example, lower caps on late fees driving more consumers to pay late. But the effects don't end there - as banks adapt their business models to new requirements, such adjustments can also affect consumers. For example, restrictions on practical sources of revenue for a product may drive banks to reduce availability of that product. Consumers may also be affected if the broader banking industry evolves in response to regulatory requirements - this happened with mortgages in recent years, with nonbanks now playing a much more prominent role in the market. BPI has also pointed out that regulators should consider the cumulative effect of multiple rules.
• Major costs: The report lays out the potential economic consequences of the proposals' practical effects on banks' revenue models. The proposed decrease in the debit interchange fee cap would have a significant effect on the profitability of low-balance checking accounts, potentially decreasing the availability of free checking accounts, and could encourage banks to recoup the costs of fraud losses. BPI made similar points in its comment letter on that proposal. The late fee rule would "have a larger impact on deep subprime, subprime, and near-prime customer segments" and "may lead banks to stop lending to these populations, decrease available lines or credit and/ or increase APRs." In addition, "more consumers may be late more often due to the lack of deterrence, thus making consumers less credit-worthy and possibly impacting their credit scores." BPI expressed similar concerns in its comment letter on the late fee measure. The Basel proposal would impose higher capital requirements on banks and could lead to reduced availability of credit, concerns also expressed by BPI in comments. (BPI has also documented the likely effects of Basel on retail lending, credit card lines and mortgage lending.)
• Confluence of effects: The late fee and debit interchange rules will particularly affect revenue among banks that offer debit cards, checking accounts and credit cards, according to the report. And the Basel proposal would impose higher capital costs across the board, especially for banks with $100-700 billion in assets "or those with >$700 billion in assets where the standardized approach proposed by [the] Basel III rule requires more capital than their internal organization models currently in use." The report warns that "[f]or these banks, the cumulative effect of lower revenue and higher capital costs can significantly impact economic performance, potentially leading banks to make significant cuts in available credit to consumers."

5. SCOTUS Vacates Lower-Court Decision on Bank Preemption

The U.S. Supreme Court this week vacated a Ninth Circuit court decision that rejected federal preemption of a state mortgage escrow law. The Court sent the case back to the lower court for further consideration "in light of Cantero v. Bank of America NA," another key bank preemption case that the Supreme Court recently decided. In the most recent case, Flagstar Bank v. Kivett, William, et al., California borrowers had filed a class action lawsuit against the bank alleging that it ignored a California state law requiring interest payments on mortgage escrow accounts, which is nearly identical to the New York law at issue in the Cantero case. The Ninth Circuit had agreed with the district court that the National Bank Act, a federal statute, did not preempt the state law. That outcome conflicted with the Second Circuit's decision in the Cantero case, which the Supreme Court addressed in its recent decision. The Supreme Court's order in Flagstar confirms that the Supreme Court did not agree with either the Second or the Ninth Circuit's reasoning in these cases, and both will need to be reconsidered in the lower courts.

• What happened in Cantero? The Cantero decision pointed to the Supreme Court's historical precedents and said courts should compare state laws with the laws at issue in those earlier cases to determine if they are preempted. The Court declined to adopt a clearer test for determining if a law is preempted. The specific question at the heart of the case - whether the New York escrow interest law is preempted-was sent back to the Second Circuit for reconsideration. Going forward, including in both the Cantero and Flagstar cases on remand, courts will probably analyze state laws to determine whether the degree of interference with national banking powers resembles cases where the Supreme Court found the law was preempted, or vice versa. For more on the Cantero case, see here.

In Case You Missed It

How Bank Credit Risk Transfers Work, and Why They Make Sense

Banks' efforts to manage capital more efficiently by transferring credit risk to outside investors through synthetic securitization align with similar efforts undertaken by federal regulators, according to a recent post by the Structured Finance Association.

• How it works: Credit-linked notes are a way for banks to convert pools of loans, such as mortgages or auto loans, to securities that they issue to outside investors as a way to manage their capital. The principal amount due on the notes is decreased if there are losses on the underlying pool of loans over a certain threshold, so investors in the notes are providing a layer of credit protection. Unlike credit default swaps, the transactions are pre-funded and the bank faces no counterparty risk. Banks can also indirectly sell credit-linked notes through a structure called a special purpose entity.
• Similar efforts: These transactions are compared in the post to similar efforts by the government to reduce taxpayer exposure to losses: long-term debt requirements for GSIBs and credit risk sharing programs for Fannie Mae and Freddie Mac. "[O]ne may view bank long-term debt as representing the bank's transfer to investors of a mezzanine risk exposure to the bank's entire asset portfolio," the post states. "This is similar in spirit to credit-linked notes transactions that reference sub-portfolios of loans using synthetic securitization.
• Response to criticism: The post responds to two criticisms of credit risk transfers: that they are part of a trend of financial intermediation migrating outside regulated banking, and that demand for these transactions will decline during a credit downturn. Bank credit risk transfers represent a minimal amount of such migration to the nonbank sector, according to the post, and "any reduction in the risk appetite of investors for future credit-linked note transactions has no bearing on the credit protection already provided by investors in existing deals since they are pre-funded."

The Crypto Ledger

Here's the latest in crypto.

• Crypto sanctions: Sen. Mark Warner (D-VA), chair of the Senate Intelligence Committee, said he is open to narrowing crypto sanctions legislation that lawmakers plan to include in a must-pass defense spending package. The legislation would impose sanctions on both banks and digital asset exchanges that facilitate transactions for terrorist groups.
• Big settlement: Terraform Labs, the company behind the TerraUSD and Luna stablecoins that drove the "crypto winter" in 2022, agreed to pay just under $4.5 billion to the SEC - one of the largest penalties ever to settle a civil securities fraud lawsuit. The company also agreed to wind down its operations. Its former CEO Do Kwon is currently detained in Montenegro, and the U.S. and South Korea are both seeking his extradition.
• Unlicensed crypto exchange: U.S. prosecutors accused Connecticut resident William McNeilly of operating an unlicensed crypto exchange, according to Law360. Scammers allegedly induced people in Tennessee and Illinois to send money through the exchange.

Bank of New York Mellon Rebrands as 'BNY'

Bank of New York Mellon has updated and simplified its branding to "BNY." "These changes complement the company's evolution as a leading global financial services company," said BNY's Global Head of Marketing and Communications Natalie Sunderland. The parent company's legal name will remain The Bank of New York Mellon Corporation. BNY is America's oldest bank, founded by Alexander Hamilton.