BPInsights: Oct. 19, 2024

BPI and TCH Seek to Intervene in Corner Post Case Challenging Debit Interchange

BPI and The Clearing House Association filed a motion to intervene this week in Corner Post, Inc. v. Board of Governors of the Federal Reserve System. Corner Post, a North Dakota truck stop, is challenging the Federal Reserve's 2011 rules governing debit interchange revenue established pursuant to the "Durbin Amendment" in the Dodd-Frank Act. Corner Post, initially joined in the litigation by a coalition of retail merchant trade associations, argues the 2011 interchange rules are contrary to the Durbin Amendment. BPI and The Clearing House Association are requesting to intervene in the case alongside the Federal Reserve to defend against Corner Post's challenge to the rule.

"Banks oppose the Durbin Amendment's price fixing requirement as a matter of policy but stand with the Federal Reserve to defend the legality of its 2011 implementing regulation," stated Greg Baer, BPI President and CEO. "Retail groups challenged this very same rule over a decade ago in the DC Circuit and lost. The law requires the Fed to set a 'reasonable and proportional' limit based on the cost incurred by the debit card issuer. We will demonstrate that the plaintiff's arguments are legally deficient, and the statute clearly supports the Fed's 2011 rule."

"Not satisfied with the multibillion-dollar windfall the Federal Reserve's 2011 rule granted them, large corporate merchants have been suing the Fed to lower the interchange cap ever since it was created," said David Watson, President and CEO, The Clearing House. "The Clearing House Association is again appearing in court to ensure that merchants pay their fair share to support the convenience and safety that the debit card networks provide them and the U.S. economy."

Here is our position:
The Corner Post case is part of a nationwide legislative, regulatory and litigation effort instigated by retail trade associations to reduce debit interchange rates. Retail trade associations petitioned the Federal Reserve to lower interchange rates in December 2022, and the Fed proposed amendments to Regulation II in October 2023 to do just that. These groups also helped get the Illinois Interchange Fee Prohibition Act passed earlier this year, which prohibits interchange fees on any tax or gratuity paid for using a debit or credit card in Illinois. This law is currently being challenged in the case Illinois Bankers Association et al. v. Raoul.

As the Office of the Comptroller of the Currency argued in its recent amicus brief challenging the Illinois law, "interchange fees play a vital role in enabling banks to protect against fraud, cover the costs of transaction processing, and provide other valuable consumer services." Studies also show merchants benefit significantly from debit card services through higher sales, greater customer reach, faster checkouts, enhanced security, easier recordkeeping and happier customers. Prohibiting banks from charging reasonable and proportional interchange would undermine investments in new technology to maintain this system and mitigate and prevent fraud.

What's the background?
Regulation II, promulgated in 2011, requires the Federal Reserve to set standards for assessing whether debit card interchange revenue is "reasonable and proportional" to the cost incurred by the debit card issuer. Corner Post challenged this rule in 2021, arguing the Federal Reserve's 2011 rate cap is contrary to the Durbin Amendment. However, Corner Post's underlying challenge was dismissed as untimely because the suit was brought after the six-year statute of limitations under the Administrative Procedure Act had run.

In a landmark U.S. Supreme Court decision, the Court determined that the statute of limitations begins when the plaintiff is harmed rather than when the rule was issued. While Regulation II was promulgated in 2011, Corner Post did not open for business until 2018; therefore, Corner Post's alleged harm occurred within the six-year timeframe and their challenge was within the statute of limitations. As a result of the Supreme Court's opinion, the district court in North Dakota is now considering Corner Post's challenge to the Fed's rule.

The motion was filed in the United States District Court for the District of North Dakota. The case is 1:21-cv-95-DMT-CRH.

Five Key Things

1. Barr Raises the Right Questions on Liquidity, But Has He Already Decided on the Answers?

Federal Reserve Vice Chair for Supervision Michael Barr recently noted that the Fed can accomplish several important goals by encouraging banks to see reserve balances and reverse Treasury repos as substitutes and by encouraging them to use the Fed's standing lending facilities. These objectives are beneficial. However, Barr also stated that the Fed was basing its approach to liquidity regulations on three principles that are at cross purposes. Moreover, stating that these are "principles" suggests they are not open to public debate.

The objectives

• The objective of making reserve balances and reverse Treasury repos substitutes can enhance financial stability, money market functioning, and monetary policy efficiency. Bank willingness to switch readily from reserves to reverse repos will help hold down spikes in the repo rate. Moreover, the Fed will be able to continue QT for longer and become smaller if banks are willing to hold a smaller quantity of reserves, and if bank examiners let them.
• The objective of making banks willing to use the Fed's lending facilities - the discount window and the standing repo facility - will achieve similar benefits. After all, having the capacity to borrow from the Fed and having reserve balances at the Fed are economically nearly identical.

The principles

Barr said that the Fed's approach was based on three principles:

• The Fed sees it as "acceptable and beneficial" for firms to incorporate the Fed's lending facilities to meet liquidity stress in "both planning and practice."
• Banks must "self-insure against their own liquidity risk," meaning the banks must have sufficient "highly liquid assets to meet their potential funding needs."
• Banks must be ready and able to use private channels to turn the assets into cash (in addition to public channels).
• Unfortunately, the second and third principles undercut the first by clearly discouraging banks from using the discount window.
  Moreover, the second and third principles seem designed to generate specific policy outcomes, cutting off public debate about difficult foundational questions for the design of liquidity regulations.

The stakes

The importance of this issue was illustrated by worse-than-normal quarter-end turmoil in the repo market that drove repo rates well above Fed policy rates for several days. The spike in repo rates evoked only very limited borrowing at the Fed's lending facilities and occurred even though banks have more than $3 trillion in reserve balances that could have been redeployed into the repo market.

2. SEC's Peirce Aims to Shed Light on Private Credit Concerns

SEC Commissioner Hester Peirce in a recent speech compared private credit to a harmless cat mistaken for a scary predator - much less alarming than it seems. "When we look at [private credit] from a distance, it seems scary, unfamiliar, and large. Surely, it will do us harm," Peirce said. "Shouldn't we turn back and seek a different path? In reality, Thomas was a mere housecat. Upon closer inspection, private credit is familiar too, as are the associated risks." She added: "We should seek to understand today's private credit, the new forms it is taking, and the attendant risks. But we should not build it up into a monster of our own imagination."

• Reasons for growth: Private credit has grown rapidly in recent years partly because of stringent capital requirements imposed on banks, Peirce observed. She described it as "fill[ing] the gap" in lending to small and midsize businesses that resulted from post-Global Financial Crisis capital requirements. This factor is not the only reason for private credit's growth, but an important one, she said.
• Features: Peirce described features of private credit that she sees as beneficial: diversifying investors' portfolios while offering stable, attractive returns; affording flexibility to meet borrowers' particular needs; shorter underwriting timelines and other features.
• Scrutiny: Growth in private credit "understandably has drawn policymakers' attention," noted Peirce. Concerns have arisen about the absence of prudential regulation for private credit funds, the reliability of private credit valuations, deteriorating credit quality and weaker creditor protections and liquidity demands that exacerbate volatility, among other issues. "Exacerbating these concerns is a perceived lack of regulatory transparency into the private credit markets," she said. Nevertheless, she cited the ability of "existing regulatory tools, paired with unflinching market discipline" as the way to address risks associated with private credit.
• Key quote: Peirce raised an important point about prudential regulators' views on the nonbank sector: "Prudential regulators almost reflexively look askance at the non-bank sector because it intentionally elevates private decision-making over regulatory decision-making."
• Strength or weakness: The relative nimbleness of nonbanks is a strength, not a weakness, Peirce said. "An orientation to the needs of other market participants, rather than to the one-size-fits-all mandates of prudential regulators, enables non-bank private credit lenders to offer tailored lending solutions to borrowers, some of which are risky. The absence of prudential regulation also fosters a healthy heterogeneity in market practices and market participants' behavior, which supports systemic resilience. Fundamentally, moving the risks associated with credit off bank balance sheets with their government backstop and into the capital markets, where fund investors' equity is the backstop, enhances systemic resilience."
• Systemic risk concerns: "Invoking systemic risk to regulate private credit in the same way we regulate bank lending would engender risks of its own," she said.

3. Ninth Circuit Leapfrogged Analysis Required by Cantero Preemption Decision

BPI, along with the American Bankers Association, U.S. Chamber of Commerce, Consumer Bankers Association and Mortgage Bankers Association, filed an amicus brief this week in support of Flagstar Bank in Kivett v. Flagstar Bank. The amicus brief urged the U.S. Court of Appeals for the Ninth Circuit to rehear the Kivett case en banc - before the court's full panel of judges.

• Background: The Kivett case centers on a question of national bank preemption: Is a California law requiring minimum interest payments on mortgage escrow accounts preempted by the National Bank Act? The issue of national bank preemption - whether U.S. federal law like the National Bank Act supersedes state laws - is "critical to the U.S. banking system," the brief states. The Supreme Court remanded the Kivett case to the Ninth Circuit after the high court's decision in Cantero v. Bank of America, a landmark bank preemption case. The Ninth Circuit skipped ahead and issued a conclusory opinion that the California law was not preempted without undertaking the "nuanced comparative analysis" required by the Supreme Court.
• What's happening now: Flagstar Bank is now petitioning the Ninth Circuit to rehear its case en banc. The BPI brief supports Flagstar's petition and argues that the Ninth Circuit failed to conduct the analysis required by Cantero. If the circuit court panel had done the analysis, comparing the state law in question to those scrutinized in the Supreme Court's preemption precedents, they should have found that the state law is preempted by the National Bank Act for multiple reasons.
• Deeper dive: To learn more about the Supreme Court's Cantero ruling, a cornerstone of national bank preemption, see BPI's explainer here.
• Bottom line: "The post-Cantero contours of NBA preemption are extremely important to the banking and financial system and deserve more analysis than two lines in an unpublished opinion," the brief says. "The Court should rehear the matter with full briefing."

4. Is Guidance a Clarifying Tool or a Process Workaround? Chopra Weighs In

CFPB Director Rohit Chopra defended the agency's frequent use of guidance rather than formal rulemaking, framing it as a way to clarify expectations rather than to sidestep accountability. Firms can glean clearer answers from guidance rather than having "lawyers shake them down for their own hypothesis," he suggested. "Lawyers can actually be great stewards of the rule of law, they can be officers of the court," Chopra said at a recent fireside chat event. "They can also be leeches on the economy." The CFPB under Chopra has frequently issued circulars, bulletins, interpretive rules and other guidance rather than formal public rulemaking, which requires public notice and comment under the Administrative Procedure Act. During the event, Chopra also dismissed criticism of the agency's frequent use of another tool - enforcement. "I don't really sweat this," Chopra said. "You hear both sides. … 'Don't do enforcement, do regulations and guidance only,' or, 'Don't do regulations and guidance, just do case-by-case enforcement.'"

5. Some Thoughts on Reforming the FDIC

Concerns about the FDIC's workplace culture and the conduct of its employees and leaders have obscured a more pressing matter: the agency's performance of its mission. Since the Global Financial Crisis, the FDIC has taken on more responsibilities while continuing to perform its core functions, and it appears to be failing on multiple fronts. A fundamental rethinking of its mission is necessary and overdue. New leadership at the agency and in Congress should consider how to reform the FDIC, according to a recent Open Banker op-ed by BPI President and CEO Greg Baer.

• Many hats: The FDIC plays several roles, including that of an insurance company, a bankruptcy court, an investment bank, a bank examiner and a regulator. In many of these roles, serious problems have emerged, such as in the resolution of Silicon Valley Bank.
• Opacity: The agency's roles in liquidity regulation and merger review have lacked public accountability and merit revisiting.
• Fundamental questions: Foundational aspects of the FDIC such as its funding and its governance structure also warrant a rethink.

Read more here.

In Case You Missed It

BPI: CFPB's Broad Redefinition of 'UDAAP' Violations Is Challengeable in Court Under the APA

BPI, America's Credit Unions and the American Financial Services Association filed an amicus brief recently supporting the plaintiffs in an industry lawsuit against the CFPB that is undergoing appeal in the U.S. Court of Appeals for the Fifth Circuit. The U.S. Chamber of Commerce, American Bankers Association, Consumer Bankers Association and other groups challenged the CFPB over aspects of the Bureau's 2022 update to its Supervision and Examination manual. The broad brush of the CFPB's updated exam manual goes far beyond policing intentional discrimination as required by Congress by redefining violations of the ban on "unfair, deceptive, or abusive act[s] or practice[s]," known as UDAAP, BPI and its trade partners said in the brief.

Through an exam manual update, rather than a formal, fully transparent rulemaking, the CFPB dramatically altered the nature of such violations and required comprehensive reforms to compliance systems. The brief argued that unless the lower court's nullification of the 2022 changes are upheld, they would create confusion, impose significant costs and potentially jeopardize access to certain financial services. The BPI brief asserted that the UDAAP exam manual is a "legislative rule" under the APA, and thus, the Chamber et al. can bring a challenge under the APA on grounds that the 2022 modifications exceeded the CFPB's statutory authority to regulate "unfair" acts or practices.

• Going deeper: The updated exam manual section on UDAAP significantly expanded scrutiny over so-called "disparate impact" - something that affects different customers in different ways, a distinct concept from intentional discrimination - and applies it to non-lending products. This exceeds the statutory authority and imposes significant new obligations and costs on financial institutions. The manual update was released in the form of an examination guidance, but it effectively has the force of law.
• Sowing confusion: The way banks should approach the 2022 updates was unclear, leading to confusion. The CFPB "provides no guidance on how financial institutions should approach compliance with the Manual Update, nor does it even acknowledge the challenges of monitoring and combatting disparate-impact liability," according to the brief. "Those subject to the UDAAP prohibition are forced to figure these things out for themselves-on pain of a supervisory or enforcement action if they guess wrong … The CFPB's attempt to sweep these problems under the rug is even more alarming."

The Crypto Ledger

Here's the latest in crypto.

• Crypto mastermind faces potential jail time: U.S. prosecutors recommended that Ilya Lichtenstein, accused of leading one of the biggest-ever cryptocurrency heists, should spend five years in prison for his role in a money-laundering conspiracy. Lichtenstein bilked $6 billion from the Bitfinex crypto exchange; his wife, Heather Morgan, also known as the rap artist Razzlekhan, helped him launder the money.
• New player on the block: A startup crypto exchange in Chicago aims to bring a form of betting popular on offshore exchanges like Binance to regulated U.S. markets. The firm, Bitnomial, is seeking to launch the first legal U.S. marketplace for perpetual futures, which allow traders to make leveraged bets on bitcoin, ether and other cryptocurrencies.

Morgan Stanley's Pick on Capital Rules: 'Direction of Travel Has Been Constructive'

Morgan Stanley CEO Ted Pick said this week that the "direction of travel" on bank capital regulations has been "constructive." The bank carries an ample buffer - 160 basis points - because "it's an uncertainty that affects Morgan Stanley," Pick said in an interview this week with Bloomberg TV. "The industry has made its case on where some real modifications should be made and I think the regulators largely are listening," Pick said.