The big decisions awaiting Biden's Fed

November 9, 2021 9:00 PM

WASHINGTON — With President Biden still contemplating key leadership decisions for the Federal Reserve, much of the central bank’s regulatory and supervisory agenda remains somewhat in limbo.

Biden is expected shortly to make a decision on whether to renominate Fed Chair Jerome Powell or name a more progressive pick, such as Fed Gov. Lael Brainard, to lead the central bank. Brainard is also mentioned as a possible successor to Fed Gov. Randal Quarles as vice chair of supervision. The White also has two open seats to fill on the Fed board of governors, plus another one when Fed Vice Chair Richard Clarida’s term expires in January.

But without indication from the administration whether Powell will remain in place or a leadership shakeup is in store, the Fed has stayed quiet on key issues that have previously dominated the docket, including potential changes to the supplementary leverage ratio, bank merger approvals and updates to the anti-redlining Community Reinvestment Act.

If Biden opts against renominating Powell, it is widely expected that he will elevate Brainard, an Obama appointee, to the chairmanship. Bloomberg reported Tuesday that Brainard visited the White House last week to interview for the Fed chair role. Powell, whose term ends in February, also paid a visit to the White House last week.

Many have theorized that the Fed is laying low while it awaits an announcement from the White House. Even after Biden names his nominees, it may be challenging for the Fed to enact certain policies until they are confirmed by the Senate.

Here are key issues on the Fed's bank regulatory agenda that will come into sharper focus once its leadership questions are resolved.

A JPMorgan Chase Bank Branch Ahead Of Earnings Figures

Bloomberg News

Status of capital measure for the largest banks

The Fed still has yet to decide whether or not to make permanent adjustments to a key capital measure in order to account for an influx of reserves in the system that banks say has become challenging for them to manage.

At the outset of the COVID-19 pandemic, the Fed allowed bank holding companies to exclude Treasuries and reserves held at the central bank from the calculation of their supplementary leverage ratios — an extra buffer imposed on the biggest banks that is supposed to serve as a secondary capital requirement. Those exclusions were meant to enable banks to expand their balance sheets and help support the economy during the pandemic.

The Fed let those exemptions lapse in March, but said at the time that it would explore ways to prevent the SLR from overwhelming risk-based capital requirements. Banks have expressed concern that without a fix, the SLR could become a so-called “binding constraint” instead of its usual backup role. In that case, banks say they have fewer incentives to invest in safe assets, like U.S. Treasuries, and more incentives to take on risk.

Indeed, since the temporary relief expired earlier this year, the SLR has become a binding constraint for several of the nation’s largest banks, including JPMorgan Chase, Bank of America, Goldman Sachs and Morgan Stanley.

Fed Chair Jerome Powell said Nov. 3 that the central bank was looking at “if there are ways we can address liquidity issues through” the calculation of the SLR but declined to say whether or not the Fed was still pursuing permanent adjustments.

Many have theorized that the Fed is likely wary of making any changes that could be perceived as weakening bank capital requirements. Key Democrats, including Senate Banking Committee Chair Sherrod Brown, D-Ohio, and Sen. Elizabeth Warren, D-Mass., had urged the Fed not to extend the temporary SLR relief at the end of March, expressing concern that it would be a pretense for diminishing overall capital rules.

Basel IV

The Basel Committee on Banking Supervision has pushed back the deadline for implementing the Basel IV rules — also called Basel III endgame — to January 2023 in light of the coronavirus pandemic.

Still, many countries, including the United States, have significant work to do to finalize rules in order to align with the last components of the global post-crisis framework.
International regulators finalized the Basel IV framework in 2017 in an effort to complement the existing Basel III guidelines, which were formulated after the 2008 financial crisis.

That framework includes revisions to the international standards governing market risk, operational risk, credit risk and leverage ratios. Fed officials have previously said that they
would look to implement Basel IV in a way that wouldn’t force banks to raise more capital, and that it could tweak the stress capital buffer or the capital surcharge for global systemically
important banks in order to make the Basel IV rules “capital neutral.”

Fed. Gov. Randal Quarles — who was previously the central bank’s vice chair for supervision — has said previously that the Basel IV rules would, in many cases, fit in with the Fed’s existing tailoring framework.

Although the Fed has until 2023 to finalize the Basel IV rules, the rulemaking process is a lengthy one that could take a considerable amount of time. In accordance with the Administrative Procedure Act, the Fed has to provide the public an opportunity to comment on potential regulations before finalizing any rules.

Pending bank mergers

The Fed’s bank merger approval process could also be put on hold as the central bank awaits new leadership. The Fed is responsible for reviewing applications to acquire banks, holding companies and certain nonbanks, and is supposed to examine antitrust implications, as well as Community Reinvestment Act obligations, anti-money laundering compliance and financial stability implications.

Some bank mergers have historically come under scrutiny as industry observers worry about both the effects of excessive consolidation and the impact that mergers might have on bank
branches, which have dwindled steadily in recent years. The Biden administration in July issued an executive order encouraging numerous agencies, including the Fed, to review current merger practices and adopt a plan for strengthening merger oversight under the Bank Merger Act and the Bank Holding Company Act of 1956. It remains unclear if the central bank is amending its bank merger approval process in light of the executive order.

Nevertheless, numerous merger and acquisition deals are currently pending. An American Banker analysis found that so far this year, deals worth more than $48 billion have been
announced. Among those are U.S. Bancorp’s deal to acquire MUFG Union Bank and M&T’s pending purchase of People’s United in Bridgeport, Connecticut.

The Fed may not take up any of those deals until the Senate confirms a Fed chair and vice chair for supervision. Certain bank mergers have proven to be hot-button political issues, with advocates and Democrats alike expressing concern about the effects of consolidation on consumers.

Fed Gov. Lael Brainard has also echoed those sentiments. In May, Brainard abstained from the Fed’s vote to approve PNC Financial Services Group’s purchase of the U.S. operations of
BBVA, saying in a statement that she was worried about “increases in banking concentration in the $250 to $700 billion asset size category, where common-sense safeguards have been weakened."

Further changes to bank supervision program

The Fed has long indicated that it is looking to modernize its supervisory regime, an effort in particular that was a focus for Fed Gov. Randal Quarles, who is stepping down at the end of the year.

In a January 2020 speech, Quarles unveiled a comprehensive set of proposals to update how the agency supervises the nation’s banks on an ongoing basis, with the overall goal of bringing more transparency to the existing regime. Among the ideas he laid out were to align the Fed’s supervisory work with the tailoring rules that the central bank finalized in 2019, which placed banks into different risk-based categories, and to put significant supervisory guidance out for public comment.

In an interview with American Banker, Quarles said he was hopeful the next vice chair of supervision at the Fed might pick up where he left off.

“I do think that a consequence of our having drawn attention to it is that a lot more attention is being paid to it. On the left [and] on the right, I think everyone recognizes [that] thinking about due process and supervision is something that we ought to think about,” he said.

Fed Gov. Michelle Bowman has also said that the central bank should update its supervisory framework in a way that encourages innovation. She mentioned in a September speech that the Fed is conducting an internal review that will look at its existing supervisory practices to determine if its approaches need to change.

Bowman cited banks' response to competition from fintechs and increased use of data analytics in how products are delivered to consumers among the issues prompting the review.

Community Reinvestment Act reform

The Fed is expected to have a key role in interagency deliberations over modernizing the Community Reinvestment Act.

CRA talks between the regulators stalled during the Trump administration after the Office of the Comptroller of the Currency went out on its own last year with a final rule reforming the anti-redlining law without support from either the Fed or the Federal Deposit Insurance Corp.

Brainard, with Powell’s support, spearheaded the issuance of an outline envisioning a more moderate approach to overhauling CRA. With the OCC now abandoning its Trump-era rule under acting Comptroller Michael Hsu and returning to the negotiating table, the Fed could potentially be in the driver’s seat on future reforms.

Last year, Brainard was particularly outspoken in criticizing the OCC proposal, echoing concerns from banks that the regulators should reach consensus on a uniform CRA rule.
Some observers have expressed optimism that regardless of whether Powell or Brainard gets the nod to lead the central bank, the three agencies could be nearing a breakthrough on the interagency reforms.

Climate risk 'scenario analysis'

The Fed has stopped short of adding climate risk assessments to its traditional stress tests, but both Brainard and Powell have sounded support for “scenario analysis” exercises to measure the impact of climate change on the industry.

Brainard said in a speech last month that the central bank is moving ahead with such analyses, but they will not have direct implications on capital requirements. Scenario analysis helps firms account for physical risk from extreme weather events as well as the transition risk resulting from changing consumer behaviors and government policies, she said.

“Although we should be humble about what the first generation of climate scenario analysis is likely to deliver, the challenges we face should not deter us from building the foundations now,” Brainard said.

In earlier comments as part of congressional testimony, Powell said that “scenario analysis is almost certainly going to be one of the principal tools” to ensure that the banks the Fed supervises are capable of managing possible climate change risks.