Category Archives: Federal Reserve

Fed intervenes: 0% interest; $700 billion quantitative easing

Governors at the U.S. Federal Reserve announced today that the central bank will slash its benchmark interest rate to 0 percent from a range of 1 to 1.25 percent last week.

The Fed, led by chairman Jerome H. Powell, also announched it will purhcase more than $700 billion in bonds and other securities — a quantitative easing — designed to keep private rates low.

The central bank also said it would encourage banks to make use of the liquidity to make loans to small businesses and families likely to be harmed by the decline in U.S. equities prices and the likelihood of a severe economic decline in 2020.

In combination, the moves continue an easing that began early in 2020 but has accelerated with the economic fallout from the global coronavirus pandemic.

Banks and the Volcker Rule — a “small” victory

One year after the Federal Reserve and its sister regulators deep-sixed the Volcker Rule, the banking barons who benefited from federal bailouts and a decade of Dodd-Frank regulations that crushed their smaller competitors are wondering how they missed out on the gravy train.

“Wall Street spent years” fighting the rule, writes Francine McKenna in MarketWatch, “but small banks win the most relief in Trump regulatory rewrite.”

The irony is rich. The purpose of the rule was to protect against system risk — not allocate burdens. But in fact, the Volcker Rule, like almost any regulation, imposed a greater burden — as a share of total costs — on small community banks than it did on the too-big-to-fail brigades.

This was truly perverse, especially in light of the fact that the best scholarship on the subject indicates that it’s larger institutions that pose greater system risk in the event of failure. The primary result of Dodd-Frank, a measure designed to punish banks “too big to fail,” was to drive nearly half the small community banks out of business, while profits, stock shares, and capitalization of the big banks soared.

Then again, the term “Volcker Rule” itself, and its substance, has a smokey, bitterly nostalgic aroma. The Volcker Rule was a response by Volcker and other regulators to the financial crisis that reflected monetary chaos they helped bring about in the early 2000s. In this, it resembles the Smithsonian Accords that blew up the Bretton-Woods monetary order; the G-7 monetary coordination effort that was a response to exchange rate chaos; and other start-a-fire-and-then-try-to-put-it-out solutions of the last 50 years.

The Volcker Rule was a second-best part of a first-worse solution to monetary chaos in the early 2000s. It won’t be missed, especially if policy-makers replace rule-writing fiat with a national and global monetary rule.

In the words of George Shultz — one of Volcker’s collaborators in the wanton monetary destruction of the 1970s and beyond — “If they’re too big to fail… make them smaller.”

Here comes the sun:
New banks in DC, Georgia, Florida, Virginia…

   GEORGIA’s NEW TANDEM BANK received FDIC approval back in May.

   When it opens, it will join Virginia’s Trustar Bank (pictured nearby), American Bank & Trust in North Carolina and others as the first community banks to appear in their states in at least a decade.

Regulator attitudes seem to be shifting as well, as we’ve noted in “Paragdim change… at the FDIC?,” and “Fed’s Gaffney on regulatory reform.”

Indded, FDIC Chairman Jelena McWilliams elaborated on the importance of new banks in American Banker, “We can do better on de novos.”

After another year of decline…
Turning point for community banks?

“The industry has been shrinking for more than a decade and many community banks have gradually disappeared,” writes

“But conditions are ripe for a comeback. Though challenges lie ahead, the newest entrants believe there’s a place for them and customers to serve who aren’t getting their needs for loans, checking or savings accounts met elsewhere.”

Sensible observers always knew a sector recovery would take some time — regulations to be written, capital to be organized. (See our May, 2018 piece, “…Fed: you’re up next.”)

Still, with US economy entering its 10th year of recovery, the continued decline of local banking and financial institutions is worrisome.

Paradigm change? New FDIC approach focuses on GSIBs

In a joint press release with other regulators, the FDIC on April 2 indicated it plans to focus rules protecting against system failures on large institutions —

“Global systemically important bank holding companies, or GSIBs, are the largest and most complex banking organizations and are required to issue debt with certain features under the Board’s ‘total loss-absorbing capacity,’ or TLAC, rule. That debt would be used to recapitalize the holding company during bankruptcy or resolution if it were to fail.

“To discourage GSIBs and “advanced approaches” banking organizations—generally, firms that have $250 billion or more in total consolidated assets or $10 billion or more in on-balance sheet foreign exposure from purchasing large amounts of TLAC debt, the proposal would require such banking organizations to hold additional capital against substantial holdings of TLAC debt. This would reduce interconnectedness between large banking organizations and, if a GSIB were to fail, reduce the impact on the financial system from that failure.”

It’s taken awhile, but federal regulators seem to be catching up with the work of economists and other scholars who realize the dangers of industry concentration — and the benefits of a healthy community banking sector. See, for example, last year’s important Federal Reserve study on the impact of bank size on system risk.

Fed’s Gaffney on Regulatory Reform

   Straw in the wind:

   Christine Gaffney of the Minneapolis Fed recently issued a brief statement, “What Does Regulatory Reform Really Mean?

   While it’s heavily couched and caveated — “some say it goes too far; some say it does not go far enough,” etc. — Gaffney (she is a regulator, after all) clearly grasps the spirit of the Crapo Act, writing that an animating goal is:

“Providing regulatory burden relief for depository institutions and small depository institution holding companies.”

Her article is also a clear indication that some at the Fed are beginning to understand the need to act to reverse the 20-year decline in community banks, a decline that accelerated under the reverse-of-intended consequences of Dodd-Frank.

Smaller banks, smaller stress. Bigger banks….
(Randal K. Quarles, call your office)

THREE CHEERS for the U.S. Federal Reserve for its recent study, “The Differential Impact of Bank Size on Systemic Risk, by Amy G. Lorenc and Jeffery Y. Zhang.

The study couldn’t come at a more critical time, as the Fed, Federal Deposit Insurance Corporation, and others immerse themselves in implementing the new requirements of the Crapo bank-regulation reform act.

   “Our empirical results,” the authors write, “show that stress experienced by banks in the top 1 percent of the size distribution leads to a statistically significant and negative impact on the real economy. This impact increases with the size of the bank. The negative impact on quarterly real GDP growth caused by stress at banks in the top 0.15 percent of the size distribution is more than twice as large as the impact caused by stress at banks in the top 0.75 percent, and more than three times as large as the impact caused by stress at banks in the top 1 percent.

These results,” they conclude, “support the idea that the largest banks should be subject to the most stringent requirements while smaller banks should be subject to successively less stringent requirements.”

Banking systems systems dominated by large banks are like a majestic ship — they can do many things; they move fast; they have big guns. But if one or two of these great vessels is hit, and sinks…

Community banks, by contrast, function like a network of rafts. They can’t move as swiftly. They don’t have huge guns. Water comes over the side and people get wet… but like a raft, the system doesn’t sink as readily.

Though the passage of the Crapo act in May was a valuable step, the fact remains, as we wrote at the time in “Fed, you’re up next, “it will take well beyond that for the Federal Reserve, FDIC, and other institutions to implement many of the new law’s provisions via regulation — and longer still for their impact to be felt in the real world.”

Note: the Fed acted in late August to implement an important increase in the threshhold level for small bank holding company policy statements to $3 billion — another step forward.

Here’s hoping the rule-writers at the Fed (att: Randal K. Quarles, pictured nearby) take the time to familiarize themselves with the Fed’s own important research contribution.

Fed: one step forward, two steps… well, yet to come

Late Friday (July 6), the Federal Reserve issued a joint statment on implementation of “the Crapo Act,” or, as its principal authors christened it, the “Economic Growth, Regulatory Relief, and Consumer Protection Act.”

The statement itself was written in regulationese — though perhaps this befits any comment on a piece of legislation that infelicitously acronyms out to “EGRRCPA.” The Fed was joined in the statement by the Federal Deposit Insurance Corporation and the Comptroller of the Currency. The regulators outlined which provisions of the Crapo At will take immediate effect, and which will require further regulatory action.

After reassuring the public (read: themselves) that their agencies “will continue” to enjoy vast discretion in oversight of the financial system, the

Good news: modification of the Volcker Rule will take effect immediately, freeing most institutions with total assets of less than $10 billion from the constraints of the Volcker Rule. The regulators way of expressing this was to say that their institutions “will not enforce the final rule implementing section 13 of the BHC Act in a manner inconsistent with the amendments made by EGRRCPA to section 13 of the BHC Act.”

Less good news: two of the more significant areas of regulatory relief for community banks — the respective increases in thresholds for the small bank holding company policy statement, and the off-ramp regarding mortgages and mortgage-backed securities — will await regulation re-writes.

That said, the statement doesn’t constitute a proverbial “two steps back.” Just, “two steps yet to come.”

Trump signs Crapo Act.
Fed: you’re up next.

On May 24, President Donald Trump signed the Crapo Bill — longer disignation, S-2155, Economic Growth, Regulatory Relief, and Consumer Protection Act — into law…

Bringing at least some relief to the beleaguered small and community bank sector.

We’ll know a bit more when the FDIC releases its quarterly banking profile in June.

But it will take well beyond that for the Federal Reserve, FDIC, and other regulatory institutions to implement many of the new law’s provisions — and longer still for their impact to be felt in the real world.

Here are three sign-posts to watch for:

1. One of the stated purposes of Crapo is to reduce the economic burden of compliance on community banks — which because of their size, must spend disproportionate resources on meeting its fixed costs. Will Crapo’s changes reach the bottom line as we head into 2019 and 2020?

2. Will community banks continue to go out of business, and banking industry concentration continue apace — or will these trends, finally, be reversed?

3. It has been nearly a decade since a new community bank was started. Will we see some new market entrants in 2019? 2020?

Good news (big banks) and bad news (community banks) from U.S. tax reform & CECL changes

“While there has been much written about the impact of the recent tax reform law on banks’ bottom lines,” the ABA Banking Journal writes, “less has been said about what it means for financial institutions in the capital markets. Specifically, if bank capital is a form of currency, how is tax reform shaping the deal-making environment for community banks to midsize and regionals?”

Brian Nixon provides some answers in “Tax Reform and table-setting,” in the recent ABA Journal.

Sadly, the bottom line is, the U.S. tax reform recently passed may help community banks in a very indirect way — by making access to certain types of capital more readily available — the same rule changes, and other regulatory changes scheduled for 2018-2019, will help large institutions much more. But the direct impact, when combined with 2018-2019 changes in capital classification requirements by the Federal Reserve, will have a much stronger, and more direct, impact.

community banks - Federal Reserve - CECL Implementation Roadmap 1For example, a 2017 analysis by Stonecastle concludes that when one combines tax reform with new tier-2 financing requirements. community banks “will see an “increased need for capital (so that banks can maintain their well-capitalized status). Even further, he expects that Tier 2 suborbinated debt “is likely the most cost-efficient form for this additional capital.” (Right-click image for larger view.)

Smaller banks “should fully appreciate” what the coming change essentially means: “as much, if not greater, [obstacles] for bank regulatory capital compliance.” More than 1,000 U.S. banks (heavily concentrated in small and community banks, “will struggle to maintain their capitalized status” when new standards for CECL (Current Expected Credit Loss) accounting are implemented.

Community banks “may have no alternative but to raise expensive equity to meet regulatory compliance.”