BPInsights: May 4, 2024

Clear, Objective M&A Standards Benefit Bank Customers and the Economy

Mergers and acquisitions enable banks to make the necessary investments to serve their customers. A healthy M&A pipeline, with clear timelines and expectations for merger approvals, allows banks to make informed decisions about how to grow and meet the needs of their customers, but recent federal proposals would create harmful uncertainty in the M&A process, BPI said in a statement for the record for the House Financial Services Subcommittee on Financial Institutions and Monetary Policy hearing titled "Merger Policies of the Federal Banking Agencies." Ultimately, the costs of languishing bank M&A ripple out to bank customers and the broader economy.

"We encourage the Subcommittee to consider the economic benefits of bank M&A activity and the costs of precluding it," the statement for the record said. "A predictable path forward for bank mergers promotes a healthier banking system and a more stable U.S. economy."

• 'Regulatory onslaught': In opening remarks at the hearing, Rep. Andy Barr (R-KY), the Subcommittee chairman, emphasized the tension between regulators' apparent opposition to M&A and the costs imposed on banks by a confluence of regulatory requirements - costs that necessitate scale. "The regulatory onslaught sets clear incentives and the necessity for mergers and acquisitions," Barr said. "At the same time, the FDIC and OCC want to make mergers all the more difficult, injecting sluggishness into their processes, even for mergers that clearly meet the approval criteria under the Bank Merger Act, with varying proposed conditions for merger approval."
• Setting a shot clock: Rep. Barr also discussed his legislation that would ensure bank merger applications are processed in a timely manner. "It's kind of like a shot clock," he said. "The regulatory purgatory, the indecision, is what we're concerned about here." He pointed out that when uncertainty looms over M&A approvals, "customers, shareholders and employees of the target bank are left on the hook indefinitely to see share prices drop and employees depart."
• Full competitive picture: Rep. Bill Posey (R-FL) asked regulatory officials how they account for increased competition from nonbank financial institutions, such as fintechs, when evaluating the competitiveness of bank mergers. Senior OCC official Ted Dowd responded that "there is at least a recognition within the OCC that the landscape and the manner in which financial services in general, and banking services in particular, have been delivered since 1995 has evolved considerably, and we need to think about that." He added that "that is part of what we're doing with our with our notice of proposed rulemaking."
• Timing questions: Rep. Brad Sherman (D-CA) noted that in 2021, the Biden Administration directed the Department of Justice, the OCC, the FDIC and the Federal Reserve to update the guidelines for bank merger approval, but only the OCC and FDIC have taken concrete action. He asked what the state of progress is with the issuance of new M&A guidelines.
• Community benefit plans: Rep. Barr also asked the regulators if banks must have entered a community benefits agreement in order for them to conclude that the merger satisfies the convenience-and-needs factor. Ted Dowd of the OCC said "the short answer is no."

Five Key Things

1. Incorporating Discount-Window Borrowing Capacity into a Liquidity Requirement

The bank failures of spring 2023 laid bare the shortcomings of the Federal Reserve's discount window and the repercussions of banks being unprepared to use it. Now, regulators are calling for banks to pre-position collateral at the window and ensure they are ready to tap it. A new BPI analysis examines large regional banks' liquidity after accounting for their borrowing capacity at the discount window.

• Important note: Behavior of uninsured deposits may differ among different types of bank customers. Depositors with longer-term, multifaceted relationships with a bank are less likely to run in times of stress.
• Results: The BPI analysis finds that large regional banks are well-prepared to manage the risk of deposit withdrawals through substantial cash assets and their ability to borrow from the discount window. Large regional banks have increased these liquidity sources since March 2023, and are now better positioned to meet deposit outflows.
• Reducing stigma: These banks are increasingly prepared to borrow from the discount window, but regulators must also take steps to reduce stigma associated with borrowing from it. They can mitigate stigma by offering incentives to borrow from the discount window more often, such as:
  • Allowing banks to fulfill liquidity requirements by holding "high-quality liquid assets" and having discount window borrowing capacity.
  • Allowing discount window borrowing capacity to count as a source of contingent liquidity in internal liquidity stress tests and resolution funding plan requirements.
• Regulators should also understand and track uninsured deposits in ways that make sense for the broader banking industry and account for differences in uninsured deposit customer bases. For example, Silicon Valley Bank's uninsured depositors were highly interconnected with one another - venture capitalists who knew each other, for example. When designing any new liquidity metric, regulators should consider the differences in such "hyper-local" uninsured deposit bases and those at other banks.

2. BPI's Heather Hogsett Calls for Substantial Changes to Cyber Incident Reporting Rule

Heather Hogsett, BPI senior vice president, technology and risk strategy for BITS, testified this week on the implementation of the Cyber Incident Reporting for Critical Infrastructure Act of 2022 (CIRCIA). Her remarks, delivered before the U.S. House Subcommittee on Cybersecurity and Infrastructure Protection, called for substantial changes to the proposed rule to increase its utility to government and industry.

"CISA should rewrite its proposed rule to avoid collecting more data than necessary and requiring cyber defenders to spend their time filing reports rather than protecting America's financial system," Hogsett said. "Reporting for the sake of reporting without timely and actionable alerts is counterproductive for banks and a missed opportunity to strengthen national security. Fixing these problems and addressing the SEC's harmful cyber incident disclosure rule would go a long way toward protecting the financial system and helping U.S. banks stay ahead of emerging threats."

See BPI's recommendationshere.

3. Intelligence Sharing, Stronger Security: BITS Statement on the Administration's Revised Critical Infrastructure Policy

The Administration issued a National Security Memorandum on Critical Infrastructure Security and Resilience this week, updating Presidential Policy Directive 21 (PPD 21), which establishes a uniform national policy for identifying and mitigating threats to U.S. critical infrastructure. The policy applies to all government agencies and is intended to protect the 16 critical infrastructure sectors - including financial services - that are considered most vital to our national security and economic interests.

BPI's Heather Hogsett stated: "BPI strongly supports the National Security Memorandum and commends the Administration for its ongoing commitment to strong public-private partnerships. The memorandum builds on effective approaches to strengthening security and resilience and recognizes that critical infrastructure entities are the first line of defense against nation-state attacks and cybercriminals. It will also support the financial sector by enhancing collaboration with national security agencies to ensure the intelligence community collects, analyzes and disseminates timely information on threats to critical infrastructure to support national-level systemic risk mitigation. We look forward to continued collaboration with Treasury, CISA and the Administration to ensure the memorandum's successful implementation."

What Has Changed?

• Treasury remains the primary cybersecurity point of contact for banks. The memorandum updates the roles and responsibilities of federal agencies and helps to clear up potential redundancies between CISA, Treasury and the prudential banking regulators.
• CISA is responsible for cross-sector risk mitigation efforts. Information sharing and collaboration between sectors of the economy help to prioritize preparedness and response activities and can minimize contagion during an incident. Emphasizing this as a top priority for CISA will help drive progress.
• The intelligence community will play a bigger role in critical infrastructure protection. The directive will require the intelligence agencies to prioritize critical infrastructure protection in internal policies, annual budgets and planning efforts so that the private sector receives timely and actionable threat information.
• Rules for how systemically important entities are designated will change. Banks are already subject to the systemically important financial institution (SIFI) designation as well as other designations from past executive orders. These changes will better align risk designations to avoid duplication and ensure they are tailored to the risks facing financial institutions. The new "systemically important entity" designation will help identify and prioritize national systemic risks across all sectors of the economy and Treasury will have direct input into these designations on behalf of the financial services sector.

4. How Big Is Jane Street? A Size Perspective on One of the Nonbanks Dominating the Trading World

The biggest trading desks and investment banks are, increasingly, not banks, and a recent Financial Times Alphaville article shows just how large some of these nonbanks' market shares are. Jane Street, a trading firm that is particularly dominant in fixed-income ETFs, accounted for 10.4 percent of all North American equity trading last year. Last year, its monthly ETF trading volumes averaged $527 billion, or about 14 percent of U.S. ETF trading volumes and 20 percent of Europe's. That's about 5x the London Stock Exchange's entire trading volumes in 2023. Jane Street accounts for 41 percent of all primary market activity in fixed-income ETFs, according to Alphaville, which dug through its bond prospectus for these figures. "The trading firm has used this as a bridgehead to break into corporate bond trading territory long dominated by banks," the article says. Jane Street's gross revenues were $21.9 billion in 2023 - equivalent to 1/7^th of the combined equity, bond, currency and commodity trading revenues of all the major global investment banks last year.

5. Federal Prosecutors Probe Block for Processing Crypto Transactions for Terrorist Groups

Federal prosecutors are probing internal practices at Block, the owner of payment platforms Square and Cash App, according to NBC News. A former employee showed prosecutors in the Southern District of New York documents to support allegations that Square processed thousands of transactions involving sanctioned countries and that Block processed crypto transactions for terrorists. Block failed to collect enough information on customers to assess their risks and failed to report certain transactions to the government as required by law, according to the former employee's allegations.

In Case You Missed It

The Crypto Ledger

Here's what's new in crypto.

• Binance founder sentenced: Binance founder and former CEO Changpeng Zhao was sentenced this week to four months in prison after pleading guilty to enabling money laundering. The sentence strikes a stark contrast with fellow crypto titan Sam Bankman-Fried's 25-year sentence in another recent case.
• Custodia to appeal: Crypto firm Custodia plans to appeal a court's ruling in favor of the Federal Reserve in the firm's lawsuit against the central bank. The U.S. district court ruled that the Federal Reserve Bank of Kansas City had the discretion to deny Custodia a Fed master account, which would have given it access to the federal payments system.

Truist Launches Financial Education Program for High School, College Students

Truist this week announced the launch of the Truist Life, Money, and Choices financial education program. The program, aimed at empowering younger generations with financial literacy and skills, is geared toward community organizations serving high school and college students.