Fed announces simplified stress test rules and finalized capital buffer, ending pass-fail. The Federal Reserve has finalized a rule to simplify its capital planning framework for the nation's largest banks. Under the Amendments to the Regulatory Capital, Capital Plan and Stress Test Rules, which will take effect in time for this year's round of testing, the Fed's supervisory stress tests will be integrated with its non-stress capital requirements. The simplification means banks will need to meet 8 capital requirements, down from the current 13. Approved by the Fed on March 4, the new rule means that large banks would no longer fail the Fed's tests for having insufficient capital; rather, the tests would be used to set a firm's capital requirements for the following year based on its results, through the calculation of a stress capital buffer (SCB). Along with the rule, the Fed released Comprehensive Capital Analysis and Review (CCAR) 2020 Summary Instructions. "By combining the Board's stress tests – which project the capital needs of each firm under adverse economic conditions – with the Board's non-stress capital requirements, large banks will now be subject to a single, forward-looking, and risk-sensitive capital framework," the Fed said in a March 4 press release. According to a memo prepared by Fed staff in February, the final rule would preserve strong capital requirements for large firms, with largely unchanged common equity tier 1 (CET1) capital requirements. "The impact of the draft final rule depends, in significant part, on a firm's planned capital distributions, which rose from a relatively low level in 2013 to a relatively high level in 2019," the Fed memo states.

  • The final rule, the last piece of an ongoing effort by the Fed to simplify capital requirements, makes some changes to the original proposal unveiled by the Fed in April 2018, based on input received from stakeholders. For example, it no longer includes a stress leverage buffer requirement. Instead, firms would continue to be subject to ongoing, non-stress leverage ratio requirements, resulting in a simpler capital framework while maintaining leverage capital requirements as a backstop to risk-based capital requirements. The final rule also allows firms to increase their planned capital distributions in excess of the amount included in their capital plans without prior approval of the Fed Board. Those firms would instead be subject to automatic distribution limitations if their capital ratios fell below the buffer requirements, which would include the stress capital buffer requirement.
  • As is often the case in higher-profile Fed actions, Governor Lael Brainard, the sole Democrat currently on the Board, cast the one opposing vote. "Unfortunately, today's rule gives a green light for large banks to reduce their capital buffers materially, at a time when payouts have already exceeded earnings for several years on average," Brainard said.
  • But the Fed Board's Vice Chair for Supervision Randal Quarles said in support of the rule, "the SCB rule adopted today will lead to an increase in the Board's common equity capital requirements for large banking firms, as measured through the cycle, of approximately $11 billion, including an approximately $46 billion increase for the US global systemically important banks. Banks also keep certain voluntary buffers above our required minimums, and those buffers will vary somewhat from time to time – nothing in the SCB rule adopted today gives banks an incentive to reduce those buffers, which will always remain above our now higher through-the-cycle requirements."

Supreme Court declines to review suspicious activity report immunity case. The US Supreme Court on February 24 declined to hear a challenge appealing a lower court ruling that suspicious activity reports (SARs) are immune from civil actions. The high court denied a writ of certiorari in the case AER Advisors Inc. et al. v. Fidelity Brokerage Services LLC, in which the Court of Appeals for the First Circuit ruled that financial institutions enjoy absolute immunity under federal law when they report suspicious trades to regulators. According to court documents, Fidelity in 2012 filed an SAR with the Treasury Department's Financial Crimes Enforcement Network (FinCEN) over an investment by AER in a Chinese medical company, which then triggered investigations by the SEC and several state agencies that were ultimately dropped. But AER said it spent hundreds of thousands of dollars in legal fees from which it did not "economically recover." AER sued, initially in federal court in Florida before the case was transferred to Massachusetts, charging Fidelity with filing an SAR based on false allegations of market manipulation. Fidelity claimed that it had absolute immunity from lawsuits alleging the filing of a false SAR and moved to dismiss the suit, citing a provision in the Bank Secrecy Act (BSA) stating that "a financial institution that makes a voluntary disclosure of any possible violation of law or regulation to a government agency … shall not be liable to any person under any law or regulation of the United States, [or] any constitution, law, or regulation of any State (…), for such disclosure." In August 2018, the District Court for Massachusetts dismissed AER's allegations, a decision affirmed by the First Circuit in April 2019 in an opinion written by Judge Ojetta Rogeriee Thompson. "[W]e concluded that the BSA immunizes financial institutions even if their 'disclosures [are] unfounded, incomplete, careless and even malicious,' just so long as they identify 'a possible violation' of law – something the bank had done there," Thompson wrote. She added that "financial institutions that file malicious or intentionally false SARs are hardly untouchable," citing legal precedents upholding federal authorities' capacity to "go after them, with fines and prison time where appropriate."

Supreme Court hears arguments on constitutionality of CFPB. Divisions between the two main ideological wings of the Supreme Court were on display March 3 during oral arguments in a case testing whether the current structure of the Consumer Financial Protection Bureau, with a leader not directly answerable to the White House, is constitutional or if it violates the separation-of-powers doctrine. The case before the high court was brought by the California-based firm Seila Law LLC, which in 2017 refused to cooperate with a CFPB civil investigative demand (CID, effectively a type of administrative subpoena), arguing that the bureau was unconstitutionally structured. In a noteworthy development, covered in the September 19, 2019 edition of Bank Regulatory News and Trends, the Trump Administration announced it agreed with the challenge to the CFPB and would not defend the bureau. The Justice Department and the CFPB itself filed a brief to the Supreme Court arguing that the structure of the bureau infringes on the president's authority to remove executive branch officials from their posts. Under Dodd-Frank, which created the CFPB, the director serves a five-year term and can be removed from office only "for cause," which is generally considered to mean severe incompetence or misconduct. CFPB Director Kathleen Kraninger also informed Congressional leaders that her agency had determined its own structure was unconstitutional. Given the Administration's position, the court appointed Paul Clement, a former Solicitor General in the George W. Bush Administration, to defend the bureau. Clement was joined by Douglas Letter, a lawyer representing House Democrats. The current Solicitor General, Noel Francisco, argued the Administration's case against the CFPB, telling the court: "The president stands for election; the director of the CFPB does not. So if the director is insulated from presidential oversight, then her exercises of executive power are insulated from democratic control. And that's not the structure that our Constitution creates and requires."

  • Francisco was joined by Seila's counsel, an arrangement that Justice Ruth Bader Ginsburg called "uncommon."
  • Ginsburg, agreeing with Clement's argument, said the "inefficiency, neglect of duty or malfeasance" standard is a "very modest restraint" on the president's power to remove an official. Justice Elena Kagan said Congress should have discretion on the structuring of agencies, while Justice Sonia Sotomayer cited precedents where other executive branch agency directors can only be fired for cause.
  • But Justices Brett Kavanaugh, Samuel Alito and Neil Gorsuch drew comparisons with cabinet-level agencies and said the fixed-term arrangement could tie a future president's hands.
  • The US Court of Appeals for the District of Columbia Circuit ruled in 2016 that the watchdog agency's structure was unconstitutional, but that decision, authored by Kavanaugh in his previous capacity as a DC Circuit judge, was overturned by the full court in 2018.
  • Congressional Democrats and Republicans have filed dueling amicus briefs in the case. Democrats support the current CFPB structure, while Republicans argue that Congress may not restrict the removal of principal executive officers, which they called a "vital element of the executive power."
  • A decision by the high court is expected in May or June.

State financial regulators launch State Examination System for fintechs and other non-banks. The Conference of State Bank Supervisors (CSBS) announced on February 19 the nationwide rollout of the State Examination System (SES), which it described as "the first nationwide platform to bring state regulators and companies into the same technology space for supervision, fostering greater transparency and collaboration." According to CSBS, the new system will allow state regulators to enhance supervisory oversight of non-banks while making the process more efficient for regulators and companies alike. SES is developed and operated by the State Regulatory Registry (SRR), a CSBS subsidiary that also operates the Nationwide Multistate Licensing System (NMLS). The new system is intended to:

  • Support networked supervision among state regulators
  • Standardize workflow, business rules and technology across states
  • Facilitate secure collaboration between licensees and their regulators
  • Help examiners focus more attention on higher-risk cases and
  • Move state supervision towards more multistate exams and fewer single-state efforts.

FDIC issues guidance to help fintechs partner with banks. The FDIC's technology lab FDiTech has published a guide to help financial technology firms and other third parties do business with banks. Conducting Business with Banks: A Guide for Third Parties is intended by the FDIC "to help third parties understand the environment in which banks operate and navigate the requirements unique to banking." FDIC said that the six-page document, which includes links to other online information resources, is the first in a planned series of educational tools intended to increase opportunities for partnerships and respond to questions and concerns raised by banks and tech companies about "the challenges associated with on-boarding at institutions." Topics covered by the FDIC guide include:

  • How banks determine which third parties to use and how to identify and control risks
  • How third parties should prepare for the due diligence process and
  • Items bank management may request from a third party as part of the due diligence and contract management process.

"Partnerships with fintechs are particularly important for community banks, which often cite cost and regulatory uncertainty as roadblocks to innovation," said FDIC Chair Jelena McWilliams. "Leveraging new technology may provide additional opportunities for these institutions and their customers."

Mnuchin: FinCEN to roll out "significant" new rules on cryptocurrencies. Treasury Secretary Steven Mnuchin recently told Congress that the Financial Crimes Enforcement Network (FinCEN) will soon announce new regulations on cryptocurrency and digital payment systems. Speaking at a February 12 Senate Finance Committee hearing on the president's budget, Mnuchin said Treasury's anti-money laundering/anti-terrorist financing unit will "roll out some significant new requirements" with "a lot of work coming out very quickly." In an exchange with Senator Maggie Hassan (D-NH), Mnuchin said, "We want to make sure that technology moves forward, but on the other hand, we want to make sure that cryptocurrencies aren't used for the equivalent of old Swiss secret number bank accounts." Mnuchin told Senator Todd Young (R-IN) that the intent of the forthcoming regulations is to promote "greater transparency so that law enforcement can see where the money is going." The secretary also cited Stablecoins as an example of where technology could "be used to reduce payment processing quite considerably, particularly for small dollar payments cross-border." But he said that central bank-issued digital currency was "something that [Fed] Chair [Jerome] Powell and I do not think the US needs to consider now, but could consider again down the road."