This regular publication from DLA Piper focuses on helping banking and financial services clients navigate the ever-changing federal regulatory landscape.

FDIC reports strong bank performance in Q1. Banks and savings institutions insured by the FDIC earned $60.7 billion in the first quarter of 2019, an 8.7 percent increase over the industry's earnings from a year earlier, the FDIC announced in its Quarterly Banking Profile released on May 29. The $4.9 billion increase in net income was mainly attributable to a $7.9 billion (or six percent) increase in net interest income, bringing the Q1 total up to $139.3 billion, according to the FDIC. Almost two-thirds of the 5,362 FDIC-insured institutions reported annual increases in net income and less than four percent were unprofitable, with the average return on assets increasing to 1.35 percent, up from 1.28 percent a year earlier. The report states that the net interest margin rose to 3.42 percent, up one-tenth of a percent from a year ago, with just shy of 80 percent of banks reporting an improvement from last year. Community banks saw a net income increase of 10.1 percent from a year earlier, to $6.5 billion in the first quarter, driven by higher net interest income, higher securities gains and lower provision expense, though lower noninterest income and higher noninterest expense partially offset improvements to net income. Total loan and lease balances increased 4.1 percent over Q1 '18. The number of banks on the "Problem Bank List" decreased from 60 to 59, the lowest number of problem banks since the first quarter of 2007, and no bank failures occurred. The Deposit Insurance Fund's reserve ratio remained unchanged at 1.36 percent, and asset quality indicators remained stable. "The banking industry reported another positive quarter," FDIC Chair Jelena McWilliams said. "The FDIC continues to encourage banks to maintain prudent risk management in order to support lending through this economic cycle."

New rule on CRA in the offing. At the press conference in conjunction with the release of the quarterly report, McWilliams told journalists that FDIC and other banking regulators are hoping to unveil a draft joint proposal for revamping the Community Reinvestment Act in the coming weeks. A more detailed proposed rule would follow in a matter of months, she said. This echoes an earlier statement by Comptroller of the Currency Joseph Otting that an initial proposal would be released this summer. Testifying before the Senate Banking Committee on May 15, McWilliams said she has "challenged" her agency to "provide clarity and consistency to financial institutions on their obligations under the CRA." In addition to FDIC and OCC, the Fed is the other regulator with jurisdiction over the CRA.

Bank reg agencies issue final rule on municipal debt liquidity. As mandated under the banking deregulation law enacted almost exactly one year ago, the Fed, FDIC and OCC have finalized a rule amending the agencies' liquidity coverage ratio rule to treat liquid and readily-marketable, investment grade municipal obligations as high-quality liquid assets. Under the rule, certain municipal obligations will be now be permitted to be counted toward a bank's required amount of liquid assets. The Final Rule issued May 30 does not include any changes from the interim rule the agencies announced last August. The Economic Growth, Regulatory Relief, and Consumer Protection Act requires the agencies to treat a municipal obligation as HQLA under the liquidity coverage ratio rule if that obligation is "liquid and readily-marketable" and "investment grade." Previously, the Fed's LCR rule, amended in 2016, permitted only those municipal obligations meeting the definition of "general obligation" municipal securities and satisfying heightened criteria to be recognized as HQLAs. FDIC and OCC rules did not permit any municipal obligations to be recognized as HQLAs. The final rule aligns the three agencies' rules to a common standard, expanding the eligibility criteria and removing the municipal obligation-specific limitations under existing Fed rules. The rule will be effective 30 days after publication in the Federal Register.

OCC warns of risks to banking sector, including fintechs and nonbank competition. The Office of the Comptroller of the Currency cited credit, operational, compliance, interest rate and liquidity risks as among the key "risk themes" facing the federal banking system. In the Semiannual Risk Perspective for spring 2019, published by OCC's National Risk Committee on May 24, the banking regulatory agency notes that the rapid growth in financial technology and regulatory technology (regtech) is implicated in each of those areas of concern. While OCC describes the overall condition of the federal banking system as "strong" – based on metrics such as earnings, credit and asset quality, return on equity, capital and liquidity – the report focuses on trends that could imperil that success. As banks adapt to "a changing and increasingly complex operating environment," the report cites operational risks such as cybersecurity threats, innovation in financial products and services, increasing use of third parties without sufficient controls, and poorly planned or managed M&A activities. BSA/AML compliance remains a challenge for banks operating "in a complex, dynamic global operating and regulatory environment." OCC also cited competitive pressures from fintechs and other nonbank providers, which "may influence customer expectations for delivery of financial services," embedded credit risks resulting from relaxed underwriting standards and low interest rates, and the use of new and rapidly evolving technologies in the financial services sector as part of the risk picture.

Powell says leveraged lending is not the next subprime mortgage crisis. Following the release of a recent Fed report noting potential risks to the financial system from the growth in leveraged lending, Fed Chairman Jerome Powell said the rise in business debt by risky borrowers does not represent the same level of threat that the subprime mortgage crisis posed in 2008. In a May 20 speech in Florida at the annual Financial Markets Conference sponsored by the Federal Reserve Bank of Atlanta, Powell said "the truth is likely somewhere in the middle" between extremes of anxiety and lack of concern over the implications of higher levels of business debt. Powell stressed that "business debt does not present the kind of elevated risks to the stability of the financial system that would lead to broad harm to households and businesses should conditions deteriorate," but added, "the level of debt certainly could stress borrowers if the economy weakens" and he assessed the risk level as "moderate." A key difference between today and a decade ago "is that financial authorities now closely monitor financial stability vulnerabilities on an ongoing basis, armed with lessons learned from the crisis," Powell said. Another key differences cited by the chairman is that the increase in business borrowing has occurred across a broad swath of sectors, including technology, oil and gas production and manufacturing, and not just in the housing sector. And he said the post-crisis regulatory framework with its "robust capital requirements backed by strong stress tests" has left banks stronger, more resilient and better capitalized. Concerns about the rise of leveraged lending were part of the Fed's semi-annual Financial Stability Report, released May 6.

FSB seeks to slow decline in correspondent banking. With ever fewer banks providing cross-border services, the Financial Stability Board on May 29 issued the latest in a series of progress reports on its efforts to check the decline in worldwide correspondent banking relationships. The FSB Action Plan to Assess and Address the Decline in Correspondent Banking reports that the number of active correspondent banks declined by 3.4 percent last year, although the figure represents a slight slowing of the rate of decline compared to the previous year. Still, the report notes a steady pattern of decline since 2015 when FSB launched its action plan to address this trend, with regions of the developing world among the most severely impacted. The report found increased concentration in the correspondent banking market, which could affect competition, raise costs and lead to more potentially fragile networks susceptible to the failure of a single participant – although it also noted that consolidation could also serve to strengthen remaining correspondent banking relationships. More clarity in terms of regulatory expectations would go a long way to help address some of the problems, FSB stated, along with coordination of domestic capacity-building to improve and build trust in the supervisory and compliance frameworks of affected jurisdictions, and more technical assistance from international organizations.

  • On the same day, FSB also published a monitoring report on implementation of its March 2018 recommendations to address problems with remittance services providers' access to banking services, which was significantly impacted by the reduction in correspondent banking relationships. The report calls for ongoing efforts by national authorities, international organizations, remittance service providers and banks to improve supervisory frameworks, enhance communication and cooperation, and provide technical assistance to affected jurisdictions, while accommodating innovative technologies. The report will be delivered to the G20 Finance Ministers and Central Bank Governors meeting in Fukuoka, Japan, on June 8-9.
  • FSB, based in Basel, Switzerland, is an international body that monitors and makes recommendations about the global financial system. Randal Quarles, the Fed Board of Governors vice chair for supervision, is the current FSB chair.

Regulators settle with payday lenders in "Operation Choke Point" suit. The FDIC announced that it has settled a long-running federal lawsuit with several payday lending companies who had accused financial service regulators of inappropriately pressuring banks to sever ties with them under an Obama Administration initiative aimed at investigating companies at risk for fraud and money laundering. FDIC said in a May 22 announcement that it had resolved the suit with the firms under which their suit would be dismissed in exchange for FDIC's issuing a statement summarizing its longstanding policies and guidance regarding BSA obligations and a cover letter to the plaintiffs summarizing applicable FDIC policy and noting that FDIC is conducting additional training of its workforce. "The FDIC acknowledges that certain employees acted in a manner inconsistent with FDIC policies with respect to payday lenders in what has been generically described as "Operation Choke Point," and that this conduct created misperceptions about the FDIC's policies," the letter states. "Regulatory threats, undue pressure, coercion, and intimidation designed to restrict access to financial services for lawful businesses have no place at the FDIC." The case, which dates back to 2014, had also implicated OCC, which separately announced that it was being dismissed from the suit. Operation Choke Point was a 2013 initiative of the Justice Department that investigated banks' ties with a wide range of businesses, from firearms dealers to pawn shops and including payday lenders, that were believed to be at higher risk for fraud and money laundering. The operation was ended in August 2017.