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

FinCEN issues interpretive guidance and new advisory on virtual currencies. The Financial Crimes Enforcement Network has issued an interpretive guidance affirming its longstanding regulatory framework for virtual currencies, as well as a new advisory warning of threats posed by virtual currency misuse. The May 9 Application of FinCEN's Regulations to Certain Business Models Involving Convertible Virtual Currencies is intended to remind persons subject to the Bank Secrecy Act how FinCEN regulations relating to money services businesses apply to certain business models involving money transmission denominated in value that substitutes for currency, specifically, convertible virtual currencies. This guidance, issued in response to questions from the industry, law enforcement and regulators, does not establish any new regulatory expectations or requirements, but is intended to help financial institutions comply with their existing obligations under the BSA as they relate to current and emerging business models involving CVC. It consolidates current FinCEN regulations, and related administrative rulings and guidance issued since 2011, and applies these rules and interpretations to other common business models involving CVC engaging in the same underlying patterns of activity. On the same day, FinCEN also issued an Advisory on Illicit Activity Involving Convertible Virtual Currency to assist financial institutions in identifying and reporting suspicious activity related to criminal exploitation of CVCs for money laundering, sanctions evasion, and other illicit financing purposes, highlighting "red flags" and identifying information that would be most valuable to law enforcement if contained in suspicious activity reports.

Fed warns of rise of leveraged lending to risky firms, but says bank exposure is limited. The Fed has reported that the growing trend of companies with large amounts of debt borrowing even more money poses potential risks to the financial system. Leveraged lending grew by 20 percent in 2018 to $1.2 trillion, and has grown at an annual rate of 15.8 percent over the past 20 years, according to the Fed's second semi-annual Financial Stability Report, released May 6. The share of loans going to higher-risk borrowers "now exceeds previous peak levels observed in 2007 and 2014, when underwriting quality was poor," the report states. Part of the reason for the increase in lending to highly indebted companies is due to the overall strong economy and interest rates that are low by historical standards, meaning that "debt service costs are at the lower ends of their historical ranges, particularly for risky firms," the report explains. The report also notes that most of this increase is due to the activities of non-bank financial firms. "On the whole, banks appear well positioned to deal with these exposures," the report states, crediting the Fed-administered stress tests that require banks to have sufficient capital, and liquidity requirements incorporating protections against draws on credit lines. "With regard to leveraged lending, banks have improved their management of the associated risks – reflecting, in part, the 2013 interagency guidance on leveraged lending – even as underwriting standards have deteriorated over the past decade," the report states. "Moreover, large banks have improved their management of syndication pipelines."

  • At a May 15 Senate Banking Committee hearing on oversight of financial regulators featuring testimony from top officials of the Fed, FDIC, OCC and NCUA, the committee's ranking Democratic member Sherrod Brown (D-OH) expressed concern that the threat to the economy from the rise in leveraged lending was not receiving sufficiently urgent attention from the regulatory agencies. In an exchange between the senator and Randal Quarles, the Fed's vice chair for supervision, Brown faulted the "cursory"treatment of the issue in Quarles's testimony as well as what he described as inadequate responses from the Treasury Department to his inquiries on the issue. "We are concerned – and appropriately so – about what is the right regulatory response to developments in the underwriting of leveraged loans that could affect a business downturn in the future," Quarles testified.
  • The quartet of regulators – the Fed's Quarles, FDIC Chair Jelena McWilliams, Comptroller of the Currency Joseph Otting, and NCUA Chair Rodney Hood – also testified before the House Financial Services Committee's regulatory oversight hearing the following day, and both hearings demonstrated differences between the two parties regarding regulation of the financial services industry. In her opening statement, Financial Services Chair Maxine Waters (D-CA) said the regulators "appear to be kowtowing to Trump's harmful deregulatory agenda" and warned that "we will not tolerate actions that threaten the stability of our financial system." On the eve of the hearing, meanwhile, all 26 Republican committee members signed a letter to the regulatory agencies calling for a stepped-up deregulatory pace and urged that they act on recommendations made in a series of Treasury Department reports over the past two years, including revisiting the risk-based capital surcharge for GSIBs, exempting transactions between bank affiliates from initial margin requirements on uncleared swaps, and bringing greater transparency to the bank stress test process.
  • Testimony and other materials from the Senate hearing is available here, and from the House hearing can be found here.

Fed regulatory report deems bank capital "strong" but finds "slight" decrease in capital ratios. In conjunction with the Congressional testimony, the Fed on May 10 released another semi-annual report, also the second edition in a new series. The Fed's Supervision and Regulation Report describes how the central bank tailors its oversight programs based on size and complexity, focusing on banking system conditions as well as regulatory and supervisory developments. "The strong performance of the economy over the past five years has contributed to the robust financial performance of the United States banking system," the report states, pointing to metrics showing increased earnings above their five-year averages and citing growth in net interest income and the recent cut to the federal corporate income tax rate as key drivers of bank profitability. The report found that banks have expanded lending throughout the economy, and that asset quality continues to improve overall. It describes capital ratios as “well above regulatory requirements," but says that larger firms underwent a "slight decline because of higher payouts and asset growth." A graph showing trend lines since 2016 demonstrates that "banking portfolios maintained strong capital positions," but that capital ratios "declined slightly" last year, "influenced by capital distributions in the form of cash dividends and stock repurchases, and by the growth in total assets held by banks," according to the Fed. Supervisory priorities in 2019 for firms in different categories are also discussed in the report.

Regulators need to improve bank supervision, GAO finds. The Government Accountability Office has called for the Fed and the FDIC to do a better job of supervising large banks' management practices and informing financial institutions of potential emerging problems. GAO, the investigative and auditing arm of Congress, issued its findings in a May 14 report to agency officials, which found that "management weaknesses – such as ineffective leadership by boards of directors, and compensation tied to quantity of rather than quality of loans – contributed to the 2007-2009 financial crisis." The report recognizes significant progress made since then, but says additional steps are needed. It offers four recommendations for executive action on the part of the agencies, including providing more complete information on supervisory recommendations and the likely cause and potential effects of any problems or deficiencies by both the Fed and FDIC, improving the completeness of matters requiring board attention (MRBA) data in FDIC's tracking system, and updating the Fed's policies and procedures to incorporate specific factors for escalating supervisory concerns.

Judge allows New York's challenge to OCC's fintech charters to go forward. A federal judge has denied a motion by the Office of the Comptroller of the Currency to dismiss a lawsuit filed by the New York state Department of Financial Services challenging the federal agency's authority to issue special purpose national bank charters to non-depository financial technology companies engaged in the business of banking. In a May 2 decision and order, US District Court Judge Victor Marrero of the Southern District of New York denied OCC's request that the NYDFS complaint be dismissed. Last year, OCC announced that it would begin accepting applications for the federal fintech charters, allowing online financial start-ups to bypass the state-by-state registration process in favor of federal oversight. New York regulators immediately filed suit to block the charters, as did the Conference of State Banking Supervisors. The CSBS suit, and OCC's motion to dismiss it, are still pending in the US District Court for the District of Columbia. New York's Acting Financial Services Superintendent Linda A. Lacewell called the decision "a resounding triumph for consumers and the regulated banking industry not just in New York, but across the nation." CSBS also welcomed the New York decision, and expressed hope that the two legal challenges will send "a clear message that the OCC does not have the authority to preempt state laws, including for consumer protection, by unlawfully expanding its mandate." OCC did not issue a public statement in response to the most recent court filing, but top OCC officials have previously strongly defended the proposed charters and asserted the agency's authority to issue them.

CFPB structure upheld by federal appeals court. The US Court of Appeals for the Ninth Circuit has rejected a challenge to the constitutionality of the CFPB's leadership structure, with a single director who can be fired only for cause. In a ruling filed on May 6, a three-judge panel of the federal appeals court sitting in Pasadena, CA, upheld a 2018 decision in a DC appellate case that the agency's structure is constitutional. The Ninth Circuit case concerns a law firm under investigation for allegedly violating telemarketing rules that is the subject of CFPB regulatory scrutiny. The firm argued that the CFPB's structure violated the Constitution's separation of powers provision and that the bureau lacks the authority to issue a civil investigative demand. Under the court's opinion, the law firm must respond to CFPB's interrogatories and requests for documents. The Ninth Circuit case represents the second time a federal court has turned back attempts to have the CFPB's structure ruled unconstitutional, and the Supreme Court declined to review the previous ruling. CFPB opponents believe the bureau should be run by a bipartisan commission and have sought to use the courts to force a restructuring of the agency. In the opinion, Ninth Circuit Judge Paul J. Watford, citing earlier case law on other federal agencies, determined that "the CFPB acts in part as a financial regulator, a role that has historically been viewed as calling for a measure of independence from executive branch control."

CFPB proposes new FDCPA rules for debt collectors. The CFPB on May 7 issued a notice of proposed rulemaking to implement the Fair Debt Collection Practices Act, including measures to protect consumers against harassment by debt collectors and a limit on how many calls per week they may place to reach consumers. The proposal would clarify how collectors may utilize communications technologies developed since FDCPA's 1977 enactment, and require collectors to provide additional itemized information to help consumers identify debts and respond to collection attempts. A limit of seven unanswered calls by telephone per week by debt collectors would be imposed, and debt collectors would have to wait at least a week after their first conversation with a consumer before calling back. Consumers could also unsubscribe to text messaging and emails and limit when and how debt collectors could contact them. Several consumer advocacy organizations said the proposed protections do not go far enough, while industry representatives expressed concerns that they go too far in impeding outreach to customers. "The Bureau is taking the next step in the rulemaking process to ensure we have clear rules of the road where consumers know their rights and debt collectors know their limitations," said CFPB Director Kathleen Kraninger. "As the CFPB moves to modernize the legal regime for debt collection, we are keenly interested in hearing all views so that we can develop a final rule that takes into account the feedback received." The proposal will be open for public comment for 90 days.

CFPB announces regulatory review, will scrutinize Overdraft Rule. CFPB has unveiled proposed procedures for reviewing its regulations under the Regulatory Flexibility Act and announced that its first RFA review will examine the 2009 Overdraft Rule. The Bureau on May 13 published a notice of plan for periodic review of rules and request for comment with an eye to regulations that have a significant economic impact on small businesses, pursuant to section 610 of the RFA, which was enacted in 1980. Following the review process, CFPB will determine whether to maintain a given rule, amend it, or rescind it altogether. The criteria include determining the need for the rule; considering public complaints or concerns about the rule; whether the rule is overly complex, duplicative of or in conflict with other regulations; and how technology, economic conditions or other factors have changed since the rule was adopted. CFPB's first RFA 610 review will look at the Overdraft Rule, which limits the ability of financial institutions to assess overdraft fees for ATM and one-time debit card transactions. The Bureau issued its notice of review and request for comment on the 2009 Overdraft Rule on the same day as the RFA review plan. The public will have 60 days to comment on the CFPB's RFA plan after publication in the Federal Register, and 45 days to comment on the Overdraft Rule review.

ABA supports Fed plan on "narrow banks" – but The Narrow Bank objects. The American Bankers Association has expressed its support for the Fed's proposed approach to pass-through investment entities (PTIE), commonly known as "narrow banks." But one of the entities that stands to be the most impacted by the proposal is calling the Fed plan a "discriminatory" threat to its very business model. In March, the Fed issued an advance notice of proposed rulemaking seeking public comment on whether to amend its Regulation D (Reserve Requirements of Depository Institutions) to lower to zero the rate of interest paid on excess reserves (IOER) by eligible institutions that hold a very large proportion of their assets in the form of balances at Federal Reserve Banks. The proposal was seen in the industry as targeting the narrow bank model, which involves taking deposits from institutional investors and holding virtually all of them at Reserve Banks, and passing on the IOER rate to depositors, less a small spread to cover operational expenses. ABA expressed its support for the Fed's proposal in a May 13 letter, agreeing that the PTIEs or narrow banks could compromise the Fed's ability to conduct monetary policy by interrupting the transmission of IOER and Overnight Reverse Repurchase Agreement Facility rates to the federal funds rate. "ABA supports the proposal to differentiate the IOER rate paid to PTIEs from the IOER rate paid to all other eligible institutions," wrote Cecelia A. Calaby of ABA's Office of Regulatory Policy.

  • The CEO of TNB USA Inc. (Connecticut-based The Narrow Bank) told the Fed that the "discriminatory IOER regime" proposed by the Fed is "an attempt to legislatively re-write the statutorily established division of chartering authority to effectively preclude states from exercising a legally valid form of chartering authority." In a May 13 letter to the Fed, TNB CEO James McAndrews wrote that the Fed plan "bases its strongly signaled intention to disrupt or eliminate the narrow bank business model on certain core premises that we believe are mistaken and contrary to fundamental principles of sound banking and prudential regulation." McAndrews was a 28-year veteran of the Fed system, retiring in 2016. TNB sued the New York Fed last year after the bank failed to act on its request to open an account there, and that litigation is ongoing.

Industry groups support FDIC record-keeping proposal. Three banking sector trade organizations have come out in support of a recent FDIC proposal seeking to make changes to Part 370 of its regulations for "recordkeeping for timely deposit insurance determination." In a May 13 joint comment letter, the ABA, the Bank Policy Institute and the Consumer Bankers Association expressed support for most provisions of the FDIC proposal, though they offered several suggested amendments to reduce the compliance burden. Part 370 requires each insured depository institution with two million or more deposit accounts (a "Covered Institution") to configure its IT system, and maintain complete and accurate information, to allow FDIC to make deposit insurance determinations in the event of the institution's failure. FDIC announced on March 29 a notice of proposed rulemaking to amend Part 370 "to clarify the rule's requirements, better align the burdens of the rule with its benefits, and make technical corrections,"and "to address issues raised as the FDIC worked with banks to implement the rule since it was originally approved in November 2016." The proposal provides an optional one-year extension of the rule's original compliance deadline of April 1, 2020.

House Financial Services Committee forms Fintech and AI task forces. In an effort to stay on top of new developments and enact sound policies to address emerging challenges, the House Financial Services Committee has announced the creation of a Task Force on Financial Technology and a Task Force on Artificial Intelligence. In a May 9 announcement, the Committee reported that Representative Stephen Lynch (D-MA) will chair the fintech task force while Representative Bill Foster (D-IL) will chair the AI task force. Representative French Hill (R-AR) will be the top Republican on both task forces. "As new technologies emerge and the financial services industry puts those technologies to use, Congress must make sure that responsible innovation is encouraged, and that regulators and the law are adapting to the changing landscape to best protect consumers, investors and small businesses," said Financial Services Chairwoman Maxine Waters (D-CA). The fintech task force will examine issues including: domestic and international perspectives on regulating fintech; utilizing alternative data for loan underwriting and modifications; assessing the infrastructure and legal and regulatory framework for efficient payments; and reviewing challenges to data privacy. The AI task force will focus on such issues as: applications of machine learning in financial services and regulation; emerging risk management perspectives; AI, digital identification technologies and combatting fraud; and the impact of automation on jobs in financial services and the overall economy. Both task forces will have seven members on the Democratic side. The full list of other Republican members has not yet been released.

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