Public Funds Investment Institute

Bank Regulation Meets Toxic Workplace Charges

May 22, 2024
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Last week two Congressional committees responsible for the nation’s financial services held six hours of oversight hearings with leaders of the Federal Deposit Insurance Corporation, the Federal Reserve, and the Office of the Comptroller of the Currency. In normal times these hearings would have focused on the significant and controversial Basel III Endgame rules proposed by Federal regulators.

  • The rules would alter the way banks do business and could shift the economics around deposit-raising, lending, custody, trading, and investment management. In short, everything that banks currently provide to public agencies. (See Basel III Endame Could Change the Playing Feld for Public Funds Investors.)
  • Instead, the hearings were dominated by a recently released report documenting a toxic workplace at the FDIC. And this week Martin Gruenberg, chair of the FDIC, responded to pressure from many committee members by announcing that he would resign from his post, perhaps imperiling these very regulations.
  • What should have been an important debate around the basics of regulating the banking industry morphed into something else.

Why it matters.

Banks are central to the financial activities of public agencies (and others, of course). Last summer the regulators proposed rules to protect the financial system against risk by strengthening the capital base of large banks and extending capital requirements to include operational risk in such areas as custody, trading, investment sales and investment management. This would implement the Basel III Endgame, a unified set of rules agreed to in 2017 by the Basel Committee on Banking Supervision, an international group. Besides requiring the largest banks to set aside additional capital to buffer their lending activities, the proposed rules could alter the profitability of fee-based bank offerings, raise the costs of these businesses, and even cause some banks to exit these businesses.

The proposal elicited unprecedented lobbying by the banking industry and their allies who have mounted a multi-million PR campaign (complete with Sunday night football (!) television ads) arguing that it would hamstring the banking industry and choke the economy. On the other side, some consumer groups, academics, and government regulators warn that without added regulation, failures like those of three banks last spring could destabilize the global financial system.

These are matters of serious economic and social consequence, worthy of strong debate. After the new rules were proposed last July there were six months of public comments. They were numerous and the industry and its supporters argued that the original proposal was so deficient that it should be withdrawn and re-proposed. Advocates for strong regulation argued that the regulators should modify the proposal and adopt it.

The regulators have signaled recently that they intend to push forward with regulations this year. The vice chair of the Federal Reserve, Michael Barr, told the Senate Banking Committee hearing last week that he expected there would be “broad and material changes” to the proposal. Not good enough, said opponents. They argue for a re-proposal and new economic analysis of the rules’ consequences, with the knowledge that there is not enough time to repropose, receive comments on, and adopt rules before the end of the year.

The subtext here is the belief that if Republicans win the White House in November the regulatory agencies would be reconstituted to be more friendly to the bank arguments, or that a Trump White House and altered Congress could pass legislation that significantly altered the regulatory landscape along lines favored by the financial industry.

Enter the issues of sexual harassment and a toxic workplace at the FDIC—a matter that some think could derail the Endgame.

 Two weeks ago, the FDIC board received a special report from its outside counsel that found extensive sexual harassment and other acts of interpersonal misconduct over a period of years. Republican members of both committees, joined by some Democrats, argued that Gruenberg, the FDIC chair, who led the organization for ten of the past 13 years, was so implicated that he should resign immediately.

Again, to the subtext:  If Gruenberg were to resign in the ordinary course, he would be succeeded by the vice chair, a Republican, and the board—with two Republicans and two Democrats—would be unlikely (and that’s probably an understatement) to adopt new bank regulations this year.

So the hearings evolved into passionate arguments by committee members either that a) the situation at the FDIC was so dire that it should be addressed immediately (via Gruenberg’s resignation) or b) that the need to additional bank regulation was so pressing that the FDIC’s management issues should not be allowed to sidetrack efforts to reform the banks.

As this week opened, Gruenberg agreed to resign—once a replacement is appointed and confirmed by the Senate. That would seem to keep the FDIC’s regulatory agenda on track, with Democrats maintaining control of the board at least until January.

The bottom line. Re-proposal—aka delay—is possible but not likely. Instead, it appears the regulators will adopt final capital rules before the summer is out. They will differ in some measures from the proposal. The key for public funds investors will not be how they affect lending activities—most public sector borrowing is in the public markets—but how they affect the economics and costs of deposit-raising and other bank activities like transaction processing, custody and investment management, and whether they affect the relative economics of community banks as compared with the mega-banks that dominate the system.

Oh, and there is T+1.

 You already know this if you are going to be affected; if not, well, it’s probably too late to react.  

Beginning May 28th trades for bonds (also equities, foreign exchange, and various other assets) in the US must settle one day after they are bought or sold. This is a change from the current T+2 requirement that was implemented in 2017. Hopefully, this is not news, and you are prepared for the change. There is some anxiety on the street that this will disrupt the markets, though that seems unlikely. It’s a bit like Y2K—some caution, a few doomsayers and a great deal of planning made it a non-event.

Happy May 28th.

Greetings, fellow colleagues in the public funds investment community! I'm Marty Margolis, a seasoned expert with a deep understanding of the intricacies of managing public sector investments. Having led the growth of PFM Asset Management and managing assets exceeding $150 billion, I am excited to connect with you through the Public Funds Investment Institute. If you haven't already — subscribe below to join our community, explore our thought leadership, and gain valuable insights. I encourage you to connect with me on LinkedIn or reach out via email to share your thoughts, feedback, and ideas. Let's collaborate and make a positive impact together.

Best regards,
Marty Margolis

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