Financial technology: A hidden path to a healthier outcome?
New financial technology (fintech) is transforming how people use money. Money, whether by its presence or absence, has an impact on health. What are, then, the health consequences flowing from fintech? The answer is even more important if access to fintech becomes a hidden gatekeeper in the ability to access new non-financial technology that can lead to better health outcomes. For example, many ride-hailing services, bike shares, and scooter shares do not take cash, so the new transportation app world won’t make it easier to get to doctor’s appointments or physical therapy for those who can’t pay through digital platforms.
On Friday, September 24, The Brookings Institution will release Klein’s new paper, “Can fintech improve health?” and he will present the paper’s key findings and recommendations. Following Klein’s presentation, there will be a conversation on the paper and the broader topic featuring Makada Henry-Nickie of Brookings, Brian Knight of the Mercatus Center, and Jennifer Tescher of the Financial Health Network.
Viewers can submit questions via email to events@brookings.edu or via Twitter using #FintechHealth
Building a more stable financial system: Unfinished business
Twice in this still-young century central banks have had to take steps, unprecedented in size and scope, to limit the economic fallout from financial instability. While we can’t expect a financial system to withstand an overnight shut down of the global economy like we experienced in March 2020 without support from central banks and fiscal authorities, the financial market turmoil at that time highlighted vulnerabilities that were visible well beforehand. The system is stronger than it was going into the Global Financial Crisis (GFC), but much remains to be done, especially in nonbank finance. I’m going to reflect on some of the actions that need to be taken, drawing on the recent recommendations of a Task Force on Financial Stability in the U.S. that I co-chaired, and on my experience as an external member of the Financial Policy Committee at the Bank of England.
My main points are:
Dealing with risks to financial stability is urgent. If the economic and financial situation evolves as seems to be expected in financial markets, credit should flow, and financial markets will continue to serve the needs of the economy. But the current situation is replete with fat tails—unusually large risks of the unexpected which, if they come to pass, could result in the financial system amplifying shocks, putting the economy at risk. Shoring up our defenses against financial instability can’t run on Federal Reserve or, even worse, FSOC time where near endless analysis and consensus building delay needed action for years.
Dodd-Frank and Basel reforms have greatly improved the resilience of the banking system. Still, I have two linked recommendations for banks. First, fix the Supplementary Leverage Ratio and perhaps some other post GFC regulations so they don’t impede market making in Treasury securities and related repo; second, improve risk-based capital regulation by utilizing a countercyclical capital buffer that builds bank capital in good times and releases it aftershocks.
There’s much more to do in nonbank or market finance. This was the focus of our Task Force and we ended up with a 135-page report with dozens of recommendations. I’m going to focus on the Treasury market, but many aspects of market finance need urgent attention.
Our regulatory processes and procedures need to adapt to provide more nimble, more transparent, more accountable responses to ever-evolving threats to financial stability. We must do a better job of spotting potential problems early and making concrete suggestions for dealing with them.
Read the full text here.
The Brookings Institution is financed through the support of a diverse array of foundations, corporations, governments, individuals, as well as an endowment. A list of donors can be found in our annual reports published online here. The findings, interpretations, and conclusions in this report are solely those of its author(s) and are not influenced by any donation.
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The future of money: The end of cash and the rise of digital currencies
Are we heading for a cashless future? Eswar Prasad, a senior fellow at Brookings and author of the forthcoming book, “The Future of Money: How the Digital Revolution Is Transforming Currencies and Finance,” thinks so. Credit card and cell phone payments have disrupted the physical cash market already, but Prasad says the real driving force will be central banks—as new cryptocurrencies continue to emerge and their popularity expands, central banks will react by developing their own more stable forms.
On September 13, the Hutchins Center on Fiscal and Monetary Policy and the Global Economy and Development program at Brookings will host a virtual conversation between Prasad and Glenn Hutchins, co-chair of the Brookings Board of Trustees, on Prasad’s argument that the world is approaching a tipping point where cash phases out and digital currencies reign supreme. This will have far-reaching implications for individuals, businesses, banks, and governments: improved efficiency, increased flexibility, and improved market access, particularly for the unbanked. But the risks include market instability, minimal accountability, and decreased privacy.
Following the Prasad-Hutchins conversation, the Financial Times’ Gillian Tett will moderate an expert panel focused on the government’s role in managing and regulating digital currencies, maximizing benefits, and minimizing risk.
During the live event, the audience may submit questions at sli.do using the code #FutureofMoney, or join the conversation on Twitter using the hashtag #FutureofMoney.
Where are the Biden financial regulators?
Seven months into the Biden administration and despite rising attention to a host of diverse issues in financial regulation and monetary policy—notably concerns about inflation, central bank digital currencies, retail investing, stablecoins—the president has shown little appetite for filling pending vacancies in the financial regulatory agencies beyond the occasional (and often inconsistent) trial balloon.
This is an old problem: Joe Biden didn’t invent vacancies in new administrations, nor the preference to hobble along with people in acting positions while nominations await them.
The age of the problem is cold comfort, however. The Biden administration is exacerbating it and should change course, immediately.
Appointments in financial regulatory positions fill three vital functions. First, and most obviously, they permit the president to make policy. The issues pending before financial regulators in 2021 are staggering. The policy priorities of the president are clear—on racial diversity, inequality, climate change, full employment, even competition in banking—but announcing a bold policy agenda is just the beginning of accomplishing the work of policymaking. Without filling these key vacancies, the policy work of the administration will suffer from a lack of clarity on what should be accomplished, when, and by whom.
Second, policymakers appointed by the president to run financial regulation must govern. The poetry of bold policy agendas will always give way to the prose of practical governance. This is true in the Oval Office and is even truer for the corridors of the Federal Reserve System, the Federal Deposit Insurance Corp (FDIC), the Comptroller of the Currency—all of which have key vacancies—as well as other arenas of financial regulation.
Take the Federal Reserve System for example. The task of managing the Federal Reserve System is enormous and has only increased in its complexity. The Board members must be central bankers, voting on the course of monetary policy; they must be bank supervisors, working with banks and other financial institutions to manage financial risk throughout the system; they must be bank regulators, writing rules for that same system; they operate a financial system as participants in payment rails that allow money to flow through the global economy; and they must be managers, supervising the employment of the quasi-private Federal Reserve Banks and the 20,000 people who work within the Federal Reserve System.
Each vacancy—and, at this rate, we risk having at least three simultaneously, a low-water mark that was never crossed before the Obama administration and has become something of a new normal in Fed vacancies—adds to the work of governance and risks muddying the work of all those who depend on the Fed’s managerial competence in all of its many areas of responsibility.
Finally, and perhaps most importantly, these appointments are the principal—in some ways, the only—mechanism for democratic governance to organize, respond to, and participate in the technical affairs of financial regulation. The logic of representative democracy is that elections inspire political organization before they occur and have policy consequences long afterward. But few people make financial regulation the sole basis for their vote in a presidential election, even in the rare instances when politicians pay close attention to financial regulation on the stump. The ballot box just isn’t the time or place where the American public engages forcefully with essential questions about monetary policy, bank supervision, or whether (and if so, how) the Fed should create its own digital currency.
The better time is when a nomination is made and the U.S. Senate engages in providing its advice and consent on the appointment. In those moments, it is astonishing how high the quality of engagement becomes across the partisan divide in debating finer points about the causes of inflation, the consequences of the Fed’s management of the public-private partnerships that characterize our financial system, or the implications of banking merger policy.
At present, however, the administration has deprived the public of these focused conversations. Failing to nominate anyone for the first one-eighth of Biden’s elected term deprives the administration of its ability to make policy and society of the ability to engage in debate on these issues. Floating and then popping trial balloons is not enough to sustain this discussion: we need presidential nominations and hearings in the Senate.
President Biden can quickly change this unfortunate state of affairs. The benches of qualified candidates who can fill them are deep, from across the coalition of Democrats (and some Republicans) who support the president’s views on financial regulation and monetary policy. Some factions within the party may resent appointments made to representatives of other factions, but this must never become a barrier to making timely nominations of qualified candidates. That very intraparty debate is itself enormously beneficial for the nation as it seeks to understand what a candidate for, say, Comptroller of the Currency promoted by the left wing of the party believes about issues of importance to the party’s center.
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There is another risk to these vacancies beyond the top line of the administration. Most (but not all) of the vacancies pending are not the top officials—the Secretary of the Treasury or Chair of the Federal Reserve—but are deeper within the organizations, including the Vice Chair for the FDIC, the Comptroller of the Currency, members of the Fed’s Board of Governors, and others. They just don’t capture the same imagination as those top jobs, and so presidents of both parties may be unwilling to wage the partisan fights that nomination and appointment might invite.
This is folly. The consequence of this “only at the top” focus is to make those top appointments even higher stakes, creating strange hydraulic pressure on a single nomination to satisfy the accountability demands that should be satisfied through the other vacancies. So it is, for example, that Fed Chair Jay Powell’s presumed views on financial regulation threaten his reappointment as the nation’s chief monetary policymaker despite the fact that his record through the Obama and Trump administrations suggests that he will defer on regulatory matters to the administration. The debate about the Fed Chairmanship—a vacancy that the administration is sure not to let occur—has become a debate about financial regulation because the other nominations with arguably more influence on those policies are still pending. The result is an inferior public discourse about both financial regulation and monetary policy alike.
Let us end this abysmal record in financial regulation. Let the president fill the large and soon-to-be growing list of vacancies in the financial regulatory agencies. The policy, governance, and accountability of the system demand it.
What is swing pricing?
The problem
In March 2020, at the start of the COVID-19 pandemic in the U.S., investors pulled more than $100 billion out of corporate investment-grade and high-yield bond mutual funds, forcing funds to sell some of their holdings. The spread between corporate bond yields and U.S. Treasuries (a market that had its own dysfunction) widened, transaction costs rose, and issuance of new bonds came to a halt, disrupting the flow of credit to the nation’s corporations. This led the Federal Reserve to intervene by offering, for the first time, to buy corporate bonds and exchange traded corporate bond funds in what proved a successful effort to keep credit to corporations flowing. It was an extraordinary move that underscores the risks these funds pose to financial stability. (For details, see this Federal Reserve note.)
The growth of open-end fixed income funds magnifies the systemic significance of the tension between shareholders’ expectations of daily liquidity and the (often illiquid) holdings of the funds. The average corporate bond is traded about once a month. Shareholders in an open-end bond fund expect (and receive in many cases) to be able to sell their shares much more easily and quickly than if they held bonds directly. When he was governor of the Bank of England, Mark Carney said, “These funds are built on a lie, which is that you can have daily liquidity, and that for assets that fundamentally aren’t liquid.”
In normal times, redemptions are modest and can be met by an offsetting inflow of funds or by selling liquid securities in the portfolio like Treasuries.[1] But big outflows can force a fund to sell holdings of less liquid securities that may require a price concession to attract a buyer. Especially in times of stress, big sales force down bond prices because of the absence of a truly liquid market for the underlying bonds. This, in turn, raises the rates that all corporate borrowers have to pay on newly issued bonds—if they can sell them at all—thus harming the overall economy.
Shareholders in a fund who get out early can redeem at a better price than those who remain, because their redemptions are met before the fire sale forces the fund to mark down the value of its portfolio. This creates a “first-mover advantage,” which can induce a rush to the door that amplifies the price movements that would otherwise occur. (With equity funds, this is less of an issue. Most equities are traded in highly liquid markets where prices quickly reflect order flow. To be sure, there are small stocks that do not trade every day, but most trade every few days, and there is not enough volume in any single small stock to create a problem. The average corporate bond trades once a month; some commercial paper hardly ever trades. So any selling of such fixed-income securities can affect the price substantially.)
A possible solution
More widespread adoption of swing pricing. Swing pricing is widely used in Europe but not in the U.S., although its use was authorized by the SEC in 2018. Basically, it allows the manager of an open-end fund to adjust its net asset value up or down when inflows or outflows of securities exceed some threshold. In this way, a fund can pass along to first movers the cost associated with their trading activity, better protect existing shareholders from dilution, and reduce the threats to financial stability.
This brief draws from the report of the Task Force on Financial Stability, which recommended more widespread use of swing pricing, and a roundtable the Task Force convened with industry, academic, and public sector officials to consider the pros, cons, challenges and costs to doing so.
What is an NAV, and why is that important for open-end funds?
The net asset value (NAV) is the price at which shareholders can purchase or sell their shares in an open-end mutual fund. The Investment Company Act of 1940 requires mutual funds to offer and redeem shares at the next net asset value calculated by the fund after receipt of an order. The NAV is usually calculated by dividing the value of the fund’s assets by the number of its shares. With swing pricing, this calculation of the NAV is adjusted up or down to account for the price impact and transactions costs that will be incurred because of redemptions and new share purchases that will occur after the NAV is calculated. Most U.S. funds calculate their daily NAV using the closing market price of the securities at 4:00 pm Eastern time. Orders from investors that are submitted after 4:00 pm are executed at the next day’s NAV.
Open-end funds can issue an unlimited number of shares. In contrast, a closed-end fund has a set number of shares, the price of which is determined in the market and can diverge from the net asset value of the underlying assets. Exchange-traded funds (ETFs) combine characteristics of open-end and closed-end funds. The price of ETFs fluctuates throughout the day and is determined by the price in the market. The movement in ETF prices is indicative of the kind of swing in an NAV that might be needed in stress, because the ETF price adjusts to attract a willing buyer.
What is dilution and the first-mover advantage in open-end funds?
If shareholders redeem a large quantity of shares in an open-end mutual fund, the fund may be forced to sell not only the highly liquid U.S. Treasuries it holds, but other assets as well. If many funds are doing the same thing at the same time—as they were in March 2020—the price of their underlying assets can fall; this is known as a “fire sale.” The first redeemer or first mover gets out at the initial NAV, which does not reflect the price declines associated with the subsequent fire sale, leaving the remaining investors to bear the costs associated with the portfolio manager having to sell assets to satisfy the first movers. This decline in the value of the fund’s holdings, which are owned by the remaining investors, is known as “dilution.” In a stress situation, therefore, investors have strong incentives to be among the “first movers,” which itself can amplify redemptions and resulting fire sales.
Using data on daily fund flows, Falato, Goldstein, and Hortacsu find that between February and March 2020, the average bond fund experienced outflows of about 10% of net asset value, far larger than the 2.2% experienced during the peak of the 2013 taper tantrum. They find that fund illiquidity and vulnerability to fire-sale spillovers were the primary drivers of these outflows, and that the “more fragile funds benefitted relatively more from the announcement effect of the Fed facilities.”
How does swing pricing address this issue?
Swing pricing is a mechanism to apportion the costs of redemption and purchase requests on the shareholders whose orders caused the trades. It is designed so that remaining shareholders don’t bear all the costs (including dilution) caused by first movers. In effect, those attempting to take advantage of limited fund liquidity are charged for their redemptions by adjusting the price they receive to reflect the liquidity of the market for the fund’s assets. With swing pricing, the incentive to be a first mover is diminished, and with it the risk that existing shareholders will be diluted and the risk that large redemptions will drive prices down sharply with spillover effects on the market and the economy. To be fair both to those who sell and those who remain, a swing price must reflect a fair valuation and approximate the costs imposed by first movers; it cannot be set simply to impose an enormous penalty on redeeming shareholders.
Under full swing pricing, the NAV is adjusted daily for the likely costs of redemptions, regardless of the amount of shareholder activity. Under partial swing pricing, the adjustment is triggered only when net redemptions exceed some pre-determined threshold—a recognition that small transactions do not pose much of a problem.
How does swing pricing work in Europe?
Many global open-end mutual funds are based in Luxembourg (because it has a favorable regulatory climate), and many of those routinely use swing pricing.
Not all funds follow the same procedures, but here’s an illustrative example. All orders that will be redeemed at a given day’s NAV must be received by noon CET on the day of the trade. In that case, any orders received after noon will be processed at the next day’s NAV. The NAV itself is not set until 4 pm CET each day. This gives the fund four hours to assess its order imbalance and determine the gap between buy and sell orders. Most buy and sell orders can be “crossed,” so that rather than buying and selling new securities, the redeeming and purchasing customers can have ownership transferred without incurring any transactions costs or putting pressure on prices. If there is a net imbalance (say, many more requests to redeem than to purchase), then to meet the net demands, some securities will need to be sold. If there is a large imbalance, then the NAV is adjusted (or “swung”) to reflect the impact of the sales.
The swing threshold is the amount of net subscriptions or redemptions that trigger the adjustment to the NAV. The fund then estimates how much prices for the assets being sold are likely to move to meet the subscription or redemption requests it has received; other factors taken into account include transaction costs and the bid-ask spread. The fund then uses those estimates to adjust the NAV by some percentage, generally no more than 2% or 3%. The adjustment is known as the swing factor.
Swing thresholds and swing factors vary depending on the market for the fund’s underlying securities. Swing factors tend to be larger in funds that invest in more thinly traded securities.
Fund managers set the rules and size of the adjustment and disclose their procedures, but precise details are not always disclosed so as to avoid investors exploiting them unfairly. A bond fund prospectus might, for instance, set a maximum swing factor of 3%, but give the fund discretion up to that level.[2] (For an example, see paragraph 17.3 of the prospectus for BlackRock’s Luxembourg-based global funds. )
Here is a stylized example of partial swing pricing from Allianz. It shows the threshold (the volume of orders) that trigger swing pricing in normal markets and in times of distressed markets, and the size of the swing under various scenarios (0.5% or 1.0%).
A survey by the Bank of England and the Financial Conduct Authority of 272 U.K. mutual funds found that 83% (202 funds) have the option to use swing pricing in place. Most funds using partial swing pricing had a trigger of net flows of 2% or less of total NAV. During COVID, however, several funds used their discretion and reduced their swing threshold or moved to full swing pricing. Swing pricing is advantageous to investors not only because it mutes dilution, but because the fund needs to hold fewer lower-yielding highly liquid assets to meet redemptions.
Researchers at the Bank for International Settlements compared the track record of Luxembourg-based funds (which generally use swing pricing) to similar U.S.-based funds (which do not use swing pricing). They found that the Luxembourg-based funds hold less cash than their U.S. counterparts. They also found that during the 2013 taper tantrum, the Luxembourg funds had higher returns than their U.S. counterparts (in part because there was less dilution and in part because they hold less cash), though there was more daily volatility in the Luxembourg funds.
In addition to the Luxembourg-based funds, funds based in the U.K., Ireland, France, Netherlands, and recently Germany use swing pricing.
While investor fairness has been the primary driver of swing pricing in Europe, market participants say it can affect investor behavior in ways that may contribute to financial stability. If an investor has a very large order to place in a European-based fund, the investor may spread out the purchase or sale over several days or otherwise break up the order to avoid imposing costs on the mutual fund that will be passed along in an adjusted swing price.
What are the impediments to implementing swing pricing in the U.S.?
The institutional structure of the market and operational issues are the main impediments to embracing swing pricing in the U.S.
Although the NAV is usually set at 4:00 pm Eastern time every trading day, many U.S. funds don’t know the size of their net inflows and outflows until late in the day or even the next morning. Many funds receive order flows from intermediaries that stand between an investor and the fund, such as 401k plan administrators, broker-dealers, and financial advisers. Some intermediaries have agreements that allow them to receive requests until 4:00 pm Eastern but not convey the order to the fund until that evening or even the next morning, but then upon passing them on still have the order serviced at that 4:00 pm NAV. In other words, the fund managers determine the NAV before they know how large the flow of orders is. Such agreements would need to be renegotiated and the software systems used by the intermediaries would need to be overhauled if new redemption rules were to be put in place. The intermediaries would also need to rework their client agreements.
Industry participants noted the following additional considerations:
Setting a cutoff at 12:00 noon New York time for investors to place mutual fund orders at today’s NAV would be 9:00 am in California and 6:00 am in Hawaii. But global funds based in Luxembourg deal with even more time zones and have navigated this problem.
Retirement fund record keepers and insurance companies require actual NAVs to process trades, e.g. an investor who wants to sell $1 million worth of shares need to know an NAV to translate the $1 million into an actual number of shares. European funds often price such trades at yesterday’s NAV.
Smaller fund management companies may not have the resources to implement swing prices.
In any event, changing all this would be costly and would require a mandate from the Securities and Exchange Commission and coordination with other regulators, including the Department of Labor (which has oversight over retirement plans) and FINRA, among others. No single fund or group of funds will make this shift unless everyone else is doing so as well.
If a shift were mandated, the same rules would need to be applied to other types of savings vehicles that are economically similar to mutual funds, such as bank collective investment trusts.
When it authorized swing pricing in the U.S. in 2018, the SEC said, “We…appreciate the extent of operational changes that will be necessary for many funds to conduct swing pricing and that these changes may still be costly to implement, but we were not persuaded by commenters who argued that these changes are insurmountable, and indeed one stated that despite these challenges ‘the long-term benefits of enabling swing pricing for U.S. open-end mutual funds outweigh the one-time costs related to implementation for industry participants.’”
What are the alternatives to full-scale swing pricing?
One alternative would be for funds to consult and gather information from intermediaries and vendors a few hours before 4:00 pm, and then allow (or mandate) the fund managers to estimate a full-day’s flows and apply a swing factor if indicated. This would accomplish some, perhaps even much, of the benefits of swing pricing without the cost of reorganizing the whole network of vendors, intermediaries, and fund managers. It probably would require a safe harbor to protect intermediaries, vendors, and funds from liability if the estimates proved inaccurate.
The SEC anticipated such a possibility in its 2018 rule: “We acknowledge that full information about shareholder flows is not likely to be available to funds by the time such funds need to make the decision as to whether the swing threshold has been crossed, but we do not believe that complete information is necessary to make a reasonable high confidence estimate. Instead, a fund may determine its shareholder flows have crossed the swing threshold based on receipt of sufficient information about the fund shareholders’ daily purchase and redemption transaction activity to allow the fund to reasonably estimate, with high confidence, whether it has crossed the swing threshold.”
Other ways that have been discussed to mitigate the impact of transaction costs to a mutual fund’s portfolio generated by subscriptions and redemptions, as well as to reduce the risks to financial stability, are:
An anti-dilution levy or redemption fee—a surcharge on investors subscribing or redeeming shares to offset the effect of those orders.
Dual pricing, i.e. one price for buying shares and another for redeeming.
Notice periods of perhaps a few days before an order can be executed.
Redemption in kind, e.g. giving the shareholder bonds, not cash (not practical for funds with retail investors).
Restricted redemption rights so investors can redeem up to a certain dollar amount on any one day.
Redemption gates that allow a fund to limit withdrawals (although the experience with these for money market funds indicates that such gates tend to exacerbate the rush for the exits).
A regulatory mandate to align redemption policies (including a requirement of advance notice) with the liquidity of the underlying securities.
Does the rising popularity of Exchange Traded Funds change any of these considerations?
ETFs require that buyers and sellers agree on a price that reflects market conditions. So during periods of stress, ETF prices move considerably. In a sense, they have an element of swing pricing built into them. Some investors may prefer ETFs because they know that it will be possible to sell on short notice.
ETFs have their own issues regarding the infrastructure that is needed to support them. To make sure the fund price reflects the value of the securities that the fund is supposed to track, ETFs rely on firms that serve as “authorized participants” (APs) to step in to buy or sell the fund to keep the price of the ETF close to the underlying securities. The APs make profits by arbitraging differences in the prices in the underlying securities and the ETFs. If the APs step back from trading, say, because they are exposed to more risk than they are comfortable with, the ETF prices can become disconnected from the prices of the securities that they are supposed to mimic.
This risk can mean that the ETF prices can also fail to reflect only fundamental risks associated with the securities. Nonetheless, ETFs are not subject to the first mover advantage and seemed to handle March 2020 better than the open-end funds.
Can swing pricing help improve the stability of money market mutual funds?
Money market funds are a special kind of open-end fund that can hold only short-dated securities such as U.S. Treasury bills, commercial paper, and certificates of deposit. By limiting the securities to those deemed relatively safe and liquid, it is expected that the price of the fund will be stable as the securities have no price risk if held to maturity. Problems can—and do—still arise for money market funds if they sell the securities they hold before maturity; in that case, there is price risk. Prime money market mutual funds invest in short-term private-sector securities such as commercial paper and certificates of deposit. Default rates on these securities are low, but they trade infrequently so they are subject to the same kind of illiquidity problems as open-end bond and loan funds.
Prime money market mutual funds suffered a run in March 2020, leading commercial paper markets to freeze up and prompting the Federal Reserve to intervene to keep credit flowing to businesses.
Investors in prime money market funds generally are using these funds as substitutes for bank accounts. They expect to withdraw, possibly large amounts in some circumstances, and at multiple times during the day. As a result, these funds often set an NAV multiple times throughout the day. Some in the industry say that feature of these funds means the information demands of setting a swing would be daunting and incompatible with how investors use them. Still, in a June 2021 consultation report, the Financial Stability Board included swing pricing among several possible policy responses to the problems posed by money market mutual funds.
[1] Heavy selling of Treasuries during the opening months of the COVID-19 pandemic created problems in that market as well. See Chapter 3 of the report of the Task Force on Financial Stability and the Group of Thirty report, “U.S. Treasury Markets: Steps Toward Increased Liquidity.”
[2] When the SEC authorized swing pricing in the U.S. in 2018, it set a 2% ceiling on the swing factor.
Anil Kashyap is a member of the Financial Policy Committee of the Bank of England and a consultant to the Federal Reserve Bank of Chicago and the European Central Bank. He did not receive financial supportfrom any firm or person with a relevant financial or political interest in this piece.
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What role should the SEC play in ESG investing?
Environmental Social Governance (ESG) issues continue to climb in importance for many investors and policy makers. What role should public policy and financial regulation play in response to ESG concerns? These questions are of particular importance for the Securities and Exchange Commission (SEC) tasked with protecting America’s capital markets and American investors.
SEC Commissioner Hester Peirce will share her perspective on these issues during a Brookings event on July 20. The conversation will continue with a panel representing investors and the public interest who will react to Commissioner Peirce and share their own views.
Viewers can submit questions for speakers by emailing events@brookings.edu or via Twitter using #ESGInvesting.
The future of bank overdraft fees
Bank overdraft fees have been on the rise for many years as income volatility rises and more Americans live paycheck-to-paycheck. Federal bank regulators have done little to help American families, failing to speed up America’s payment system to address one of the many root causes of overdrafts (slow deposit times) while giving a thumbs up to banks who choose to increase profits at the expense of those living on the financial edge. A few banks and financial technology firms are choosing a different path, creating new products designed to help consumers avoid overdraft, attacking the problem of why it is so expensive to be poor.
Join Brookings as we engage in an in-depth conversation with these banks, financial technology firms, and consumer advocates to explore alternatives to overdraft. We will analyze whether new technology and products can meet people’s needs for financial flexibility in a more fair and efficient manner. To facilitate this discussion we will premier a new format to engage industry and consumer voices in this provocative conversation.
Viewers can submit questions for speakers by emailing events@brookings.edu or via Twitter using #Overdraft.
Report of the Task Force on Financial Stability
Following the Global Financial Crisis of 2007-09, the U.S. and other economies shored up the resilience of their banks through more demanding capital and liquidity requirements and rigorous stress testing. The disruptions of financial markets at the onset of the pandemic in March 2020 underscored the vulnerabilities of markets and institutions that comprise the important—and growing—nonbank sector of the financial system through which much credit to businesses, households, and government flows.
The Task Force on Financial Stability was formed before the pandemic, in October 2019, by the Hutchins Center on Fiscal & Monetary Policy at the Brookings Institution and the Initiative on Global Markets at the University of Chicago Booth School of Business. Its mission was to identify gaps in the regulatory architecture and other features of the financial system (outside the regulated banking sector) that make it insufficiently resilient, and to recommend mitigating policies to regulators, Congress, and the industry.
The report focuses on the U.S. Treasury market, open-end mutual funds, housing finance, derivatives clearinghouses, and life insurance companies; it also makes recommendations for the structure and process of regulation, including the Financial Stability Oversight Council and the Office of Financial Research, both created by the Dodd-Frank Act, to increase the likelihood of spotting and addressing issues that will arise in the future.
The Task Force was chaired by Glenn Hubbard of Columbia University and Don Kohn of the Hutchins Center at Brookings. Other members were Laurie Goodman, Urban Institute; Kathryn Judge, Columbia Law School; Anil Kashyap, Chicago Booth; Ralph Koijen, Chicago Booth; Blythe Masters, Motive Capital; Sandie O’Connor, independent; and Kara Stein, University of Pennsylvania and University of California law schools.
Read the full report here.
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Overdraft fees are big money for small banks
Once upon a time, if you tried swiping your debit card to buy something and your bank account was empty what happened was simple: Nothing. The register denied your payment. This happened all the time, particularly to Americans living paycheck-to-paycheck.
Then banks figured out that they could cover the overdraft for their customers with little risk and charge quite a lot for the service. It is hard for people to keep track of just how much is in their bank account, particularly since deposits including direct deposits can take days to post to the account.
Overdraft fees can be high, often $35, sometimes charged for each swipe of your debit card when you are out of money. This fee has become big money for banks, generating more than $31 billion in revenues in 2020. It has also become a major cost for tens of millions of families: One out of eleven Americans spends $350 or more a year in overdraft fees. Overdraft is one of many reasons why it is expensive to be poor in America.
Overdrafts are bigger business for some banks than others. JPMorgan Chase collected the most of any bank, more than $2 billion in 2019, which works out to more than $35 in overdraft fees per account. Sen. Elizabeth Warren (D-Mass.) called JPMorgan Chase CEO Jamie Dimon “star of the overdraft show” at a recent Senate hearing. Even when compared to other big banks, JPMorgan Chase earns a lot more in overdraft; Citibank, by contrast, averaged just over $5 per account.
But stopping the analysis with the largest banks misses an important reality: A handful of smaller banks are the true overdraft giants.
Read the rest of this article in Politico, published on June 24, 2021.
Bank regulator’s True Lender Rule undercuts bank regulatory protections and shelters predatory lending
A recent rule by the Office of the Comptroller of the Currency (OCC), a federal bank regulator, threatens to upend the rights and responsibilities between banks and their nonbank lender partners, displacing state regulators and subjecting consumers to predatory loans. The U.S. Senate has already, with a bipartisan vote, passed legislation to rescind the rule, using a mechanism called the Congressional Review Act (CRA). The House of Representatives is scheduled to vote on the measure this week to do the same, which would then send the legislation to the President’s desk for final approval. Passing this measure is needed to protect consumers and to preserve long-standing precedent permitting states to enforce their laws.
Banks regularly enter into partnerships with nonbank entities in carrying out their operations and providing services to customers. However, some nonbank lenders have attempted to use banks as vehicles to evade state laws, since banks are typically exempt from certain state laws by virtue of federal preemption. Some nonbanks have added the name of a bank to their loan documents and then claimed they are entitled to the bank’s preemption rights over state regulation and consumer protection laws, including usury limits.
This reached a peak in the early 2000s when some states moved to prohibit 400% interest payday loans. Some payday lenders responded by entering into agreements whereby they paid a small fee to a few banks to add their names to the loan documents and claimed preemption from these state laws. They combined this with mandatory arbitration clauses that effectively prevented consumers from being able to challenge these arrangements in court. Eventually, state regulators and attorneys general joined with federal regulators to shut down these arrangements. They won by utilizing legal precedent, dating back to at least 1825, that courts look at transactions to determine who was the true lender – the party with the predominant economic interest — and that state laws apply to the loan if the true lender was not a bank with preemption rights. At that time the OCC was adamant that preemption rights were not something that banks could lease out to nonbank entities for a fee. This shut down these so-called “rent-a-bank” schemes, and state laws were again enforced against these nonbank lenders.
In recent years, lenders have again sought to use these bank partnerships to avoid state regulation and laws. Last October, the OCC reversed its prior position by issuing a rule that seeks to displace this longstanding law by both asserting that the OCC has authority to override the court true lender doctrine and enacting a standard that would specifically grant preemption rights to nonbank lenders if they merely put the partner bank’s name on the loan document.
This rule would upend the current bank regulatory system without a coherent alternative. It would grant nonbank entities sweeping preemption without the chartering requirements or oversight requirements of banks.
Defenders of the rule claim the OCC will prevent banks from enabling predatory loans. The track record shows otherwise. One op-ed defending the OCC states that the “OCC has shown itself willing to bring enforcement actions against banks that fail to exercise proper control.” The author provides a link to two enforcement actions, which were both taken nearly two decades ago. However, there are several high-cost rent-a-bank schemes that the OCC – and the Federal Deposit Insurance Corporation (FDIC) – have allowed to operate for the past few years while ignoring repeated entreaties from Congress, state officials, and consumer advocates to enforce the law.
During a recent congressional hearing, the former acting comptroller who issued the rule could not point to any enforcement actions when asked by Senator Elizabeth Warren (D-Mass.). The senator referred to the experience of a married couple who owned a small restaurant supply distributor in Massachusetts. They are immigrants, with a limited knowledge of English, who took out a loan with a 92% annual interest rate, well above Massachusetts’ usury cap of 20% that applies to nonbank lenders in the state. The non-bank World Business Lenders arranged the loan, set the terms, and collected the payments even though the name Axos Bank, an OCC-supervised bank, was on the loan document. The couple had to sell their house to get out from under the loan.
Similarly, a restaurant owner in New York is facing foreclosure as a result of a loan at 268% annual interest from World Business Lenders, which again is using the name of Axos Bank.
The FDIC and OCC have also made clear what they view as acceptable lending by jointly filing an amicus brief defending a rent-a-bank loan of $550,000 at 120% interest to a small business in Colorado, where the state has a rate cap far below that.
More broadly, the OCC has a long history of preempting state consumer protection law to the detriment to consumers and the economy, most notably in the run-up to the 2008 Financial Crisis. In recognition of this harm, the Wall Street Reform Act of 2010 “curtailed its power to preempt state laws, especially as to nonbank entities….”
Another claim by defenders of the rule, made recently on the U.S. Senate floor, is that banks in these partnerships would have to “assess a borrower’s ability to repay before making the loan” or “face serious consequences from their regulator….” The existence of around a dozen ongoing partnerships with loans near or far exceeding triple-digit interest rates indicates that unaffordable loans are being made without repercussions. So the evidence does not support that federal regulators will prevent an explosion of predatory schemes likes these should the OCC’s rule remain in place.
Abundant research from California, SEC filings, and elsewhere show that consumers are more likely to default on high-interest loans. High-interest lenders often target Black and Latino communities with products that pull people into financial quicksand. These loans are not responsibly underwritten, as a credit union in the deep south analyzed rent-a-bank loans taken out by their members and documented “a clear disregard for borrowers’ ability to repay.”
Nearly every state has an interest rate cap. These limits are seriously undercut by the OCC rule, so it’s unsurprising that state officials are pushing back. Eight state attorneys general have sued over the rule, which was hastily proposed and approved in just 100 days. The District of Columbia attorney general has sued nonbank lenders trapping his constituents in debt through rent-a-bank loans. He has alleged that OppFi and Elevate “misleadingly marketed high-cost loans” they made to thousands of D.C. residents.
A letter calling for Congress to rescind the rule was signed by a bipartisan group of 25 state attorneys general. The Conference of State Bank Supervisors (CSBS), which represents Republican and Democratic officials, sent Congress the same message, saying “the OCC should not erode state consumer rights and protections, particularly when it refuses to follow the process mandated by Congress to preempt those protections.”
The Biden administration has announced its support for the CRA resolution to repeal the rule, noting its harm to financial regulation and consumers. The House of Representatives now has an opportunity to help protect consumers by approving the measure and sending it to the President’s desk for his signature.
The author did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. They are currently not an officer, director, or board member of any organization with an interest in this article.