2022 FDIC Accounting and Auditing Conference
RESILIENCE AND REINVENTION
Questions
Our speakers were unable to address several questions from the FDIC Accounting and Auditing Conference participants due to time constraints. In the follow-up below, those questions have been answered.
Day1 Topics - Q&A |
Day2 Topics - Q&A |
Digital Assets: 360 Degree View
Irina Leonova, Corporate Expert (Capital Markets), Division of Risk Management Supervision, FDIC
- It seems that crypto and other digital assets become less risky as banks and regulators get involved, but is it possible that banks and regulators themselves become too risky from involvement in the crypto space? i.e. A bank makes a big investment in a new crypto stewardship division and ultimately most of the assets managed by that division end up worthless.
I would cite the findings of the FSOC Digital Asset Report issued on October 3, 2022: “Crypto-asset activities could pose risks to the stability of the U.S. financial system if their interconnections with the traditional financial system or their overall scale were to grow without adherence to or being paired with appropriate regulation, including enforcement of the existing regulatory structure. The scale of crypto-asset activities has increased significantly in recent years. Although interconnections with the traditional financial system are currently relatively limited, they could potentially increase rapidly. Participants in the cryptoasset ecosystem and the traditional financial system have explored or created a variety of interconnections. Notable sources of potential interconnections include traditional assets held as part of stablecoin activities. Crypto-asset trading platforms may also have the potential for greater interconnections by providing a wide variety of services, including leveraged trading and asset custody, to a range of retail investors and traditional financial institutions. Consumers can also increasingly access crypto-asset activities, including through certain traditional money services businesses. Some characteristics of crypto-asset activities have acutely amplified instability within the crypto-asset ecosystem. Many crypto-asset activities lack basic risk controls to protect against run risk or to help ensure that leverage is not excessive. Crypto-asset prices appear to be primarily driven by speculation rather than grounded in current fundamental economic use cases, and prices have repeatedly recorded significant and broad declines. Many crypto-asset firms or activities have sizable interconnections with crypto-asset entities that have risky business profiles and opaque capital and liquidity positions. In addition, despite the distributed nature of crypto-asset systems, operational risks may arise from the concentration of key services or from vulnerabilities related to distributed ledger technology. These vulnerabilities are partly attributable to the choices made by market participants, including crypto-asset issuers and platforms, to not implement or refuse to implement appropriate risk controls, arrange for effective governance, or take other available steps that would address the financial stability risks of their activities. Many nonbank firms in the crypto-asset ecosystem have advertised themselves as regulated. Firms often emphasize money services business regulation, though such regulation is largely focused on anti-money laundering controls or consumer protection requirements and does not provide a comprehensive framework for mitigating financial stability vulnerabilities arising from other activities that may be undertaken, for example, by a trading platform or stablecoin issuer. While some firms in the crypto-asset ecosystem have attempted to avoid the existing regulatory system, other firms have engaged with the existing regulatory system by obtaining trust charters or special state-level crypto-asset-specific charters or licenses. Compliance with and enforcement of the existing regulatory structure is a key step in addressing financial stability risks. For example, certain crypto-asset platforms may be listing securities but are not in compliance with exchange or broker-dealer registration requirements. In addition, certain crypto-asset issuers have offered and sold crypto-assets in violation of federal and state securities laws, because the offering and sale were not registered or conducted pursuant to an available exemption. Regulators have taken enforcement actions over the past several years to address many additional instances of non-compliance with existing rules and regulations, including illegally offered crypto-asset derivatives products, false statements about stablecoin assets, and many episodes of fraud and market manipulation. In addition, false and misleading statements, made directly or by implication, concerning availability of federal deposit insurance for a given product, are violations of the law, and have given customers the impression that they are protected by the government safety net when they are not. Further, misrepresentations by crypto-asset firms about how they are regulated have also confused consumers and investors regarding whether a given crypto-asset product is regulated to the same extent as other financial products. Though the existing regulatory system covers large parts of the crypto-asset ecosystem, this report identifies three gaps in the regulation of crypto-asset activities in the United States. First, the spot markets for crypto-assets that are not securities are subject to limited direct federal regulation. As a result, those markets may not feature robust rules and regulations designed to ensure orderly and transparent trading, prevent conflicts of interest and market manipulation, and protect investors and the economy more broadly. Second, crypto-asset businesses do not have a consistent or comprehensive regulatory framework and can engage in regulatory arbitrage. Some crypto-asset businesses may have affiliates or subsidiaries operating under different regulatory frameworks, and no single regulator may have visibility into the risks across the entire business. Third, a number of crypto-asset trading platforms have proposed offering retail customers direct access to markets by vertically integrating the services provided by intermediaries such as broker-dealers or futures commission merchants. Financial stability and investor protection implications may arise from retail investors’ exposure to certain practices commonly proposed by vertically integrated trading platforms, such as automated liquidation. To ensure appropriate regulation of crypto-asset activities, the Council is making several recommendations in part 5 of this report, including the consideration of regulatory principles, continued enforcement of the existing regulatory structure, steps to address each regulatory gap, and bolstering member agencies’ capacities related to crypto-asset data and expertise.” The complete report is available at this link: https://home.treasury.gov/system/files/261/FSOC-Digital-Assets-Report-2022.pdf
- Is gold still viable to hold, or have digital assets taken over that role?
I would suggest reading an interesting academic paper titled “Bitcoin Is Not the New Gold: A Comparison of Volatility, Correlation, and Portfolio Performance.” The paper states that “Cryptocurrencies such as Bitcoin are establishing themselves as an investment asset and are often named the New Gold. This study, however, shows that the two assets could barely be more different. Firstly, we analyze and compare conditional variance properties of Bitcoin and Gold as well as other assets and no differences in their structure. Secondly, we implement a BEKK-GARCH model to estimate time-varying conditional correlations. Gold plays an important role in financial markets with flight-to-quality in times of market distress. Our results show that Bitcoin behaves as the exact opposite and it positively correlates with downward markets. Lastly, we analyze the properties of Bitcoin as portfolio component and no evidence for hedging capabilities. We conclude that Bitcoin and Gold feature fundamentally different properties as assets and linkages to equity markets. Our results hold for the broad cryptocurrency index CRIX. As of now, Bitcoin does not reflect any distinctive properties of Gold other than asymmetric response in variance.” https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3146845
Exam Scoping Panel: There’s a Story Behind the Numbers
Panel Moderator: Yolanda Y. Thomas, Senior Financial Analyst, Division of Insurance and Research, FDIC
Panel Speakers: Tiajuana Smith, Supervisory Examiner/Case Manager, Division of Risk Management Supervision, FDIC
Stacy T. Meisel, Chief, Consumer Compliance & UDAP Examination Section, Division of Depositor and Consumer Protection, FDIC
Pamela A. Freeman, Chief, Fair Lending & CRA Section, Division of Depositor and Consumer Protection, FDIC
John R. Penkala, Supervisory Examiner, Fair Lending & CRA Section, Division of Depositor and Consumer Protection, FDIC
John Quartironi, Senior Examiner Large Financial Institutions, Division of Risk Management Supervision, FDIC
Zrinka Dusevic, Complex Financial Institution Specialist, Division of Complex Institution Supervision & Resolution, FDIC
- Can you provide any insight into whether (and how) mixed majority-minority tracts will factor into redlining reviews in the next few years?
The FDIC will assess redlining risk depending on the facts and circumstances of each individual case. A “majority minority” area is one in which over 50 percent of the residents are from prohibited basis groups. Otherwise, a majority-Black or majority-Hispanic census tract is a census tract that has more than 50 percent Black or more than 50 percent Hispanic populations, respectively. The FDIC could also consider geographies with something other than a majority-minority population. As stated in the Interagency Fair Lending Examination Procedures, “an area or neighborhood may only have a minority population of 20%, but if the area’s concentration appears related to lending practices, it would be appropriate to use that area’s level of concentration in the analysis.” When setting the scope of the redlining analysis, we could combine any specific racial or ethnic composition of geographies, such as combining majority-Black or majority-Hispanic census tracts together, or evaluate all majority-minority tracts combined, if we believe that all of the groups that comprise those areas are disadvantaged. In general, this approach provides us with the flexibility to adjust the analysis based on what risks we identify and it should remain consistent in the foreseeable future.
- Since there has been a recent census redistricting that I’m pretty sure has captured our ethnicity for voting location purposes, do you think that will impact these practices or none at all? For example, they have redistricted my neighborhood in Triangle, VA to one in Fairfax, VA.
We’re going to evaluate the risks based on what the specific geographies are at the time of our examination. So, for example - if a majority-white tract becomes a majority-Black tract, that’s what we’re going to consider at the time of our Redlining analysis.
- How do you examine large banks for cyber risks?
Our dedicated team has a group of IT examiners that are responsible for examining the bank’s IT risks including cyber risks throughout the year. The IT examiners evaluate cyber risks through target reviews, ongoing monitoring, and collaboration with our Federal Reserve counterparts. Cyber is an area that is constantly evolving with new threats impacting the environment regularly, which makes execution of ongoing monitoring fundamental to our annual assessment of cyber risks. The team meets with bank management at least quarterly to discuss various IT areas including cyber risks and reviews committee packages all the way up to the Board Technology Committee for pertinent information. In addition, protocols are established to ensure two-way communication occurs regarding any incidents impacting the bank. Target reviews of aspects of cyber risk typically occur annually and we try to run those reviews concurrently with the Federal Reserve’s annual Horizontal Cybersecurity Review. Cyber risks heavily influence the Support and Delivery component of our IT ratings in the annual Report of Examination. The exam team will also hold ad hoc meetings with bank management when necessary to discuss more cyber threats or incidents. Examiners leverage internal audit reports/findings, third-party/consultant cyber assessments, 2nd line cyber assessments, and the portfolio of management identified issues to assist our annual supervisory assessment of cyber risks.
- Since the re-presentment issue is relatively 'new' and seems to be industry-wide, how do examiners determine whether to include this in examinations and determine whether to cite violations? How do the violations affect a bank’s rating? What is FDIC’s supervisory strategy relating to providing restitution to bank customers?
The FDIC’s consumer compliance program focuses on identifying, addressing, and mitigating the risk of consumer harm, based on an institution’s business model, risk profile, and complexity. Examiners conduct an extensive review prior to each compliance examination to determine the risk of consumer harm in an institution’s products and services, including re-presentments. As a result of this review, examiners determine at each examination which areas exhibit the most risk for consumer harm and transaction test in these areas. Therefore, re-presentments may be subject to review and transaction testing if unmitigated risk is identified.
Please refer to FIL 40-2022: Supervisory Guidance on Multiple Re-Presentment NSF Fees for additional details about FDIC’s Supervisory Approach.
Compliance examiners assess bank ratings in conformance with the Uniform Interagency Consumer Compliance Rating System. The consumer compliance rating reflects the overall effectiveness of an institution’s compliance management system (CMS) to ensure compliance with consumer protection laws and regulations and reduce the risk of harm to consumers. Ratings are reflective of consumer harm and focus on the strength of a financial institution’s CMS. Violations of consumer protection laws and regulations are just one consideration in the determination of an overall rating.
Government Guaranteed Loan Fraud Presentation
Jeff Shaw and Chris Conn, Special Agents, FDIC Office of Inspector General
- How were the restitution amounts determined? They're all the same, $2,289,681. Thanks
The restitution amount is based on the amount of loss the Government or institution suffered as a result from the fraud. Due to the fact that these individuals were charged with a conspiracy charge, the restitution in question was ordered to be paid as joint and several. Which means that all three individuals will held responsible to pay the same restitution amount.
- How long was the trial? How many loans did you have to present at trial to convince the jury?
The trial prep took months and the actual trial lasted approximately a week and a half. We presented approximately 8-10 loans to show the variety of the fraud that was being perpetrated. We had dozens more to present, however getting the jury to understand the regulations and rules of the program and to simplify the scheme as much as possible was very challenging. At the end of the day the DOJ trial attorneys did a great job and our SBA employees and borrowers were perfect and made the case easy to understand.
- Did these cases have any negative implications for the lender (bank)?
The case changed the way SBA approves and monitors the LSP’s activities involving the lenders. The SBA also closed some areas involving monetary gains that the LSP’s were exploiting as well (such as sharing in the secondary market proceeds when selling the loans guaranteed portion as an investment on the secondary market). A few bankers were charged and many more could have been. All of the loans that were found to contain fraud were subject to SBA’s review and the guaranty would be subject to a denial or a repair thus shifting the entire/portion of the failed loan bank to the bank.
- With the growing popularity of Government-guaranteed loans, do you believe that ongoing coordination with administering agencies is warranted in this area of institutions that participate heavily?
Coordination with administering agencies can be very helpful with regards to policies/regulations etc. If a high number of customers who are struggling financially at an institution and have non-guaranteed loans but then obtain government guaranteed loan(s) that may be a sign of lenders shifting the risk and may warrant coordination. Additionally, if an institution’s involvement in government guaranteed loans grows rapidly over a short period of time, it may be beneficial to coordinate with the administering agency to examine the underlying changes.
- Thank you. I learned so much especially the issues with the use of proceeds. Generally examiners only look at SBA loans when past due. Any good SBA procedures on use of proceeds? I feel the use of proceeds issue, likely happens a lot and examiners do not know the rules.
Typically, each administering agency has rules governing the use of loan proceeds. Regarding SBA, the uses of proceeds should be disclosed to the SBA during the loan origination process. Some lenders have preferred lending program (PLP) status and can make their own SBA credit decisions and the use of proceeds should be well documented. For instance, if a payoff of non-SBA debt is disclosed then the funds should be used for that approved purpose and not to pay an affiliated business debt etc. Working capital funds are generally for day-to-day business operations and in fraud schemes it can be common to use working capital funds to pay delinquent loans, repay affiliate businesses, etc. that are not disclosed during the origination process. It can be beneficial to look at the lender credit write-up and compare that to the closing documents/ledger that is prepared for the administering agency. Any discrepancies may warrant further review.
- Why weren't the lenders charged?
There was one banker charged who pleaded guilty. Since Banc-Serv generally acted on the lender’s behalf, most of the incriminating evidence i.e. emails involved Banc-Serv representatives.
Economic and Banking Conditions Update and Outlook
Kate Fritzdixon, Senior Financial Economist, Division of Insurance and Research, FDIC
- When is the best time in 2023 to: a) buy a house and b) sell a house?
The best time to buy or sell a house would depend on specifics of the local housing market and what happens with interest rates and home prices. Interest rates are expected to stay elevated through 2023. And, on a national level, home price appreciation is expected to decline, but home prices are not expected to fall year-over-year in 2023. Prices may fall in 2023 in some markets that saw especially high price growth, but it’s not clear when in the year that may occur.
- What are your thoughts with housing assessments being high which you want if you are selling but if you are staying put, the taxes then mortgages are increasing causing some owners to lose their homes?
High home appreciation can cause tax assessments to rise and cause some homeowners to not be able to afford their homes. A number of state and local governments have put in mechanisms to slow or offset that increase over the past decade or so, and those programs may get more use now with the high home price appreciation. Mortgage payments are not likely to change for existing homeowners because almost all mortgages are fixed rate now, but it will have an effect on new buyers.
- Do we still have a risk of stagflation?
Stagflation is a period of high inflation and high unemployment. Currently, while we have high inflation, unemployment is very low. The expectations for the next year are for inflation to slowly come down while unemployment rises. This would be in line with typical slowing growth or recession behavior, not with stagflation. But if monetary policy does not bring down inflation and the economy slows, we could see stagflation.
Questions?
If you have any questions related to the Conference, please Contact Us.
PDF Help - Information on downloading and using the PDF reader.