Before the financial crisis, federal and state regulators unabashedly pitched their charters to banks as the better choice. Now regulatory competition is back, despite warnings that such jousting might result in lax oversight.
The renewed competition is a marker of how far the proverbial pendulum has swung in the decade since the crisis. The practice, still in its early stages, may be a boon for some — foreign banks and financial technology companies are among those that seem poised to benefit. But skeptics fear that it will ultimately add risk to the financial system and harm consumers.
One post-crisis study by a Federal Reserve Board economist determined that banks get substantially higher supervisory ratings after they switch charters. Based on historical outcomes, a bank’s odds of being rated fundamentally safe and sound increased to almost 100% when they opted for a new overseer, the study indicates.
“If banks can improve their ratings by changing charters, then regulators should be concerned with losing banks that they already supervise and could possibly lower the standards that they apply to these banks,” Fed economist Marcelo Rezende wrote in the 2014 paper.
A couple of decades ago, it was common for government officials to tout the benefits of regulatory competition. Their main argument was that the existence of multiple chartering options allowed for more industry innovation.
But critics saw these rivalries — with states picking off federally chartered banks, and vice versa — as contributing to an erosion of regulatory standards. They argued that this dynamic allowed companies under scrutiny to seek more favorable treatment elsewhere, a practice referred to derogatorily as “regulatory arbitrage.”
In one example of the lengths that regulators went to entice banks, then-Comptroller John D. Hawke Jr. flew to Memphis in 1999 to talk National Bank of Commerce out of switching to a Tennessee charter.
Around the same time, the website for Georgia’s banking department featured a comparison between the examination fees that banks could expect to pay under a state charter and the substantially higher fees that the OCC would charge.
“I saw instances where certain states in the United States put together videos promoting the fact that if you gave up your national charter, took a state charter for your bank, you were going to get a friendlier regulator,” recalled Kevin Jacques, a former OCC official.
Both the OCC and state agencies are funded by exam fees paid by the banks they regulate, which gives them a financial incentive to attract more banks to their charters.
“That sort of eat-what-you-kill approach to regulation can have some perverse incentives,” said Thomas Vartanian, a former OCC lawyer who later represented banks in private practice.
Vartanian, the founder of a soon-to-be-launched financial regulatory institute at George Mason University’s Antonin Scalia Law School, argued that competition between regulators also has benefits. “And the question at the end of the day is whether it offsets the negative,” he said.
By the onset of the crisis, the Treasury Department had determined that regulatory competition was doing more harm than good. In a July 2008 speech, then-Treasury Secretary Henry Paulson touted a proposal to consolidate various agencies, saying: “These recommendations eliminate regulatory competition that creates inefficiencies and can engender a race to the bottom.”
'That sort of eat-what-you-kill approach to regulation can have some perverse incentives,' says Thomas Vartanian, a former OCC lawyer.
After the crisis, one of the relatively uncontroversial conclusions in various post-mortems was that banks were able to secure more lenient oversight by switching regulators.
The Financial Crisis Inquiry Commission, which studied the causes of the financial meltdown, later uncovered documents showing that the subprime mortgage giant Countrywide Financial was attracted to the Office of Thrift Supervision because the agency was seen as less sophisticated than the Fed. Even at the time, Countrywide’s move to a thrift charter, announced in 2006, was seen as an effort to find a more tolerant regulator than the Fed and OCC. Ultimately, the troubled lender’s application for a thrift charter was approved in March 2007, less than a year before its sale to Bank of America.
The Dodd-Frank Act took various steps to prevent a replay, including the elimination of the Office of Thrift Supervision, which was widely seen as having a feathery touch. (The OTS was dissolved in 2011 and absorbed by the OCC.)
The 2010 financial reform law also placed restrictions on charter conversions by banks that were operating under enforcement orders. Two years later, federal and state banking officials released a joint statement on how they would interpret the language of the statute.
But the comity between federal and state agencies began to break down later in the tenure of Comptroller Thomas Curry, who put forward the idea of offering federal charters to state-regulated fintechs.
Twice in less than two years, the Conference of State Bank Supervisors has sued to stop the OCC’s proposal, which has continued to move forward following Curry’s departure. The state regulatory group argues that the OCC’s new charter will make consumers vulnerable to predatory firms that no longer have to follow state consumer protection laws.
Dennis Kelleher, the president and chief executive of Better Markets, which advocates for stricter regulation, compared the OCC’s recent moves to efforts by the same agency in the early 2000s that allowed national banks to avoid state predatory lending laws.
“Fintech is an umbrella word into which everyone is pouring their wildest, latest dreams about banking in the future,” Kelleher said. “And while innovation can be good, it can also be incredibly destructive.”
Under Trump administration appointees, the OCC also has begun tangling with state regulators over foreign bank charters.
In late 2017, the Bank of Tokyo-Mitsubishi UFJ decided that it would rather operate a national bank in the United States than a depository chartered in New York state.
The Japanese banking giant’s abrupt switch — made in concert with the OCC — came at a time when its efforts to combat money laundering were facing close regulatory scrutiny in the Empire State. Its move sparked a loud backlash from New York’s financial services regulator, which openly accused the company of engaging in regulatory arbitrage. The agency argued in litigation, which is still ongoing, that the Dodd-Frank Act required a non-objection from state officials for the charter conversion to be approved.
That imbroglio served as a backdrop for Comptroller Joseph Otting’s November trip to Tokyo, where he pitched foreign bankers that operate in the U.S. on the idea of abandoning their state charters. He argued that getting licensed in various states adds complexity and increases operating costs. He also said that federal supervision results in regulation that is both more efficient and more thorough.
Otting’s speech drew a retort from John Ryan, president and CEO of the Conference of State Bank Supervisors, who noted that foreign banks with multistate operations have a single point of contact among state regulators. “Thus, our approach ensures nationwide coordination, regulatory efficiency and local accountability,” Ryan said.
Curry, who served as comptroller from 2012 to 2017, declined to comment on specific actions taken by his successor. But during an interview, he called for adhering to “the letter and the spirit” of the Dodd-Frank provision that restricts charter conversions by banks that are facing supervisory scrutiny. The New York State Department of Financial Services made a similar argument following the charter conversion by Bank of Tokyo-Mitsubishi UFJ.
'He apparently is unaware of anything that happened in the past,' Better Markets' Dennis Kelleher says of Comptroller Otting.
Curry drew a distinction between what he sees as healthy regulatory competition and the unhealthy kind. “I’ve seen both in my lifetime,” he said.
The former comptroller argued that competition between regulators can encourage responsible innovation, but that it becomes destructive if it focuses on bolstering an agency’s bottom line.
In a statement to American Banker, Otting said that the OCC supports the dual banking system of state and federal regulation and the power of banking companies to choose the charter that is the best fit for their businesses.
“When making a chartering decision, a company should be fully aware of the particular advantages and disadvantages that each charter offers based on their particular facts and circumstances,” Otting said in an email. “As comptroller of the currency, I am proud to discuss the merits of the federal charter and the quality and value of OCC supervision that helps ensure the federal banking system operates in a safe and sound manner, treats customers fairly, and complies with applicable laws and regulations.”
But Otting’s critics warn that he is ignoring the lessons of the financial crisis. “He apparently is unaware of anything that happened in the past,” Kelleher said.
