10 must-watch Washington battles between banks and regulators

August 2, 2022 11:54 AM

Presidential administrations tend to arrive in Washington with one agenda and end up pursuing something quite different. The Biden administration is no different.

While banking policy was not a cornerstone of Joe Biden's 2020 campaign, he nonetheless laid out some broad priorities for his financial regulatory apparatus, primarily focusing on fair lending and finding ways to expand marginalized communities' access to loans and services.

The administration is sticking to that focus, particularly in the form of a newly energized Consumer Financial Protection Bureau. Rohit Chopra, the CFPB's director, has expanded the scope of the agency's review of so-called Unfair, Deceptive or Abusive Acts or Practices beyond traditional loans to include all manner of financial activity — a move for which he has been roundly criticized by the financial and business communities.

The Federal Reserve, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency have also issued a joint proposed rule to overhaul the Community Reinvestment Act, a project that was first embarked upon in the Trump administration.

But administrations are also driven by forces outside of their control, and again the Biden administration is no exception. Leaving aside the increasingly urgent imperative of taming inflation, regulators are also addressing climate change, implementing a new law for disclosing the beneficial ownership of corporations and a range of other priorities that can't wait.

With the confirmation of Michael Barr as vice chair of supervision at the Federal Reserve last month, the administration will finally be able to put its mark on all of these policy areas and more. But there's no guarantee these efforts will succeed, and any policy choices will likely be fought over in Congress and even in the courts.

What follows is a breakdown of the 10 leading regulatory battles being waged in Washington.

Acting Comptroller of the Currency Michael Hsu

Acting Comptroller Michael Hsu recently rescinded former OCC chief Joseph Otting's CRA proposal in favor of the joint one.

Ting Shen/Bloomberg

A new joint rule for the CRA

In May, the Federal Reserve, the OCC and the FDIC issued a joint proposed rule to revamp the way the agencies implement the Community Reinvestment Act, a landmark 1977 law that requires banks to offer loans, accounts and services to low- and moderate-income customers in the communities they serve.

This proposal is a long time coming. Treasury Secretary Janet Yellen — who was chair of the Federal Reserve at the time — said in 2015 that the agency was looking for ways to improve CRA implementation, but ultimately never issued a proposal. The Trump-appointed OCC chief Joseph Otting put forward his own proposal in 2018, which was finalized in 2020 and more recently rescinded by acting Comptroller Michael Hsu in favor of the joint proposal.

Through all of these iterations, the fundamental issues have remained consistent — community advocates want the CRA to be a policy lever that results in more investment in underprivileged neighborhoods, while banks want the test to be more consistent over time.

There are other issues that need to be addressed as well. One of them is accounting for the rise of mobile banking, which allows banks to serve customers in areas far removed from their branch network. Another is deciding what kinds of lending and services qualify for CRA credit.

And still another is deciding how rigorous the CRA review process ought to be and what a bank should have to do to earn a satisfactory rating — or, for that matter, an outstanding one.

The most recent proposal from the banking regulators threads these needles in various ways. Bank branches remain the central aspect of determining banks' service areas, but the proposal also would apply CRA requirements to large banks with significant loan and service market shares. The proposal also would consider community development projects outside of bank service areas and would require banks to disclose the racial and ethnic backgrounds of its customers to better ensure that banks are serving underserved communities.

Under the existing CRA rules, banks are subject to three tests to determine their CRA rating: lending, investment and services, which are weighted as 50%, 25% and 25% of the rating respectively. The revised framework instead would use four tests: a retail lending test, a retail services and products test, a community development financing test and a community development services test. Small and intermediate banks would have the option of being tested under a combination of new and/or existing tests, while large banks would be subject to all four new tests. Banks with more than $10 billion of assets would have to collect and report additional data for each test.

The proposal also includes a holdover from Otting's foray into CRA reform: the promise of a codified list of the types of services, investments and activities that would qualify for CRA credit.

While public comments on the proposal will likely not be issued until closer to the end of the public comment period on Aug. 5, early results suggest regulators are getting close to a deal that everyone can live with.

David Dworkin, president and chief executive of the National Housing Conference, a coalition of industry and advocacy interests, said making the tests tougher is a good start. The FDIC estimated that under the new framework, 9% of banks with assets of $10 billion to $50 billion and 4% of banks with more than $50 billion of assets would receive a "needs to improve" rating. By contrast, no bank with more than $10 billion of assets received that rating in 2021.

"Sure, I want to encourage everyone to succeed, but the idea that no one ever fails is not credible," Dworkin said. "What they've done now is said that's not going to be the case anymore; this is now going to be real grading."

The expanding reach of UDAAP violations

The CFPB is at the forefront of enacting antidiscrimination policies urged by the Biden administration.

One specific policy change implemented by Chopra will put more financial firms at risk of enforcement actions for allegations of discrimination. Chopra announced a new policy in March in which discrimination associated with any financial product — not just credit products— is considered illegal.

The change went into effect immediately. For the first time ever, the CFPB will look for discrimination in noncredit financial products including payments, deposit and checking accounts, prepaid cards, remittances and debt collection, among others.

The key concern is that the CFPB now can allege that discrimination based on age, race or sex (or other attributes) — regardless of intent — violates the federal prohibition on "unfair, deceptive or abusive acts or practices."

With more financial companies potentially facing UDAAP violations, industry pushback and litigation against the agency could increase. Some also see the move as an expansion of authority that Congress never approved, since laws prohibit discrimination in mortgage lending and in credit applications.

In the meantime, the CFPB has beefed up its fair lending exams and supervision. Chopra also has vowed to crack down on lending violations in home loans, small business loans and in lending decisions using artificial intelligence and machine learning.

Waiting on the Fed for merger reform

The ball is in the Federal Reserve's court on the issue of bank merger reform. The FDIC and the OCC have already begun the process of revising how they oversee mergers and acquisitions.

The Department of Justice, which has antitrust authority over any deals, is also looking into the topic. A dustup over reforming the rules that govern mergers led Jelena McWilliams to resign as chairman of the FDIC 16 months before her term was to expire. Her resignation came after FDIC board members CFPB's Chopra and Martin Gruenberg, who is now acting director of the regulator, carried out a notational voting process to issue a request for public comment. Chopra and Gruenberg are Democratic appointees, while McWilliams was appointed by Trump.

The OCC followed suit in May, with Hsu, the acting leader of the agency, saying that mergers of large regional banks presented a threat to financial stability.

The OCC joined the debate roughly one month after Sen. Sherrod Brown, D-Ohio, chairman of the Senate Banking Committee, wrote a letter calling on the OCC and the Fed to join the FDIC in rewriting the rules on bank mergers.

Brown said lax merger review policies have led to a decrease in competition that has in turn led to higher costs for bank customers.

"At its core, consolidation hurts consumers. In the aftermath of a merger, the rates banks pay depositors go down, while the rates and fees banks charge borrowers go up," Brown wrote in the April 6 letter. "Bank branches invariably close, making it harder for consumers to access financial services in their neighborhoods."

Like many issues for the Fed, the matter of bank mergers has been put on the back burner until the central bank has a new vice chair for supervision. Because of the uncertainty about the prudential regulators' approach toward mergers, approvals of combinations that would result in a bank with $100 billion or more in assets have slowed to a crawl.

President Biden has nominated Barr to become the Fed's chief regulator. During the Senate Banking Committee's confirmation hearing, Sen. Pat Toomey of Pennsylvania, the panel's ranking Republican, asked Barr whether he felt the Fed had the "statutory authorization to impose a universal moratorium on bank mergers."

Barr said he was not aware of any such authority. Toomey followed up by asking how Barr would approach mergers broadly if confirmed. Barr said mergers could have positive or negative effects on competition, convenience and financial stability, so he would take each merger at face value.

"I don't have an a priori view," Barr said. "I think the merger should be conducted based on the evidence."

The ongoing battle over the CFPB

Legal challenges are hardly new to the CFPB, an agency declared unconstitutional by the Supreme Court in 2020 but that still survived intact.

Two years ago, the Supreme Court ruled in Seila Law LLC v. CFPB that the bureau's single-director structure was unconstitutional. That decision allowed the agency and eight years of its rulemakings and actions to stand.

Several cases winding their way through appeals courts stand a better chance of disbanding the agency entirely or invalidating all of its past actions. These cases are a test of whether the current Supreme Court's conservative majority will uphold the agency's creation by the Dodd-Frank Act of 2010.

The arguments this time around have to do with the CFPB's funding through the Fed and not through the typical congressional appropriations process. When Congress created the CFPB, Democrats sought to have the agency be independent. Several plaintiffs have alleged that the CFPB is unconstitutional because its funding outside of appropriations violates the Constitution's separation of powers. Republican lawmakers also have recently taken up the call and are teeing up bills to give Congress budgetary oversight of the bureau.

Basel III: The end(game) is near

Randal Quarles, former Federal Reserve vice chair for supervision, hoped to have a framework in place to implement the final components of the Basel Committee on Banking Supervision's latest standards for bank regulation before leaving office last fall.

The Fed's scramble to keep the economy from collapsing during the onset of COVID-19 made that impossible. A deadline extension from the Basel committee allowed the central bank to put off its final preparations for the Basel III endgame — also known as Basel IV — until next year.

Finalized in 2017, Basel IV revises the standards governing market risk, operational risk, credit risk and leverage ratios at banks around the world. Using a risk weighted approach, the rules put a greater emphasis on operational and market risks within banks while easing requirements related to credit risk.

Its overarching goal is to rework capital requirements and standards to make them simpler, encouraging standardized capital requirement models over internal ones devised with the banks themselves.

Because the U.S. has one of the more stringent capital requirement regimes globally, the switch to Basel IV standards will probably not have the effect of raising overall capital requirements. Nonetheless, taken at face value, the changes could result in substantially greater requirements for some banks, Quarles warned during his parting speech last December, noting that the largest institutions would have to increase their capital holdings by as much as 20%.

The Fed would like to avoid those kinds of drastic changes and has suggested it would be open to reducing the capital surcharge for global systemically important banks or tweaking its stress capital buffer requirements to make the Basel IV implementation "capital neutral."

Along with figuring out how exactly to achieve capital neutrality, the Federal Reserve Board of Governors must also decide if and how the Basel IV rules might be applied to medium-sized and smaller banks.

All these changes would have to go through the Fed's lengthy rulemaking process, which can take more than a year to complete. While the Fed's staff has continued working on Basel IV, the board has awaited the confirmation of Michael Barr before closing the rule. Barr's confirmation last month means the Basel IV rules should be completed quickly.

Cannabis banking crawls towards reality

An almost decade-long effort to make it easier for legal cannabis businesses to access the banking system could reach the finish line by the end of the year, but it remains to be seen exactly what shape the reform will take in Congress.

Cannabis companies that operate lawfully at the state level are generally banned from conducting their business on major payment networks like Mastercard and Visa. That has left most of the firms reliant on cash.

Enter Rep. Ed Perlmutter of Colorado, who in 2013 introduced a bill that would provide a federal safe harbor for banks to work with cannabis firms. Perlmutter's bill, the Secure and Fair Enforcement (SAFE) Banking Act, passed the House in 2019 with nearly 100 GOP votes, and the reform has since cleared the House six times. But the Senate has never voted on the bill.

Policy analysts remain optimistic that SAFE Banking could become law in one of two ways before 2023. It could be included in the must-pass National Defense Authorization Act, or the proposal could be considered as a standalone bill. The bill was included in the House version of the NDAA, which passed the lower chamber handily on July 14. It remains unclear if it will be included in the Senate's version of the bill.

Perlmutter, who is set to retire after the end of the current session of Congress, has vowed to keep pushing for SAFE Banking to become law.

"The Senate continues to ignore the public safety risk of forcing cannabis businesses to deal in all cash," Perlmutter said in a statement released in June. "In the wake of the Senate's inaction, people continue to be killed, businesses continue to be robbed, and employees and business owners in the cannabis industry continue to be excluded from the financial system," he added.

Big questions remain on key AML reform

Signed into law in early 2021, the Corporate Transparency Act was supposed to make banks' anti-money-laundering compliance burdens lighter. But analysts say that true reform is far from assured, and banks might still be responsible for much of the existing burden.

Passed as part of a broader legislation package titled the Anti-Money Laundering Act of 2020, the CTA requires businesses to enter their beneficial ownership information into a new national database maintained by the Financial Crimes Enforcement Network. The primary objective of the law was cracking down on anonymous shell companies in the U.S. — a frequent component of modern illicit finance and tax-avoidance schemes.

But banks and their advocates were hoping that a bonus benefit from that new database would be regulatory relief. Today, much of the anti-money-laundering regime revolves around bank monitoring of customer funds and the suspicious activity reports, or SARs, which bankers have long identified as one of their more time-intensive regulatory burdens.

The problem, analysts say, is that the statutory text of the CTA is silent on key details about the new anti-money-laundering framework, which will go into effect over the next several years in three separate rulemaking processes led by Fincen. Whether the law actually provides bankers any relief will likely hinge on the way that Fincen collects its beneficial ownership information from U.S. businesses. In order for the database to actually be helpful, experts agree that the information must be verified.

Up until now, that task has fallen to banks via their customer due diligence requirements — a job that much of the industry is eager to shed. But Fincen, a relatively small government agency, may not have the resources to police such a database on its own. That could make it tempting for policymakers to lean on banks or other financial institutions to help verify the information.

Beyond the proposed rulemakings already in the works and the others still to come, the structure of the new framework could come down to resources.

Representatives for Fincen have pleaded with Congress to appropriate millions more in funds to better equip the agency to implement the CTA, but it remains to be seen whether lawmakers will consent.

New rules for stablecoins

Financial regulators and Congress are still trying to coalesce around a unified regulatory framework for stablecoins, a crucial portal between crypto finance and the financial system.

The atmosphere changes fast in the crypto world, and a second major headline-snatching crash around the Celsius Network has quieted some of the loudest proponents of cryptocurrency in Washington, and reinforced banking regulators' cautious approach to digital assets.

The crashes "confirm some of our prior thoughts that there are some vulnerabilities and risks in that space that do warrant a cautious and careful approach," Hsu, the acting comptroller of the currency, told reporters after the Celsius market turmoil.

With the volatility of cryptocurrency increasingly in the spotlight, there's more eyes looking toward stablecoin regulation. Stablecoins, which are meant to be backed by real assets such as Treasuries and bonds, underpin crypto markets. The hope is that, if stablecoins are backed by relatively liquid assets and regulated similarly to banks, they'll lessen the frequency and severity of runs on other digital assets.

A bipartisan bill emerged in early June from Sens.Kirsten Gillibrand, D-N.Y., and Cynthia Lummis, R-Wyo.

The crypto industry generally applauded the proposal, which took a comprehensive approach toward defining digital assets and establishing regulatory jurisdiction over them.

The bill offers a few options for stablecoins. One of those echoes the Biden administration's suggestion: to put stablecoin issuers under the FDIC and impose banklike regulation on them.

The other would require issuers to fully back their coins with hard assets, a mandate that would subject them to similar scrutiny as exchange-traded funds, which are required to have their underlying assets verified by third-party groups.

Banks had a more tepid response to the bill than the crypto industry. A provision in the bill would mean any depository institution with a state charter is entitled to an account at a Federal Reserve bank, regardless of whether they are federally insured or supervised. Bank groups say this gives fintechs an unfair advantage.

Movement on stablecoin regulation could come as quickly as before the end of the year, said Toomey, the ranking GOP member of the Senate Banking Committee. Toomey has put forward his own bill on the issue that would create a new federal license for stablecoin issuers and authorize the OCC to issue it.

How to regulate stablecoin is a tricky issue for banks to take a stand on. On one hand, requiring stablecoin issuers to adopt banklike regulations would help even out the playing field, giving issuers similar oversight, giving them deposit insurance and requiring that they be backed by relatively liquid assets.

But it could also reintroduce risk into the banking system, some industry watchers have warned. While banks have seen little impact from the recent market volatility, that could change if risk from crypto is put back on the balance sheets of highly regulated financial institutions.

"Dodd-Frank was about de-risking the big banks, and now the President's Working Group contemplates that we're going to add more risks to these institutions," Rep. Pat McHenry, R-N.C., said in May during a House Financial Services Committee hearing with Yellen.

Yellen and other key Treasury Department officials, notably Nellie Liang, undersecretary for domestic finance, have called for this banklike regulation, although some lawmakers on both sides of the aisle have balked.

"It occurs to me that limiting stablecoin issuance to insured depository institutions, which have a high barrier to entry, could limit competition," Rep. Gregory Meeks, D-N.Y., said during a House Financial Services Committee hearing in February.

Movement to regulate stablecoins goes beyond Washington. The New York State Department of Financial Services released new guidance for stablecoin issuers in early June, calling for reserve requirements and monthly independent audits.

SLR: A needed change for a new capital normal

The Federal Reserve has a problem with the calibration of its supplementary leverage ratio, or SLR, and it knows it.

The calculation determines how much capital large bank holding companies must retain relative to their total leverage exposure, which is their assets plus their off-balance- sheet exposures. The SLR counts all assets the same, regardless of risk, meaning risk-free assets such as deposits at the Fed and U.S. Treasuries carry the same risk weight as loans and investments.

The problem is that the standard was set in 2014, when the expected baseline of deposits at the Fed, also known as reserves, was expected to be $25 billion.

Currently the amount of reserves in the system tops $3 trillion, with the expectation that the long-term average will be more than $1.5 trillion. Similarly, the level of Treasuries in circulation has increased dramatically during the pandemic, thanks to the government's various stimulus programs.

This level of reserves and Treasuries paired with the current SLR calibration has created all sorts of problems, according to the Bank Policy Institute. It is a binding constraint for four of the largest 20 banks in the country, accounting for 45% of large-bank assets. It has also pushed some banks to lean more heavily on the Fed's overnight reverse repurchase facility and has created issues within the Treasuries market because banks have been disincentivized from purchasing them.

Earlier this year, Quarles, the former Fed vice chair for supervision, told American Banker "our leverage capital framework is calibrated too tightly for the smooth functioning of the Treasury markets." He also said that banks were being pushed to keep capital in higher-risk assets, such as money market funds, because they provided better returns while coming with the same capital requirements under the SLR as reserves or Treasuries.

Early in the pandemic, the Fed allowed bank holding companies to exclude reserves and Treasuries from the capital ratios, to allow banks to absorb the fiscal and monetary support from the government and turn them into credit to support the economy.

Banks hoped the Fed would make the change permanent, but it allowed the measure to expire in March 2021. That June, Quarles said tweaking the SLR was "likely something that will need to be done" because "the system can't hold the amount of cash that it has without a change."

The topic has fallen by the wayside since Quarles left office in October, leaving open the Fed's chief supervisory position. In January, Fed chief Jerome Powell noted that it had not dropped off the board's radar entirely, stating "we think there's something we may be able to do on SLR," when asked about it during his confirmation hearing with the Senate Banking Committee.

Barr, the Biden administration's pick for vice chair for supervision, was also asked about the SLR during his confirmation hearing in May. He said addressing it would be a top priority but noted that he did not want to tie himself to any specific policy position before getting his hands on the full gamut of issues that would be on his desk.

"What I'd like to do is to come into this position confirmed and wrap my arms around the whole capital liquidity picture," Barr said. "That includes the SLR and the Basel III endgame and stress testing and the like, and make sure I understand the full package of potential issues."

The SEC seeks greater climate disclosures

The Securities and Exchange Commission is proposing a rule that would widen required disclosures by publicly traded companies on climate risk.

The SEC's roughly 500-page climate disclosure proposal would ask publicly traded companies to disclose a wide array of climate-related information, including a firm's carbon emissions across its value chain. The rule, which had a comment period that closed in June, drew criticism from large banks, which urged the agency to narrow the proposal's scope and to let bank regulator oversight preempt the SEC.

Two large banking trade groups, the Bank Policy Institute and the Financial Services Forum, called on the SEC to significantly cut any "scenario analysis" requirements, saying that bank regulators will likely soon add them in their supervision.

The data banks would report to banking regulators would also be private. That would spare the companies from having to disclose confidential supervisory information or other proprietary business information, the Financial Services Forum said.

The bank groups also asked the SEC to reconsider Scope 3 emission disclosure requirements for banks. That requirement would have a far heavier burden on banks, the groups said, because it could mean the agency requiring the collection of climate data for all the companies a bank invests in.

The requirements could drive business away from banks and into the private credit market, according to the Financial Services Forum.

"The Scope 3 emissions disclosure requirement could also have unintended consequences that are detrimental to capital formation because public financial institutions will need to collect emissions information from customers in order to comply with the required disclosures, which could result in those customers seeking capital from private companies not subject to these new rules," the group said.

The proposal also drew pushback from a large group of House Republicans, led by the ranking members of the House Financial Services Committee and House Energy and Commerce Committee — McHenry and Rep. Cathy McMorris Rodgers of Washington.

"It is Congress' job to set our environmental policy, not the job of unelected regulators," the lawmakers wrote. "The SEC should focus on its core mission — protecting investors; maintaining fair, orderly, and efficient markets; and facilitating capital formation rather than a far-left social agenda."