BankThink

How to fix the biggest flaws in today's banking system

August 24, 2023 3:32 PM

Enjoy complimentary access to top ideas and insights — selected by our editors.

The banking crisis of 2023 revealed gaps in bank regulation and enforcement as well as other systemic issues. U.S. banks are among the safest in the world, but experts have pointed to a variety of places where the government could shore up infrastructure or add rules to improve the industry's health. Here are a dozen ideas from BankThink about changes to make.

Change how banks gather deposits

What went wrong with First Republic, the failed bank that at first survived the 2023 banking crisis, and then fell victim to it anyway, becoming part of JPMorgan Chase? Plenty of bankers have theories on interest rate risk and liquidity risk, but Brett King, CEO of Moven, points to the bank's inability to gather deposits quickly enough online to offset those leaving. "For banks to survive, it is increasingly clear that the ability to acquire customers and deposits digitally is no longer a 'nice to have,'" King writes.

Read more: What killed First Republic? Failure to gather deposits at 'digital scale'

Change how regulators look at deposit insurance and bank conduct

Justin Sullivan/Photographer: Justin Sullivan/Ge

As for the future, what fixes do regulators need to make in the wake of this crisis? Srinivas Nippani, a finance professor at Texas A&M, proposes a "conduct risk' authority, a new regulatory body: "Big bank failures could have been prevented if a central agency capable of publicly issuing ratings had looked at the bank's asset portfolio before the crisis." Banking consultant Bert Ely points to First Republic's failure as a cautionary tale for the Federal Deposit Insurance Corp., which, he says, should hurry up and design a market-based mechanism for deposit insurance premiums.

Read more: First Republic's failure shows need for major deposit insurance reform

Recent bank failures point to the need for a 'conduct risk' authority in the U.S.

Resist the temptation to slash bank fees

Samuel Corum/Bloomberg

CFPB Director Rohit Chopra has been on a campaign to fight what he calls "junk fees" – levies that amount to extra revenue for financial institutions without any benefit to customers. One flashpoint for banks has been the proposed $8 credit card late-fee proposal. "If implemented, the rule would actually increase overall costs for the large majority of credit card customers, both those who pay on time and those who pay late," write attorneys Brad Karp and Roberto Gonzalez. "An $8 fee is not sufficient to deter late payments; as a result, delinquencies would meaningfully rise."

Read more: The CFPB's late-fee proposal would harm the consumers it seeks to help

Issue clear AI rules — now

Samuel Corum/Bloomberg

Now that machine learning is being adopted more widely in financial services, it's the right time for regulators to allow lenders to use artificial intelligence to make sure they're not discriminating against certain groups of buyers, writes Yolanda McGill, vice president of policy and government affairs at Zest AI. The CFPB ought to issue clear rules about how lenders can use AI for this purpose, so that companies can get started using it within the guidelines, she writes.

Read more: CFPB should encourage the use of AI to reduce lending discrimination

Rethink old assumptions, starting with deposit flows

Angus Mordant/Bloomberg

What if regulators are wrong about the types of deposits that will flee first during a bank run like those on Signature Bank or Silicon Valley Bank? Rules written using data from the financial crisis of 2008 may no longer apply, now that technology has sped up the pace of withdrawals, writes Brian Graham, a partner with Klaros Group: "It is reasonable to ask whether these changes may be having similarly fundamental impacts on long-held presumptions of the relative stickiness of various types of deposits during this period of banking stress."

Read more: Are we totally wrong about which types of deposits are risky?

Mix banking and commerce

When banks falter, only other banks can step in to help them. This is because of rules restricting bank ownership and control, which is why you never see cash-flush tech companies like Google or Apple buying banks. (Apple has a partnership with Goldman Sachs, but that deal has run into rocky waters.) If we can mitigate the risks of letting Big Tech into our financial system, we might be able to help banks and encourage innovation, writes Ram Ahluwalia, CEO and co-founder, Lumida Wealth Management.

Read more: Outdated laws are denying banks access to a vast source of capital

Set clearer rules on M&A one way or the other

Henry Zimmerman

Merger policy is a hot-button issue for banks, which advise on and finance M&A transactions, as well as sometimes buy each other. With the Biden administration turning down or discouraging mergers, two former Trump-era officials of the Office of the Comptroller of the Currency write that the government should rethink how it considers bank combinations. "The market needs a system it can rely on for timely, transparent decisions based on facts and the economic sense of the individual deals, not politics or incumbent protection," write Keith Noreika and Bryan Hubbard. But maybe the industry's already seen too many bank mergers, argues Shahid Naeem, a policy analyst at the American Economic Liberties Project, in an opinion piece about the aborted TD-First Horizon merger: "As the [Department of Justice] and FDIC review their bank merger guidelines, they must strengthen the merger review process to account for the wide array of harms caused by bank consolidation."

Read more: Regulators were right not to greenlight the TD-First Horizon merger

TD's failed acquisition highlights our broken M&A process

Encourage green lending

Bloomberg Creative Photos/Bloomberg Creative

Many banks have said they would help fund renewable energy and other environmental projects, and they also said they would stop or slow lending to fossil-fuel companies. They've made these commitments, but they're not keeping them, especially since the war in Ukraine made oil and gas prices spike. That's a problem for our future, writes Adele Shraiman, a senior campaign representative with the Sierra Club.

Read more: Big banks are breaking their promise to fund a green energy transition

Democratize credit scoring

Pedestrians pass in front of residential buildings in Cary, N.C.

Why is there a persistent racial and age gap in homeownership? One possible reason is a reliance on FICO scores for mortgages that receive federal backing. Because old-school models have been trained only on high-FICO-score borrowers, they fail to recognize when an applicant with a thin credit file – often a minority or younger person – actually has the ability to repay a mortgage, write fair-housing advocates Syeed Mansur, Michael Akinwumi, Joss Tillard-Gates and Garnet Heraman: "Tens of millions of Americans have been unfairly denied homeownership due to fixable inaccuracies in the very technology the [Federal Home Loan] banks impose on their ecosystem of lenders."

Read more: The Federal Home Loan banks and the disappearing American dream

Think twice about CBDCs

The Federal Reserve has been discussing creating a central bank digital currency, as nearly a dozen countries worldwide have already done. The idea would be to have a rapid way to move money around the world and between companies and consumers. But this could cause problems for banks, warns Nicholas Anthony of the libertarian Cato Institute: "All banks — large and small — stand to lose if a CBDC were to be created."

Read more: Introducing a CBDC would be a catastrophe for the banking system

Bar credit union purchases of banks

If there's one issue that bankers consider a problem with the banking system, it's the practice of credit unions buying banks. Because credit unions are tax-exempt, banks bought by a credit union vanish from the tax rolls. "Given the tax and regulatory disparities, increased cybersecurity risks and consumer impact of credit union purchases of community banks, policymakers should take a closer look at these deals and whether government policy should continue supporting them," writes Derek Williams, president and CEO of Century Bank & Trust.

Read more: Why are taxpayers still subsidizing credit unions' bank buyouts?

Force banks to treat lower-income consumers better

Shelby Tauber/Bloomberg

When American Banker wrote about Comerica's troubles with Direct Express, the benefit card program it administers for the federal government, it wasn't the first time we'd covered these issues, writes John Heltman, AB's Washington bureau chief. It's an ongoing problem that isn't getting solved, he writes: "There has to be some kind of accountability for companies that benefit from implementing such a program in such a way that defrauds so many people of their only means of income." (Comerica's CEO, Curt Farmer, wrote a letter to the editor disagreeing with AB's reporting on this story.)

Read more: Direct Express scandal is typical for how banks treat the unbanked;

Comerica CEO challenges American Banker articles on Direct Express

Harden FedNow against fraud

March 17, 2023, Brazil. In this photo illustration the FedNow Service (Instant Payments) logo seen displayed on a smartphone

Rafael Henrique - Adobe Stock

To see what's likely to happen with the new FedNow instant-payments system, it's helpful to look to the U.K., which launched a similar system in 2008. The picture isn't pretty – fraud was rampant – but legislation and strict enforcement led to a crackdown on scamsters that has made the system safer. FedNow will need to take steps to avoid fraud flooding the system and scaring off customers: "The U.K.'s experience can benefit everyone in the FedNow ecosystem if participating financial institutions proactively deploy fraud prevention controls as a carrot, instead of waiting for the stick of regulation to arrive," writes Alisdair Faulkner, CEO of Darwinium. "They'll not only lower online fraud rates but also build digital trust with FedNow customers, which in the still-nascent world of instant payments will be essential for FedNow to thrive."

Read more: FedNow represents the next frontier for digital fraud in the U.S.