Regulators Wrong to Judge Banks on 'Reputation Risk': Hensarling

House Financial Services Committee Chairman Jeb Hensarling is challenging the idea that regulators should restrict banks' activities based on a judgment about the potential harm to their reputations.

In letters to federal regulators Thursday, the Texas Republican writes that reputational risk is a "vague, subjective and unquantifiable" indicator. He adds that it would be "an abuse of regulatory discretion" to use reputational risk to justify and outcome that could not otherwise be justified using objective criteria such as capital adequacy and liquidity.

The letters were sent to Federal Reserve Board Chair Janet Yellen, Comptroller of the Currency Thomas Curry, Federal Deposit Insurance Corp. Chairman Martin Gruenberg and National Credit Union Administration Chairman Debbie Matz.

Hensarling's letters come in the midst of a controversial Department of Justice probe, dubbed Operation Choke Point, in which regulators appear to be restricting certain businesses' access to the payment system. The stepped-up regulatory scrutiny has sparked concern that banks are choosing to sever ties with even some lawful customers, including check cashing businesses and porn actors.

Hensarling writes that reputation risk "could ostensibly be evoked to compel a depository institution to sever a customer relationship with a small business operating in accordance with all applicable laws and regulations but whose industry is deemed ‘reputationally risky' for no other reason than that it has been the subject of unflattering press coverage, or that certain executive branch agencies disapprove of its business model."

The letters also note that the OCC and FDIC cited reputation risk in recent guidance that led to the demise of small-dollar bank loans that resembled payday loans, and that the Fed made a brief reference to "reputational damage" in its proposed restrictions on banks' control over physical commodities.

Hensarling is asking the four agencies to respond to a series of questions about how they use the concept of reputation risk in their supervision of banks.