After every banking crisis, policymakers in Washington flood the halls of Congress and the airwaves with thoughts and ideas, dissecting the crisis with an urgent call to fix the current problems. Invariably, the proposed solution usually calls for more regulation, paired with a discussion about the role and size of deposit insurance.
Today's "solutions" in response to headline-grabbing bank failures are once again centered around the "nationalization" of the U.S. banking system. This includes discussions of government guarantees on all deposit accounts, no matter the amount, and the expansion of the "too big to fail" regime to regional banks. If anyone wants to know what universal guarantee of all deposits looks like, look no further than the two government-sponsored enterprises Fannie Mae and Freddie Mac, which are now in their 14th year of government conservatorship, and the Savings & Loan crisis in the 80's that cost U.S. taxpayers some $160 billion. What could possibly go wrong when a bank management team decides to onboard undue risk but does not have to worry about deposits leaving the bank?
A sound banking system is essential to a free market economy. Failure is part of the free enterprise system, as well as rewards for understanding and accepting risk in the marketplace. The safety and soundness of the U.S. banking system is key to this country's macroeconomy and business in general. There are policymakers in Washington who think we should regulate the "risk" out of the U.S. banking system. If that were to happen, we would not, in fact, have a functioning banking system. The business of banking is managing risk; those who are good at it are successful, those who are bad at it often fail.
While the proper role of bank regulation has been well established over decades, there have been attempts by recent administrations to refocus the overall mission of the bank regulators. Recently there has been an attempt to graft a "social agenda" onto the banking system. The same people who want to nationalize the banking system, and who do not understand many basic principles like stock buybacks, are requiring the banking system to be responsible for climate change, economic equity, credit allocation, prohibition of lending to industries they do not like and mandating boardroom diversity over qualifications. Complexity surrounding corporate governance, capital adequacy, credit underwriting, liquidity and interest rate risk are often not appreciated by some policymakers in Washington.
Two years after Illinois became one of several states to pass their own version of the federal Community Reinvestment Act, credit unions and banks continue to fight over whether the law is necessary and how strict the corresponding regulations should be.
There is one reason the banking system was not adversely affected to a large degree during Covid. It is because the regulators doubled the amount of capital in the system in 2008 in the wake of the financial crisis. Capital should be defined as paid-in equity plus retained earnings. Quite simply, debt is debt; intangibles and loan loss reserves are not capital. Regulators need to require strong minimum capital levels and should be forceful in requiring more for banks where management takes on higher risk.
Banks should not be used as forced conduits of social policy by special interest groups. There is a long history, including the Community Reinvestment Act (CRA), of the federal government requiring banks to help meet the needs of the communities in which they operate, as long as safety and soundness mandates are adhered to. In other words, the CRA is working and recognizes the need for social action to be balanced with the fundamental mission of the bank. The market is the right place to determine which banks are good citizens in the community, and it is up to the bank customers to place a value on it.
Governance must be a focus on both the quality of management and a constant review of the capacity of the board of directors. Independence, including moral authority and an understanding of the business of banking and managing risk, are essential traits of every board member. An engaged board is a skeptical board, not afraid to question management and is not intimidated when searching for answers to concerns. Strong risk management culture needs to be present in all banks; and it was clearly lacking at some of those that recently failed.
The American people also deserve competent banking regulators. Authority and accountability are intertwined and inseparable. So where is the accountability in the wake of these recent failures? Is there a conflict within the FDIC board, and if so, should the membership be scaled back to address these conflicts? Are there divided loyalties within the Federal Reserve between monetary policy and bank regulation? Are the bank supervisors within the Federal Reserve district banks always in sync — not only with each other, but with the Fed's leadership in Washington? Are there activities conducted within bank holding companies that would not be acceptable in an FDIC-insured Bank? Are field examiners at the various agencies being overruled by political appointees and acting agency heads? Are the standards of all state banking departments above reproach?
All these questions, and others, should be addressed and, where necessary, changes need to be implemented regardless of political sensitivities. The focus of bank regulation needs to get back to the simple basics of ensuring the safety and soundness of the U.S. banking system.
