Coercive Regulators have Straitjacketed Banking Services

Historically banking regulators have weaponized the bank examination process to compel banks to freeze or close accounts and adopt environmental, social, and governance standards. Lawmakers need to restrain regulators and ensure they do not use political agendas as a guideline for how to scrutinize banks.  

Bank Examinations 

During the Obama Administration, the Federal Deposit Insurance Corporation (FDIC) and the Department of Justice (DOJ) coerced banks to shut down business accounts deemed to be a “reputational risk” to banks. While regulators purported to protect banks from “risky” lines of business, the real goal was to redistribute the flow of capital away from individuals and businesses the executive branch found to be unaligned with the politics of the contemporaneous administration.       

Congress needs to codify prohibitions against regulatory coercion, also known as “Operation Choke Point.” Rep. Blaine Luetkemeyer (R-Mo.) and Sen. Ted Cruz (R-Texas) introduced legislation several times to codify protections against regulatory abuse. The same language could also apply to state regulators. For too long regulators have pressured banks to adopt governance policies that promote DEI/ESG and dictate certain lines of business. This legislative solution nips the problem in the bud. 

Regulators use the opaque bank examination process to coerce bank activity. Bank examiners use the six-pronged rating system of “capital adequacy, asset quality, management, earnings, liquidity, and sensitivity” (CAMELS) to rate banks’ risk. The “management” metric imposes governance mandates on banks. Bank examiners should be prohibited from considering the “management” factor and any immaterial risks. Examiners should only focus on material financial risks. Focusing on nebulous governance issues steers examiners away from material financial risks such as the risk of not accounting for a steep increase in interest rates and its effect on bond prices. Regulators’ excessive concern with immaterial governance standards largely contributed to their failure to expressly identify and ameliorate material financial risks at Silicon Valley Bank (SVB).  

Anti-Money Laundering and State Laws

In addition to bank examinations, federal statute is also impeding banking services. While well-intentioned, certain provisions of federal anti-money laundering (AML) statute are turning into roadblocks for bank customers. Federal law prohibits banks from acknowledging the existence of suspicious activity reports (SARs). The Treasury Department’s Financial Crimes Enforcement Network (FinCEN) requires banks to file SARs in instances where there is potential suspicious activity that might augur illicit activity, or if an account owner authorizes a transaction exceeding $10,000. This creates a disconnect between banks and customers if a customer account is frozen or shut down without any explanation. Lawmakers need to amend statute and implement regulations to prevent FinCEN from prohibiting banks from revealing the existence of a SAR. Language could be drafted that allows banks to confidentially explain to customers why an account has been frozen or closed. While combatting terrorist financing and other illicit activity is important, the status quo is inciting significant friction between banks and some of their customers. 

National Banks and Federal Preemption 

Certain state laws dictate how banks manage their accounts, which interferes with a bank’s ability to exercise normal business operations. Impeding a national bank’s business operations is a legal standard that stems from Barnett Bank of Marion County, N.A. v. Nelson and is codified in Section 1044 of the Dodd-Frank Act. According to Dodd-Frank, state law will be preempted if it “prevents or significantly interferes with the exercise by the national bank of its powers.” That said there needs to be “substantial evidence” that state consumer financial laws are impeding a bank’s operations as outlined in Barnett if the Office of the Comptroller of the Currency (OCC) is to successfully invalidate the state law. If a bank is forbidden from terminating or suspending an account even though there may be AML concerns, this could be perceived or even found to be impeding the “business of banking.” 

Dodd-Frank appears to allow state consumer financial laws to apply to a national bank’s subsidiary or affiliate unhindered. However, if the subsidiary or affiliate is chartered as a national bank then federal law preemption may apply. The application of state laws will depend on the type of bank to which it applies. If a subsidiary or affiliate is not chartered as a national bank, then it is likely state laws would not be preempted.   

Existing state laws may contradict federal case law. One court ruling out of the D.C. Circuit Court of Appeals found that unsafe and unsound practices only apply to activities “that threaten the financial integrity of the” bank. The unsafe practice “must pose an abnormal risk to the financial stability of the banking institution.” Anything else is negligible, and in the eyes of the law does not fall under what is considered unsafe or unsound for the purposes of filing an enforcement action. While it is unethical, immoral, and reprehensible to freeze, or close bank accounts based on social, religious, or environmental issues, it is not likely to constitute an activity that poses an “abnormal risk” to a bank’s financial stability and thus, as a matter of common law, may not be considered an unsafe or unsound practice. Impartiality with regard to managing customer accounts is of paramount importance. 

Conclusion

Instead of targeting banks, policymakers need to hold regulators accountable. The correct policy approach is codifying protections against regulatory pressure on banks. The root of the problem is unelected bureaucrats tinkering with banks’ operations and through the opaque bank examination process pressuring them to amend governance standards. Legislation is desperately needed to rein in the administrative state and to prevent accounts from being arbitrarily shut down. Codifying prohibitions against “Operation Choke Point” activities and amending federal AML statute should be lawmakers’ primary focus.