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Senate Banking Committee Hearing on Banking Agency Regulation and Supervision

Senate Banking Committee

“Guidance, Supervisory Expectations, and the Rule of Law: How do the Banking Agencies Regulate and Supervise Institutions?”

Tuesday, April 30, 2019

Key Topics & Takeaways

  • Guidance: Baer said that BPI has typically engaged in notice and comment rulemaking regarding things that matter to them. He added that agencies treating guidance as a binding requirement is the wrong approach, and there should be clarity from the Fed to what citation means regarding to MRA and whether guidance previously issued will serve as a basis of grandfathering MRAs. Baer added that bank relationships with regulators is unique and the informal process is leading to the level of enforcement becoming one sided, preventing bank expansion.
  • MRA: Baer said that much of the MRA information is kept secret and prevents adequate examination of violations. Baer said BPI’s concerns are not around MRAs being based on the violation of the law, but rather the lack of clarity from the Fed on guidance regulation regarding binding and citations without adequate reports to review. Tahyar recommended that agencies make more (necessary) information public for scholars to further study the matter.
  • Appeals Process: Baer recommended members further study the appeals process and suggested a neutral arbitrator to avoid retaliation from agencies should be implemented in the appeals process, considering many appeals do not go anywhere because they are filed to the institution that made provided guidance. He also mentioned the close work between the ombudsman and banks prevents appeals from going further. Tahyar said an ombudsman with real power, acting independently, would be a helpful step in the process, and right now the process is limited in a path forward for appeals. She said there is a clear need for transparency, while maintaining an appropriate and systematic appeals system. McCoy said current regulators are working to reduce the current number of appeals and it is important to educate and train examiners on the proper use of MRAs. She said Baer’s proposals are impractical to make MRAs part of the notice and comment process and said an empowered ombudsman would be a good idea.

Witnesses

Opening Statements

Chairman Mike Crapo (R-Idaho), Senate Banking Committee

Crapo said in many cases the nature and trust between supervisors and institutions are informal and confidential, but that as these relationships grow it is leading to cases where banks are not complying with rules and other times supervisors are making inappropriate verbal commitments to banks. He said this has led to Congress exercising its authority to utilize the Congressional Review Act (CRA) but that it is broad in scope, especially in cases of guidance, and expressed his concern of certain agencies trying to give legal effect to general legislative statements and policies to circumvent the advice and consent procedures. He referenced a memo issued by the Office of Management and Budget (OMB) to reinforce agency obligations under the CRA and compliance across the Executive branch to prevent abuse of power. Crapo referenced Operation Choke Point under the Obama administration and said such inappropriate behavior should be curtailed through increasing transparency and accountability efforts in the supervisory process.

Ranking Member Sherrod Brown (D-Ohio), Senate Banking Committee

Brown said the need for guidance is necessary for banks to comply with a variety of laws and that the big banks “love” guidance to prepare for stress tests, to continue lending to regions hit with disasters, to trade derivatives with foreign banks, and to know how to use their capital. He said they “hate” guidance that curtails laws which help them exploit and hurt their customers, which benefit people of color being able to seek automobile loans, for regulators to keep tabs on Wall Street, and prevent them from offering risky leverage loans. Brown said Republican efforts to repeal issued guidance, support to take it “easy” on big banks, and to meddle with the independence of agencies from the Executive branch will lead to the entire country suffering from the lack of guidance.

Testimony

Greg Baer, President and CEO, Bank Policy Institute (BPI)

In his testimony, Baer said his focus would be on three parts: 1) examination of matter requiring attention (MRA) reports becoming enforcement action tools and being treated as binding; 2) the basis of MRAs to support supervisory efforts for guidance of unwritten rules rather than leading to a violation of the law occurring; and 3) examining mandates to combat a growing shadow enforcement regime post-2008, which subjects firms to limitations of growth and expansion after violations for policies not approved by Congress. He noted his concern that the basis of MRAs have become focused on how banks handle their vendors, monitor transactions, update models or spreadsheets, or structure reporting lines rather than focusing on capital or liquidity, as well as there being an unclear guideline for safeness and soundness for bank operations. Baer also said that often banks who fail to comply are subject to stricter expansion rules than any other industry. He recommended that: 1) the banking agency should grant BPI’s petition that guidance is not binding and that MRA use should occur on the basis of unsafe and unsound banking practices; 2) to better define what an MRA is; 3) zero based review of the application process should be undertaken to clarify what factors are relevant; and 4) the CAMELS rating system should be rethought entirely and the Fed’s recently adopted thoughtful revision of the holding system could be the model used. Baer said Congress did not pass the Administrative Procedures Act to be a blow to the independency of agencies but to have rules in place to have an informed, transparent process, open for scrutiny.

Margaret Tahyar, Partnet, Davis Polk & Wardwell LLP

In her testimony, Tahyar said many of the U.S. sectors of the economy are well regulated and the banking sector is the only one that is supervised, creating a need for an open, public legal framework to govern the sector. She said there has been a long, uneasy rift between the transparency of the legal and supervisory frameworks, and that confidential matters shield supervisors from being held accountable, restricting the necessary information for studying to be public. Tahyar had three recommendations: 1) regulations regarding confidential supervisory information should be updated and narrowed to minimum need, especially regarding first principles relationships between zone of secrecy to securities loans; 2) there is need to address moral suasion, MRA, and horizontal review of the expansions of secrecy and discretion in the existing shadow regulatory system; and 3) Congress and banking agencies should rethink the training and legal infusion of supervisory staff as the rise of compliance issues continue to focus on governance and understand MRAs. She said Federal Reserve Vice Chairman for Supervision Randy Quarles and Federal Deposit Insurance Corporation (FDIC) Chairman Jelena McWilliams have taken “strong” steps to support these efforts of transparency, adding that training should be expanded into core modules that regulates governance of the State and should be content neutral in the education process.

Patricia McCoy, Professor of Law, Boston College Law School

In her testimony, McCoy said banking regulations need more transparency and said the other panelists’ recommendations for using CRA or notice and comment would result in less transparency. She said banking regulators issue guidance to provide more transparency and there is a need to shed light on agency supervisory perspectives, priorities and concerns. McCoy said guidance makes agency decisions more predictable and helps reduce risks, and that many firms have vocalized their support for guidance. McCoy continued that agencies get critiqued for unnecessarily penalizing third-parties for violating compliances but that it is unclear how often this occurs. She said normally agencies are addressing violations for notice and comment rules and unsafe or unsound practices, not guidance, and referenced recourse tools such as litigation for invalidating binding guidance, meeting privately with federal regulators to file complaints and formally appeal adverse compliance findings or seeking judicial review to contest enforcement actions for occurrences of violations of guidance. McCoy said agency guidance should look at preventing imposing high hurdles such as CRA oversight or notice and comment periods, which would delay the process and “badly” hurt financial institutions. She said agencies would respond by turning binding to unbinding guidance and could even stop issuing guidance all together. McCoy said regulators have the responsibility to enforce statutes and rules, which firms would still have to comply with, but without any guidance on how to follow them, which could result in less compliance for banking laws and lead to another pre-2008 regime.

Question & Answer

Guidance

Sens. Pat Toomey (R-Pa.), Catherine Cortez Masto (D-Nev.) and Brown asked questions regarding  guidance that is binding and the supervision process. Baer responded that BPI has typically engaged in notice and comment rulemaking regarding things that matter to them. He added that agencies treating guidance as a binding requirement is the wrong approach, and there should be clarity from the Fed to what citation means regarding to MRA and whether guidance previously issued will serve as a basis of grandfathering MRAs. Baer added that bank relationships with regulators is unique and the informal process is leading to the level of enforcement becoming one sided, preventing bank expansion.

MRA

Sens. Crapo, Toomey, and Cortez Masto asked about MRA compliance and violation of the laws. Baer responded that much of the MRA information is kept secret and prevents adequate examination of violations. Baer said BPI’s concerns are not around MRAs being based on the violation of the law, but rather the lack of clarity from the Fed on guidance regulation regarding binding and citations without adequate reports to review. Tahyar recommended that agencies make more (necessary) information public for scholars to further study the matter.

 

Appeals Process

Sens. Thom Tillis (R-N.C.), Jerry Moran (R-Kan.) and Toomey asked about creating an effective and consistent appeals process and making further recommendations to agencies for rulemaking. Baer recommended members further study the appeals process and suggested a neutral arbitrator to avoid retaliation from agencies should be implemented in the appeals process, considering many appeals do not go anywhere because they are filed to the institution that made provided guidance. He also mentioned the close work between the ombudsman and banks prevents appeals from going further. Tahyar said an ombudsman with real power, acting independently, would be a helpful step in the process, and right now the process is limited in a path forward for appeals. She said there is a clear need for transparency, while maintaining an appropriate and systematic appeals system. McCoy said current regulators are working to reduce the current number of appeals and it is important to educate and train examiners on the proper use of MRAs. She said Baer’s proposals are impractical to make MRAs part of the notice and comment process and said an empowered ombudsman would be a good idea.

Independence

Sens. Brown and Cortez Masto asked about the Office of Information and Regulatory Affairs (OIRA) and OMB’s actions in the regulatory process. McCoy said she believes OIRA is working towards a “power grab” to directly affect the independence of the regulatory agencies and the Executive branch. She said Congress closed off the independence of the banking regulators to create stability from the Executive branches short-term decision-making process and Congress provides the oversight for this process. McCoy said there is no statutory language that allows OIRA or OMB oversight to any of the regulators, and it should remain this way.

Operation Choke Point

Sen. Crapo asked about reputational risk and deterring financial institutions from lending to certain markets as displayed in Operation Choke Point to provide more transparency. Tahyar responded that reputational risk cannot be found in any statutes, and concerns revolve around examining personal preferences in the examination process. She said there need to be consistent and economically sound and transparent decisions. McCoy said there are multiple layers when it comes to making enforcement decisions, such as the Consumer Financial Protection Bureau (CFPB) director being able to review decisions. She said many enforcement actions are public but many agencies are careful to ground those enforcement actions on violations of statues, legislative rules, unsafe or unsound practices.

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