[Senate Hearing 116-25]
[From the U.S. Government Publishing Office]
S. Hrg. 116-25
GUIDANCE, SUPERVISORY EXPECTATIONS, AND THE RULE OF LAW: HOW DO THE
BANKING AGENCIES REGULATE AND SUPERVISE INSTITUTIONS?
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED SIXTEENTH CONGRESS
FIRST SESSION
ON
EXAMINING HOW BANKING AGENCIES SUPERVISE AND REGULATE FINANCIAL
INSTITUTIONS, HOW REGULATED INSTITUTIONS INTERACT WITH THEIR
REGULATORS, AND THE CONGRESSIONAL REVIEW ACT AND THE SCOPE OF ITS
APPLICABILITY TO AGENCY STATEMENTS OF POLICY
__________
APRIL 30, 2019
__________
Printed for the use of the Committee on Banking, Housing, and Urban Affairs
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Available at: https: //www.govinfo.gov /
______
U.S. GOVERNMENT PUBLISHING OFFICE
35-540 PDF WASHINGTON : 2019
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
MIKE CRAPO, Idaho, Chairman
RICHARD C. SHELBY, Alabama SHERROD BROWN, Ohio
PATRICK J. TOOMEY, Pennsylvania JACK REED, Rhode Island
TIM SCOTT, South Carolina ROBERT MENENDEZ, New Jersey
BEN SASSE, Nebraska JON TESTER, Montana
TOM COTTON, Arkansas MARK R. WARNER, Virginia
MIKE ROUNDS, South Dakota ELIZABETH WARREN, Massachusetts
DAVID PERDUE, Georgia BRIAN SCHATZ, Hawaii
THOM TILLIS, North Carolina CHRIS VAN HOLLEN, Maryland
JOHN KENNEDY, Louisiana CATHERINE CORTEZ MASTO, Nevada
MARTHA MCSALLY, Arizona DOUG JONES, Alabama
JERRY MORAN, Kansas TINA SMITH, Minnesota
KEVIN CRAMER, North Dakota KYRSTEN SINEMA, Arizona
Gregg Richard, Staff Director
Joe Carapiet, Chief Counsel
Catherine Fuchs, Professional Staff Member
Laura Swanson, Democratic Deputy Staff Director
Elisha Tuku, Democratic Chief Counsel
Corey Frayer, Professional Staff Member
Cameron Ricker, Chief Clerk
Shelvin Simmons, IT Director
Charles J. Moffat, Hearing Clerk
Jim Crowell, Editor
(ii)
C O N T E N T S
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TUESDAY, APRIL 30, 2019
Page
Opening statement of Chairman Crapo.............................. 1
Prepared statement........................................... 23
Opening statements, comments, or prepared statements of:
Senator Brown................................................ 3
Prepared statement....................................... 24
WITNESSES
Greg Baer, President and Chief Executive Officer, Bank Policy
Institute...................................................... 5
Prepared statement........................................... 25
Responses to written questions of:
Senator Brown............................................ 58
Senator Cortez Masto..................................... 59
Margaret E. Tahyar, Partner, Davis Polk and Wardwell LLP......... 6
Prepared statement........................................... 36
Responses to written questions of:
Senator Cortez Masto..................................... 59
Senator Sinema........................................... 60
Patricia A. McCoy, Professor of Law, Boston College Law School... 8
Prepared statement........................................... 48
Responses to written questions of:
Senator Warren........................................... 61
Senator Cortez Masto..................................... 64
Additional Material Supplied for the Record
Letter submitted by CBA.......................................... 68
Letter submitted by CUNA......................................... 70
(iii)
GUIDANCE, SUPERVISORY EXPECTATIONS, AND THE RULE OF LAW: HOW DO THE
BANKING AGENCIES REGULATE AND SUPERVISE INSTITUTIONS?
----------
TUESDAY, APRIL 30, 2019
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:01 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. Mike Crapo, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN MIKE CRAPO
Chairman Crapo. The Committee will come to order.
Today the Committee will turn its focus to guidance,
supervisory expectations, the rule of law, and how banking
agencies regulate and supervise institutions.
Banks receive significant forms of Government support and
benefits, including deposit insurance and access to the Fed's
discount window.
In exchange for these benefits, which ensure that American
consumers have stable access to their deposits, banking
agencies supervise banks and in return expect them to operate
in a safe and sound manner.
The nature of the supervisory process and the need for
trust between the supervisor and the supervised institution
means that sometimes supervisory expectations are communicated
in an informal and confidential manner between the supervisor
and the supervised institution, which can be appropriate in
certain circumstances, especially when protecting confidential
supervisory information.
With that being said, there appears to be a number of
situations where the banking agencies have enacted guidance or
other policy statements that are being enforced as rules and
therefore do not comply with notice-and-comment rulemaking
processes and do not comply with the Congressional Review Act.
In addition, there are a number of situations where
supervisors make verbal ``recommendations'' to banks that are
inappropriate given the tremendous power supervisors have over
banks.
All rulemaking authority at the banking agencies derives
from authority delegated to the banking agencies by Congress,
which means Congress has the authority to disapprove any rule a
banking agency enacts.
In addition to the absolute authority Congress has to
disapprove any agency action, Congress enacted the CRA in 1996
to provide Congress with an expedited process to disapprove
agency rules.
Under the CRA, before a rule can take effect, agencies must
submit it to Congress for review.
Congress then has 60 days to disapprove the rule with a
majority vote.
A rule is defined, with a few exceptions, as ``the whole or
a part of an agency statement of general or particular
applicability and future effect designed to implement,
interpret, or prescribe law or policy or describing the
organization, procedure, or practice requirements of an
agency.''
That is a very broad definition.
The CRA applies to more than just notice-and-comment rules.
It encompasses a wide range of other regulatory actions,
including, among others, guidance documents, general statements
of policy, and interpretive rules.
Even though the text itself is clear about the broad scope
of what constitutes a rule, during the floor debates leading up
to the passage of the CRA, then-Senator Reid reinforced this
point and said: ``[t]he authors are concerned that some
agencies have attempted to circumvent notice-and-comment
requirements by trying to give legal effect to general
statements of policy, guidelines,' and agency policy and
procedure manuals. The authors admonish the agencies that the
APA's broad definition of rule' was adopted by the authors of
this legislation to discourage circumvention of the
requirements'' of it.
Too often we see banking regulators implementing policy
through guidance and other informal means without following the
requirements in the CRA.
For instance, some in the agencies may argue that guidance
is not binding, but as a practical matter, supervised
institutions and supervisors know that informal guidance and
other communications between supervised institutions and
supervisors change behaviors within institutions.
Legal departments at the banking agencies often assert that
guidance is nonbinding, but the language the supervisors at the
agencies use often suggest that supervisors treat guidance as
binding and expect supervised institutions to treat it as
binding.
Actions like this within agencies are problematic and
require congressional oversight, including by ensuring banking
agencies comply with the CRA.
Recognizing the importance of agencies complying with the
CRA, Acting Director of the Office of Management and Budget
Russell Vought issued a memorandum recently, which ``reinforces
the obligations of Federal agencies under the CRA in order to
ensure more consistent compliance with its requirements across
the executive branch and sets forth guidelines for analysis
that the Office of Information and Regulatory Affairs will use
to properly classify regulatory actions for purposes of the
CRA.''
This memorandum is a step in the right direction.
The abuse of Government and agency power should not be a
partisan issue, and no Administration or agency should be able
to use their powers to influence the private market wrongly.
I continue to encourage the regulators to follow the CRA
and to submit all rules to Congress, even if they have not gone
through a formal notice-and-comment rulemaking.
In addition, I encourage the banking regulators to provide
more clarity about the applicability of guidance and ensure
that supervisors throughout the agencies--especially outside of
Washington, DC--know about how guidance should be treated and
do not inappropriately use their significant discretion.
As a final note, during the Obama administration, I fought
against Operation Choke Point, an initiative in which Federal
agencies pressured banks to ``choke off'' politically
disfavored industries' access to payment systems and banking
services.
Operation Choke Point initially began in the supervisory
process. Operation Choke Point was inappropriate and
demonstrates why supervisory staff at the agencies need to be
transparent and accountable.
I look forward to hearing from each of our witnesses on
their views as to what can be done to ensure that there is
greater transparency and accountability in the supervisory
process.
Senator Brown.
OPENING STATEMENT OF SENATOR SHERROD BROWN
Senator Brown. Thank you, Mr. Chairman.
This is a hearing to talk about guidance, the nonbinding
advice from Federal agencies that is supposed to make it easier
for the banking industry to follow the rules.
There is a reason we have lots of banking laws. It is a
complicated industry that affects everyone's lives with a great
deal of potential for special interests to do a whole lot of
harm. It takes a lot of oversight to prevent terrorist
financing and to protect consumers and to stop discrimination
in lending and to keep Wall Street from taking down the economy
again.
Banks need guidance to help them comply with those laws. In
fact, industry begs for guidance all the time, so why this
hearing? Why hold this hearing at all? The same reason we
always seem to have hearings in this town: to make things a
little bit easier for Wall Street.
We know that this hearing is not actually about making it
easier for big banks to follow the rules, that it is really
about making it easier for big banks to get around the rules.
It is about what kind of guidance the industry wants and the
kind of guidance it does not want.
Big banks love guidance that makes it easier to trade
derivatives with big foreign banks. Big banks love guidance
that tells them how to track their capital or how to prepare
for stress tests. I hear that all the time. Big banks love
guidance that makes sure they can keep lending when a town is
hit by floods or wildfires.
The guidance that big banks hate, though, the guidance we
are actually talking about at this hearing today, is the kind
that makes it easier for them to skirt the laws or take
advantage of their consumers. And as usual, Wall Street has
plenty of Senators lining up to help them every single time.
Big banks hate guidance that explains how regulators are going
to enforce the laws, the laws that say you cannot discriminate
against people of color. They hated that one so much they
persuaded darn near every Republican to help them repeal it.
Guidance had never been repealed before, as we know, but
Republicans used the Congressional Review Act to repeal
instructions from the consumer protection agency that would
have made it harder for auto dealers to charge people of color
more for car loans.
Big banks also hate guidance that says they should be
cautious about risky leveraged loans that might crash the
economy. They hate it because it cuts into the huge fees they
were getting for making these types of loans to corporations.
And they really hate guidance that explains how the regulators
are going to keep tabs on Wall Street.
Last week, Senator Tillis, a Member of this Committee, sent
a letter to the GAO to start the process of having Congress
step in and tell regulators to take it easy on the largest
banks in the country.
Two weeks ago, the Office of Management and Budget
announced they want the President to have direct influence over
the guidance that independent banking agencies put out. That
means the President can lean over to his Acting--or maybe he is
not acting anymore--Chief of Staff Mick Mulvaney, who is also
the head of the OMB, who also, as we know, is head of the CFPB,
and in some sense still is, and tell independent agencies--the
President can lean over and tell Mulvaney and tell independent
agencies what we do--what they should do, and they saw how Mick
Mulvaney ran the CFPB.
These agencies are supposed to be independent for a reason.
We know how corporate special interests spread their influence
around in this town. The agencies policing Wall Street are
supposed to be independent to guard against that influence. But
now the same President, whose Cabinet looks like a Wall Street
executive retreat, wants to meddle--although ``meddle'' is
probably an understatement. Remember S. 2155, the bill that
gutted many of the rules for the biggest banks in the country
and the foreign megabanks. Right in that bill, in Section 109,
the bill that Chairman Crapo wrote and skillfully shepherded to
the floor, that President Trump signed into law, Congress
instructed the CFPB to give guidance on filling out mortgage
forms. Republicans demanded, they insisted, they fought for
language instructing agencies to give more guidance. This is
the kind of guidance they pretend to be opposed to today. This
hearing is not about guidance. It is about getting rid of the
rules that Wall Street does not want to follow, and as everyone
knows, everyone except Republicans on the Senate Banking
Committee, as everyone knows, the whole country will end up
paying for it.
Thank you, Mr. Chairman.
Chairman Crapo. Thank you, Senator Brown.
Today our witnesses are Greg Baer, president and CEO of the
Bank Policy Institute; Margaret Tahyar, partner at Davis Polk
and Wardwell; and Patricia McCoy, professor of law at Boston
College Law School.
I would like to inform our witnesses that their written
testimony has been included in the record. I encourage you to
follow the 5-minute guideline so we can have time for our
questions and your oral remarks, and we will proceed in the
order I introduced you. Mr. Baer, you may proceed.
STATEMENT OF GREG BAER, PRESIDENT AND CHIEF EXECUTIVE OFFICER,
BANK POLICY INSTITUTE
Mr. Baer. Chairman Crapo, Ranking Member Brown, my name is
Greg Baer, and I am CEO of the Bank Policy Institute. I am here
to testify today about how legal process has broken down in the
regulation and examination of banks. I will not focus on the
substance of postcrisis requirements but, rather, on a process
that has prevented the public--not only banks but also their
customers, academics, and even Members of Congress--from
learning what many of those requirements are and having a say
in their content.
The breakdown has three parts:
First, examination reports have effectively turned into
enforcement actions, as their mandates--specifically, Matters
Requiring Attention, or MRAs--are treated as binding orders. By
law, an examination report is not binding. Make no mistake,
however. The banking agencies take the position that MRAs must
be remediated. So, too, do bank compliance teams. This is
significant because the volume of MRAs is extreme. Between the
OCC and the Fed, at any given time over the past 10 years,
there have been between 8,000 and 20,000 MRAs outstanding. Each
could be viewed as a quasi-enforcement order. Each under agency
rules is also secret, and bankers are subject to criminal
penalties for discussing or complaining about them publicly.
Notably, many of these, if not most of these MRAs, have not
focused on capital and liquidity, the core rules that protect
taxpayers. They are, rather, on matters such as how banks
manage their vendors, update models or spread sheets, structure
reporting lines, or monitor transactions.
Second, the basis for those MRAs frequently has not been a
violation of law but, rather, of guidance or unwritten rules.
Postcrisis the agencies have generally avoided notice-and-
comment rulemaking in favor of a massive volume of guidance in
the form of supervisory letters, bulletins, and circulars.
Guidance also includes examination handbooks and even
enforcement actions, which are read to bind all banks.
In other cases, MRAs are not even based on guidance but
simply examiner preference. Asked for the legal basis for such
actions, examiners generally cite ``safety and soundness.''
Indeed, they do so increasingly, as the law has recently become
clearer that guidance is, in fact, not binding.
But ``safety and soundness'' must be shorthand for an
``unsafe and unsound banking practice,'' which is defined in
the case law as referring only to ``practices that threaten the
financial integrity of the institution.'' That is a high bar.
The vast majority of MRAs likely fail to meet that standard.
Third, these examination mandates must nonetheless be
obeyed because a shadow enforcement regime has grown up
postcrisis whereby a firm with unresolved MRAs is potentially
subject to limitations on its growth, limitations never
authorized by Congress. That is why banks have diverted
extraordinary resources to comply with mandates that are often
immaterial to their safety and soundness and against their
better judgment.
For a perspective on how odd this new enforcement regime
is, consider that we routinely see compliance violations across
American industries. Those companies are appropriately required
to pay fines and remediate their practices, but no one suggests
that they should be stopped from opening new franchises,
building new plants, developing new drugs, designing new cars,
or launching new apps. Yet in banking, regulators often
prohibit any type of expansion by the bank as a reaction to a
compliance failure.
How could this be improved?
First, the banking agencies should grant the petition filed
by the Bank Policy Institute and the ABA and confirm what they
have already said in a recent statement: that guidance is not
binding and that only a violation of law (including an unsafe
and unsound practice) can be the basis for an MRA. This step is
necessary because by numerous accounts their earlier statement
has been ineffective.
Second, more broadly, the agencies should seek public
comment on what an MRA is.
Third, a zero-based review of the application process
should be undertaken to clarify what factors are relevant.
Fourth, the CAMELS rating system should be rethought
entirely. The Federal Reserve has recently adopted a thoughtful
revision of holding company ratings which could serve as a
model.
In closing, Congress did not enact the Administrative
Procedure Act as a sop to regulated entities or a blow to the
independence of agencies but, rather, out of a genuine and
well-founded belief that rules are better made when they are
informed by an open process and not as well made when they are
made in secret, without fear of public scrutiny or challenge.
That spirit should be reinjected into the bank examination
process.
Many thanks for the opportunity today.
Chairman Crapo. Thank you, Mr. Baer.
Ms. Tahyar.
STATEMENT OF MARGARET E. TAHYAR, PARTNER, DAVIS POLK AND
WARDWELL LLP
Ms. Tahyar. Thank you very much for inviting me here today.
Many sectors of the economy today are regulated, but only
the banking sector is also supervised. The legal framework
governing the banking sector is open and public. You might
agree or disagree with the policy choices, but they are open to
all. Supervision happens behind closed doors and involves
discretionary actions. The secrecy has traditionally been
justified by financial stability or safety and soundness. There
has long been an uneasy truce between the transparency required
by the rule of law and the secrecy of supervision.
That uneasy truce has become untenable. One canary in the
coal mine is the increase in leaks of confidential supervisory
information. The canary is warning us about changed social
expectations around transparency.
I know that the supervisory staff is made up of men and
women of good faith doing a tough job, but it matters that
confidential supervision can be a shield that makes it more
difficult to hold the supervisors accountable. The public,
congressional oversight committees, scholars, and others have
limited information about the work of the supervisors. Should
they be praised or criticized? Nobody knows. The public debate
and academic scholarship is critically underinformed.
As Minsky noted, ``Perfection is out of the question, but
better is possible.'' So I have three suggestions. I hope, I
dare to hope, they might be bipartisan.
First, the regulations governing confidential supervisory
information should be updated. They were put in place in the
1960s. That is a long time ago. They are not fit for the
digital age. It should be narrowed to the minimum necessary for
financial stability. There should be a serious reexamination
from first principles of the relationship between the zone of
secrecy and the securities laws.
One thing is certain. Whatever changes are made should be
done on a systemic basis. Right now the practical reality is we
have a system where some banks sometimes are subject to leaks
and disclosures and others are not.
Second, there has been an expansion, a vast expansion in
the zone of secrecy and discretion. Social and economic policy
choices that affect jobs and credit are being made in a shadow
regulatory system. These include moral suasion, MRAs, and
horizontal reviews. The concept of secret law in a democracy is
on shaky ground. We have recently seen strong steps in the
right direction from Vice Chair Quarles and Chairman
McWilliams. These steps should be supported.
Third, Congress and the banking agencies should rethink the
training of supervisory staff. The rise in compliance with law
exams, the focus on governance, and the increase in violation
of law MRAs all mean that staff are making more judgments that
are legally infused. And yet as the zone of secrecy and
discretion has widened, it has increasingly become delinked
from the legal framework. I recommend that training for the
supervisory staff should be expanded to include core modules on
the Constitution, the separation of powers, congressional
oversight, the rule of law, and due process--essentially the
legal framework that governs the regulatory State.
I believe that the time has come for a rebalancing in favor
of more transparency, accountability, and observance of the
rule of law, and I believe that regardless of the policy
choice, regardless of whether you are thinking about Wall
Street banks or consumers. I believe it content neutral.
We need to get this balance right now because we are moving
to a digital age, and if the legal framework, due process, and
the rule of law are not in the supervisory culture, they won't
make it into the technology and the algorithms. Cultural change
is hard. I suspect that both banks and supervisors might be a
little uncomfortable with what I am saying today, but if,
however, the changes I recommend are made and there is a little
discomfort on both sides, I think the balance might be moving
in the right direction.
We should not jettison confidential supervision, but we
ought to reform it for the 21st century digital age. Thank you
very much.
Chairman Crapo. Thank you, Ms. Tahyar.
Ms. McCoy.
STATEMENT OF PATRICIA A. MCCOY, PROFESSOR OF LAW, BOSTON
COLLEGE LAW SCHOOL
Ms. McCoy. Chairman Crapo, Ranking Member Brown, and
Members of the Committee, thank you for inviting me here today
to talk about guidances and supervision.
My colleagues have argued that banking regulation needs
more transparency. They have singled out guidances as an
offender in that regard. In the interest of transparency,
proposals are on the table to put guidance through notice and
comment and routine congressional act review. Today I argue
that that would backfire and result in less transparency, not
more.
In fact, Federal bank regulators issue guidances because
they want to provide transparency, not because they have to.
Guidances help financial institutions navigate the thicket of
Federal banking statutes and rules. Firms find guidances
valuable because they shed light on agencies' supervisory
perspectives, priorities, and concerns. Guidances make agency
decisions more predictable and reduce compliance risk. For
these reasons, financial providers want guidance, and they
vocally request it. I have cited in my testimony quotations
from financial trade associations to that effect.
Despite the benefits of guidances, agencies are sometimes
criticized for penalizing third parties for failure to comply
with them. How often this occurs is unclear. Normally, agencies
base adverse actions on violations of statutes, notice-and-
comment rules, unsafe or unsound practices, or UDAP laws, not
on guidances. However, if financial institutions are ever
penalized for violating guidances, they already have ample
recourse. They can sue to invalidate binding guidances for
failure to provide notice and comment under the APA. They can
and do meet privately with Federal bank regulators to lodge
complaints. They can ask the agency ombudsman to help resolve
any problem. They can formally appeal adverse examination
findings. And they have the right to judicial review to contest
enforcement actions based on guidance violations.
The question is, more specifically, should agency guidance
go through notice and comment and Congressional Review Act
oversight? Let me cut to the chase. Imposing higher hurdles on
the adoption of agency guidance would badly hurt financial
institutions and the financial system. Normally, fast-track
notice and comment takes 2 years, and many rulemakings take
longer. CRA review prolongs this process further.
Agencies might respond by turning nonbinding guidances into
binding rules. That would just increase companies' legal risk.
Alternatively, agencies might stop issuing guidances
altogether. They would be under strong internal pressure to do
so given the daunting staffing and budgetary challenges of a
vast increase in notice-and-comment requirements.
Is this what companies really want? Federal bank regulators
have statutory responsibility to enforce the statutes and rules
under their jurisdiction. If agencies stopped issuing
guidances, they would still be responsible for enforcing those
statutes and rules, and firms would still have to comply with
them. But in the meantime, companies would lack guidance about
agency interpretations or about how to comply. This would
result in less transparency, not more. This would leave
financial firms to fend for themselves and might well produce
the ``regulation by enforcement'' that they intensely dislike.
Moreover, companies would not be able to get quick
responses to their implementation questions due to onerous
notice-and-comment requirements. The result, unfortunately,
might be less compliance with banking laws. We went down this
road before pre-2008. It is not a risk that we can ever take
again. Moreover, GAO has repeatedly criticized Federal bank
regulators for not citing violations and for failing to require
their remediation.
Thank you.
Chairman Crapo. Thank you very much, Ms. McCoy.
I will start my questioning with you, Mr. Baer. Your
association, along with the ABA, recently petitioned the
banking agencies to engage in a rulemaking clarifying the role
of supervisory guidance, to codify, to ask the agencies to
codify their recent interagency statement clarifying the role
of supervisory guidance, and in that process to clarify that
MRAs, MRIAs, and other supervisory action should be based on a
violation of statute or regulation, not on a failure to comply
with a supervisory guidance.
Can you explain why a rulemaking will help provide clarity
in the regulated institutions?
Mr. Baer. Yes, Mr. Chairman. We commend the banking agency
for the statement that they did issue. They stated in their
statement that guidance was not binding, could not form the
basis for an MRA, and, furthermore, that an MRA needs to be--
well, that a citation by an examiner needs to be based on a
violation of law. I think that was all very good.
It turns out, though, that I think there has been a lot of
confusion about that statement. Some have read citation to mean
MRA; some have not. There are, I think, numerous reports that
it is not really being observed in the field. And so really all
we have asked the agencies to do is to formalize in regulation
what we believe they have already said in a statement, which,
of course, is guidance and, therefore, nonbinding itself. But
all we have asked them to do is put into regulation what they
have already said through guidance.
Chairman Crapo. All right. Thank you. And for Ms. Tahyar,
picking up on the topic of transparency, there is concern that
the use of guidance is really just a substitute or a work-
around for the notice-and-comment rulemaking standard set in
statute. The lack of transparency around regulators'
supervisory activities makes it difficult to decipher when
regulators use the threat of supervisory actions that
constitute confidential supervisory information against
institutions punitively and when they use it for legitimate
safety and soundness purposes.
For instance, as I mentioned in my introductory comments,
in Operation Choke Point Federal regulators used informal
communications to express concerns about services to industries
engaged in what they called ``high-risk activities'' to
pressure banks to cutoff services to lawful businesses engaged
in politically disfavored industries, and they openly admitted
that that was exactly what they were doing.
The question I have is: In this regard, can you discuss
your concern around the concept of reputational risk and the
use of this concept to deter financial institutions from
lending to certain markets as displayed during Operation Choke
Point?
Ms. Tahyar. Reputational risk, like supervision, isn't in
any statute anywhere. I think the concerns that arise when
supervisors within the confidential exam process express
examiner preferences either around banking services to a sector
or their own concerns--and these concerns may be done in the
field and not in Washington, so there may not be consistency--
around how supposed violations of law or other economic choices
take place. All of this is happening behind closed doors, and
all of it is happening--you know, some guidance is subject to
notice and comment. Much guidance is public. Some guidance is
major and some isn't. And, of course, the banking sector likes
guidance. But it is the closed-door aspect of the economic
choices that are being made, and in my view, these need to come
out into the open.
I hope I have answered your question.
Chairman Crapo. Thank you.
Ms. McCoy, could you respond to the same question? The
general issue is the utilization of non-rulemaking or non-
statutory standards for enforcement actions or supervisory
actions.
Ms. McCoy. Yes, in my experience, there are multiple layers
of review of enforcement decisions; for example, at the CFPB,
enforcement decisions are reviewed all the way up to the
Director's office. And I have information that enforcement
decisions similarly at the prudential banking regulators
undergo many layers of review.
The agencies are very careful--many of these enforcement
actions are public, and that is a very good thing. I encourage
that. They are very careful to ground those enforcement actions
on violations of statutes, legislative rules, unsafe or unsound
practices, or in the case of the CFPB, UDAP violations. And so
I am not seeing the evidence that enforcement is being brought
based on guidances in isolation.
Chairman Crapo. Thank you.
Senator Brown.
Senator Brown. Thank you, Mr. Chairman.
Mr. Baer, the BPI, the Bank Policy Institute, represents
some of the biggest, most powerful banks on Wall Street. You
are its CEO, correct?
Mr. Baer. Correct.
Senator Brown. Those banks talk a lot about their diversity
initiatives and their antidiscrimination policies. I applaud
that. I assume you do.
Mr. Baer. I do.
Senator Brown. We have a President of the United States who
said there are good people on both sides in Charlottesville,
who has made disparaging comments about immigrants, who has
publicly insulted my friend and colleague, the Chair of the
House Financial Services Committee, Maxine Waters. The
President's racism I assume is offensive to many of your
executives and many of the employees of your member banks. Do
you think the President is a racist?
Mr. Baer. Senator Brown, I do not know the President.
Senator Brown. I do not know his heart either, but do you--
well, I will ask it this way: Do you think his words and his
actions are racist?
Mr. Baer. Again, I do not think it is my position to
characterize at a hearing on bank process what is in the heart
of our President.
Senator Brown. Well, I think it is. I am disappointed, but
let me shift to another question.
Has the BPI or the Clearing House Association of the
Financial Services Roundtable, which merged to create you, I
guess, ever asked regulators to provide guidance?
Mr. Baer. I would say that is unusual. Generally, we are in
the position of asking them to engage in notice-and-comment
rulemaking around things that really matter.
Senator Brown. But you have supported some guidance as BPI,
correct?
Mr. Baer. I am actually trying to recall an occasion when
we have done so, and I do not recall----
Senator Brown. Well, let me give you a larger historical
context, a wider time period. So as either the Financial
Services Roundtable, the Clearing House Association, either of
them, or you as the BPI now, you have asked regulators to
provide guidance in the past?
Mr. Baer. Senator, we may well have. I just cannot recall
an instance. In every recollection that I have, we have been
asking them to use notice-and-comment rulemaking more, not
less.
Senator Brown. Did you have a position on Congress' repeal
of the CFPB guidance, either you or your two predecessors that
merged, that instructed banks on how to avoid making
discriminatory car loans? Did you have a position on that
repeal?
Mr. Baer. I do not think we engaged on that issue--of the
two initiatives on the CRA. We were more focused on the
leveraged lending one.
Senator Brown. So you did not take a position or do any
lobbying on that guidance, that rule?
Mr. Baer. I know we strongly supported review of--well,
submission of the leveraged lending guidance and congressional
review of that. I do not recall our taking a position on the
CFPB auto.
Senator Brown. Professor McCoy, Congress repealed--we have
talked about a number of times now the CFPB's guidance on
discriminatory auto lending.
Ms. McCoy. Yes.
Senator Brown. Did that make CFPB's plans for enforcing the
Equal Credit Opportunity Act more or less clear for industry?
Ms. McCoy. It certainly made it murkier. I want to stress
here that before the CFPB was ever enacted, there is
substantial Federal case law that established that disparate
impact theory applies to auto lending by indirect auto lenders.
The CFPB in that guidance was observing decided Federal case
law that predated its existence. The CFPB remains statutorily
responsible for enforcing ECOA, and firms have to comply with
that.
What it means then to disapprove that guidance in the face
of the still existing statute, which has not been repealed or
amended, and the decided case law is really unclear. What does
disapproval mean? If I were industry, I would not know.
Senator Brown. That is helpful. This is for you again,
Professor McCoy. The financial crisis took many Wall Street
insiders by surprise. Consumer advocates and community
activists were less surprised, were sounding the alarm about a
foreclosure crisis, urging regulators to take action before the
crisis. I wonder about the collective amnesia in this body
about what happened a decade ago, but I am still hopeful that
we have learned something.
If OIRA has the ability to block independent regulators'
actions, do you think our financial system will be more or less
safe?
Ms. McCoy. I am very concerned about what I view as a power
grab by OIRA. It is a direct attempt to abridge Federal banking
regulators' statutory independence. Congress clothed the
Federal banking regulators with independence for a very
important reason. It is for the stability of the banking
system. It is to make sure that the executive branch and the
White House do not improperly interfere with neutral expert
bank regulatory decisions for short-term political advantage.
The result of Federal bank regulator independence is to
reside oversight of Federal banking regulators where it
belongs, which is here in Congress. So I view OIRA's memo as
actually not only a power grab vis-a-vis the Federal bank
regulators, but an attempt to wrest control away from Congress
and consolidate it in the White House.
Senator Brown. Thank you.
Chairman Crapo. Senator Toomey.
Senator Toomey. Thank you very much, Mr. Chairman.
Two years ago, I sent two letters to the GAO. I asked the
GAO to review the CFPB's indirect auto lending bulletin, their
indirect auto bulletin, and let me be clear, this was an ill-
considered bulletin. It was really aimed at auto dealers
despite the fact that that industry was explicitly excluded
from the CFPB's jurisdiction. It was based on extremely dubious
and speculative statistical analysis, and it ultimately would
have made offering dealer discounts more difficult. In other
words, it would have raised the cost of buying cars.
If Congress intended for dealers to have a harder time
providing discounts and to raise the cost of buying cars for
our constituents, in my view, we should pass a law to do that.
In any case, the second letter was regarding leveraged
lending, and I specifically asked the GAO to determine if these
two guidances, bulletins, met the CRA's definition of a rule,
which the CRA defines in part as ``the whole or part of an
agency statement of general or particular applicability and
future effect designed to implement, interpret, or prescribe
law or policy.''
In both cases, GAO concluded that the agency actions did
meet the definition of a rule, despite the fact that they did
not go through the Administrative Procedures Act. This is not a
surprise. It is not unheard of for agencies to intentionally
circumvent the transparent rulemaking process and instead
implement its will through these tools such as guidance. In
fact, the authors of CRA, including Senator Reid, acknowledged
this reality, and the Chairman quoted from his remarks.
So I want to say I am glad to see the Committee is taking
this up. I appreciate that, Mr. Chairman, and I would remind
agencies of their obligations under the Congressional Review
Act.
Now, the banking regulators have published a statement
making it clear that they understand the law and that they do
not believe that their guidance has the binding force of law or
of a rule. I think that is widely acknowledged, at least at a
theoretical level. My question for you, Mr. Baer: In your
experience with banks as they interact with the regulators and
supervisors, do supervisors treat guidance as binding even
though the heads of the regulatory agencies have said that they
are not supposed to be?
Mr. Baer. Thank you, Senator. I have to start with an
important caveat. As noted, and I think as Meg Tahyar noted,
the examination process is secret, and the communications
between the examiners and the banks, therefore, are considered
confidential supervisory information, and it is actually a
crime for them to discuss that with me or you. So I think my
knowledge here is quite limited. I think the Committee may have
a better opportunity to find out what is really going on than
I. But I can certainly tell you that I have heard from multiple
banks, and I think in some cases even from supervisors, that
there is confusion about what that statement means,
particularly whether a citation means a MRA, whether guidance
that was previously the basis of an MRA is somehow
grandfathered. And so, again, it seems to us to be a very low
cost and quite potentially beneficial move for the agencies to
clarify and formalize that in a regulation.
Senator Toomey. What about the argument that if a bank
feels that their examination or their rating is not accurate or
is not done properly or is not fair or somehow is inconsistent
with the rules, they can just appeal it? Is that an effective
mechanism for regulated institutions?
Mr. Baer. Sure, Senator, I will confess, I think as a young
man at the Federal Reserve, I actually at one point drafted the
appeal rule there and did so in all sincerity and with the
hopes that it would be used. There has been some terrific
academic work on this by Professor Julie Anderson Hill who
actually has documented the effectiveness of that regime.
Again, consider as backdrop that we are talking about tens of
thousands of MRAs. I think interagency appeals, the OCC has
been averaging about nine per year, and----
Senator Toomey. Can I interrupt for a quick clarification?
With respect to the MRAs, if I as a Member of this Committee
wished to examine the MRAs so that I could determine whether or
not the enforcement--whether they were being used properly in
accordance with the law, how many would I be able to read
through?
Mr. Baer. I think it would depend on the law and your
relationship with the relevant agency. Certainly I am not
allowed to read any of them.
Senator Toomey. You are not allowed to read any of them?
Mr. Baer. No.
Senator Toomey. They are not public?
Mr. Baer. Correct. And, again, given the numbers involved,
the fact that you are only seeing between two and nine appeals
per year is an indication that that is not really a live option
for institutions.
Senator Toomey. Ms. Tahyar, are you aware of the extent to
which these MRAs are available to Members of Congress for
review?
Ms. Tahyar. Well, the confidential supervisory privilege
belongs to the agencies, and they could waive it if they chose
to do so.
Senator Toomey. And if they chose not to?
Ms. Tahyar. That is also totally in their discretion.
Senator Toomey. And there are thousands of these each year.
Ms. Tahyar. There are thousands of these each year.
Senator Toomey. There is a lot happening that never sees
the light of day.
Ms. Tahyar. That is exactly right, Senator. My
recommendation would be on MRAs that the agencies continue the
process that the Fed did in its supervisory report. Let's get
more information out, more in the aggregate, more granular,
taking out the names of banks. Let's see what the trends are.
Scholarship is critically uninformed, and the congressional
oversight committees are critically underinformed.
Senator Toomey. Thank you, Mr. Chairman.
Chairman Crapo. Thank you.
Senator Cortez Masto.
Senator Cortez Masto. Thank you.
Let me just get some clarification because I am kind of
confused with what I am hearing. Are you telling me that the
banks want these confidential supervisory examinations to be
public, Mr. Baer.
Mr. Baer. I think that is certainly something to be
considered. I do not----
Senator Cortez Masto. So the banks are not concerned about
information that may become public, so the banks are open to
any type of examination, a supervisory examination, being
public and people being aware? That is what I am hearing you
say.
Mr. Baer. I have not surveyed our members, and I do not
know that there is one consensus view among the banks.
Senator Cortez Masto. I would be curious to know that
because I would think just the opposite. I think from what I am
seeing, and somebody who has enforced the laws and has dealt
with regulation, that sometimes there is a need for secrecy for
purposes of the banking industry, and they request that.
Now, let me ask you this: With respect to matters requiring
attention, are you here telling me today that there are some
enforcement actions taken against banks that were enforced
because of a violation of an MRA that is not based in a
violation of law?
Mr. Baer. I think we can say with great confidence, given
the numbers and some background knowledge, that most MRAs are
not based on a violation of law.
Senator Cortez Masto. So you are telling me that what I
heard you say is that there is some violations that have been
implemented that were violations just based on an MRA and that
MRA was not based in law?
Mr. Baer. The way I would put it is MRAs frequently, I
believe, are not based on a violation of law or an unsafe and
unsound banking practice.
Senator Cortez Masto. But what I heard you just say is that
there were some violations based on an MRA. Is that correct?
Mr. Baer. I do not think that is correct.
Senator Cortez Masto. So no MRA--what I am understanding is
that there are MRAs have been out there and that no bank has
been issued a violation based on an MRA?
Mr. Baer. Well, an unremediated MRA would probably lead to
an MRIA, immediate attention, and then if it were unremediated,
the agency would take formal enforcement action.
Senator Cortez Masto. Action based on a violation of law,
correct?
Mr. Baer. At that point they would need a violation of law
to take a formal enforcement action, for example, an order----
Senator Cortez Masto. So any enforcement action is based on
a violation of law?
Mr. Baer. Correct.
Senator Cortez Masto. OK. So there is not a misuse of the
MRAs or MRIAs from what I heard you say earlier. So I am just
trying to clarify. Let me jump, because I only have so much--so
many minutes to ask a question here. And, Ms. McCoy, let me ask
you this: I am concerned from what I am seeing and what I have
just heard that OMB's decision that they have authority to
review independent bank regulatory--or regulators' actions, in
essence what you have put in your writings, you basically say
the OMB memo improperly treads on Federal bank regulators'
independence and violates Executive Order 12866, particularly
when it comes to the cost-benefit analysis. Can you talk a
little bit about that and why you think that is a violation?
Ms. McCoy. Yes. The Congressional Review Act only requires
Congressional Review Act review in Congress of major rules. So
somebody has to decide what is a major rule. Congress entrusted
OIRA with that decision.
Agencies submit financial information about the effect of
proposed rules, of final rules, to OIRA. What OIRA is doing in
the memo is specifying the methodology that the agencies must
use when they submit this financial information assessing the
impact. That is totally improper under Executive Order 12866.
OMB and OIRA have no statutory authority to tell the
Federal bank regulators how to conduct their cost-benefit
analysis. In fact, they are barred from doing so.
Senator Cortez Masto. Because that treads on the
independence and the province of the banking regulators,
correct, under the law.
Ms. McCoy. Exactly.
Senator Cortez Masto. And that is the whole intent why
there is that independence, so the White House cannot come in
and try to usurp that for their own short-term gain or long-
term gain, whatever that is, correct?
Ms. McCoy. Totally.
Senator Cortez Masto. OK. Thank you.
Let me just say one thing. I get that we have to find
balance, and I think, Ms. Tahyar, you are trying to find a
balance between the two. And I get that that needs to be there.
What I heard earlier, that to the extent that my colleagues
have issued requests to the GAO to determine whether there is a
rule or not and action is taken, at least we still have that
authority to take that action and the process was followed. But
with this new guidance, that changes the game. This is the
White House now coming in and making a determination and
usurping the independence of the financial regulators for their
own short-term gain over the banking industry. That concerns
me. We should all be concerned about that. I get that bank
examiners have discretion, and sometimes that discretion--they
overstep their discretion. And I think what we are trying to do
is find a balance here.
But let me ask you this, Mr. Baer: Are you saying that
there should be no supervision?
Mr. Baer. To the contrary, Senator.
Senator Cortez Masto. So let me ask you this: Are you
saying there should be no guidance with that supervision?
Mr. Baer. What I am saying, Senator, is that if the
agencies are going to treat guidance as a binding requirement,
which is effectively what MRAs have become, even without resort
to consent orders or an order----
Senator Cortez Masto. So I guess I am still trying to
understand that. Maybe I need to see some of these, and I know
they are confidential. But if I am an enforcement agency and I
am trying to give you the benefit of the doubt without taking
enforcement to guide you, to give you that opportunity to clean
it up, clear it up, before enforcement action is taken, and you
have not done it, then I am going to enforce it based on a
violation of the law. So the only time enforcement is going to
happen is if there is a violation of law. But I am going to
give you the benefit of the doubt, and I am going to let you
try to take--cure it before you do.
Mr. Baer. Right.
Senator Cortez Masto. So what I am hearing is that is not
happening?
Mr. Baer. Here is, I think, the crucial distinction. The
situation you are describing I think describes agencies that
use only enforcement as a way to impose their wishes, so
basically anybody but banking agencies. Banking agencies are
unique in that they are resident at these institutions. They
are always with them, and they are telling them a lot of things
that would never rise to the level of an enforcement action,
you know, how to minute your meetings, how to structure your
reporting lines, how to review your models. Those are things
that would never end up becoming a violation of law or even an
unsafe and unsound banking practice.
So really the question is--there has always been an
informal give-and-take between bank and regulator about, you
know, ``We would like your report line to look like this,''
``No, we like it the way it is,'' and you have that discussion.
That has gone on for a century.
What has changed over the last 10 years is that that has
become a much more one-sided conversation, and the notion is
that if the agency wants you to do something and you do not do
it, well, then you are subject to, you know, nonpublic
sanctions, particularly around your growth. ``You do not want
to do it our way, we are going to give you a 3 for management,
we are not going to let you open any branches for a year.''
And all of that, to the extent it is happening behind the
scenes, I think that is what you hear us objecting to.
Senator Cortez Masto. Thank you. I appreciate that.
I know I went over my time. Thank you for the indulgence,
Mr. Chairman.
Chairman Crapo. Thank you.
Senator Moran.
Senator Moran. Chairman Crapo, thank you.
Before we turn to the specific topic of today's hearing, we
are on the topic of accountability, and I want to restate, once
again indicate my concern with the lack of accountability at
Financial Accounting Standards Board and its requiring banks to
forecast and book current and expected losses over the life of
loans at the time the loan is made. Those actions are not
subject to review, and I do not think we ought to be allowing a
self-governing body to, in effect, set national economic policy
without congressional input and Federal regulators should
acknowledge.
On the topic of today's accountability, let me start with
Mr. Baer, but I am fine to have comments from any of you.
Effective supervision and regulation of financial institutions
require accountability of the regulators. That is what some of
you--maybe all of you--have been saying. One of the most
important components of accountability is the thread of
legitimate appeal process, and Senator Toomey raised this topic
a moment ago.
As mentioned in the testimony, the ultimate arbitrator of
an examination appeal is made by the same agency that made the
original decision. I think it is a difficult argument to make
that this does not have an effect on the impartiality of the
appeals.
In addition to reining in the shadow enforcement regime
that was discussed in the testimony, would establishing an
independent ombudsman within the regulators be one of the most
effective legislative items this Committee could take up to
address the examination appeals process that is currently in
effect? Mr. Baer.
Mr. Baer. Senator, thank you. I think that would certainly
be of help. I think there are really two things that drive the
fact that banks generally do not appeal supervisory ratings or
loan classifications. The first, as you note, is they are
effectively appealing to the agency that made the decision, so
you are unlikely to succeed.
I think the bigger factor, though, is really--and this gets
to my conversation with Senator Cortez Masto, which was that
you have to continue to live with those examiners.
Senator Moran. All the other things they regulate or can
do.
Mr. Baer. Right. I liken it to you can file for divorce and
continue to live with your spouse, but you need to sleep with
one eye open. And I think the notion that you can be contesting
an appeal with regard to the examiner you are seeing every day
and maintain the relationship you have--and this is not of
recent vintage. This goes back forever. Examiners have long
memories, and they will tell you that. And so, you know, I
think it is very difficult, even to the extent that the
agencies are well meaning--and I think they are. They recently
actually just put out a request for how can we do more to
prevent retaliation and make the system work better. I think
they genuinely wish to make the system work better. But I think
just as it is structured currently, it is very difficult to
make progress on that.
Senator Moran. I was surprised a number of years ago at the
number of bankers in Kansas who had a particular complaint
about a particular regulator, and I invited the regulator to my
office and invited my Kansas bankers to come meet with the
regulator. Not one was interested in doing that. Instead, they
sent the president of the Bankers Association on their behalf,
again, highlighting what I was surprised to learn was the fear
of retaliation if they were complaining about something at
least they thought was legitimate enough to complain to me over
a long period of time in numerous occasions.
Either of you have a thought about an ombudsman?
Ms. Tahyar. I think an ombudsman with real power, acting
independently, would be a helpful step. But, ultimately, the
appeals process from examinations is a limited way forward
because I think ultimately the balance of power is such that,
as you experienced in Kansas, banks will be reluctant to come
forward. That is why some system of more transparency is
needed. I am not necessarily suggesting that suddenly
everything comes out. I think change is hard, and it would have
to be done in an appropriate and systemic way. But more
information, trends in aggregate of MRAs, MRIAs, more
information coming out I think would make a lot of difference.
Senator Moran. Thank you.
Professor.
Ms. McCoy. Yes, and, Senator, I am a fellow Kansan. It is
wonderful to meet you finally in person.
Senator Moran. Thank you so much.
Ms. McCoy. Yes. I think it is really important that we
focus on improving the MRA and MRIA process. The current
regulators are really starting to focus on that to reduce the
number. I totally agree with Ms. Tahyar that it is imperative
to do a better job of training examiners--we have a lot; we
have over 10,000 examiners in the United States--on the proper
use of MRAs and MRIAs. But if I can look at Mr. Baer's
proposal, let us say that a particular regulator wants to adopt
an MRA with respect to one bank on a particular safety and
soundness issue. Do I understand him to say that the agency
would be required to publish that in the Federal Register,
naming the bank, naming the alleged unsafe and unsound
practice, seek public comment, and then decide whether to make
it final? Putting aside the time that that would take, I very
much doubt that banks want to be put through that ordeal. So
that suggestion does not seem to be at all practical to me. But
an empowered ombudsman is a very good idea.
Ms. Tahyar. I think there is no suggestion that individual
MRAs be put through notice and comment. I will turn to Greg to
see where he is.
Mr. Baer. No. Again, it depends on what an MRA is. It would
never be a notice-and-comment rulemaking would be de facto in
order, which under the rules, if you are issuing a capital
directive or an order, there is a notice and process appeal
right to the institution. And if it is going to have an effect
on your ability to establish branches and grow, then perhaps
you should have a formal appeal process akin to what you would
have with an order or capital directive or a prompt corrective
action directive. But, you know, again, most MRAs are not
anywhere near that level, and if they were truly treated as
nonbinding orders, there would be no need for that appeal
process.
Senator Moran. Thank you all three.
Thank you, Mr. Chairman.
Chairman Crapo. Senator Tillis.
Senator Tillis. Thank you, Mr. Chairman. Thank you all for
being here.
I think it was said by the Ranking Member that I dislike
guidance. What I dislike--it has nothing to do with guidance.
Guidance has a place in the regulatory process. What I dislike
is the inappropriate use of guidance for things that should
give rise to a rule, which is why we have already utilized the
CRA and the GAO process on three, and we have got a long, long
list of other actions that regulatory agencies have taken that
we are saying, look, maybe this does relate to safety and
soundness of the banking industry. Just do your homework and go
through the rulemaking process and then determine whether or
not you have got a rule that is sustainable, that regulates the
risk, that gives appropriate insight into the risk, but not so
burdensome that we just layer more and more and more on the
banking industry. And I believe based on some of the actions
they just want to de facto nationalize the industry through a
combination of rules that sometimes overreach and guidances and
speeches and policy memos and a number of agency actions that I
think are inappropriate.
Look, that would be like the Congress deciding, well, you
know, we are going to pass laws when we think we can and when
we have, you know, the time to do it. But, otherwise, we are
going to start passing guidances that, unless the President
vetoes them, they are just in place. That is an absurd concept,
and I think it is also equally absurd for administrative
agencies to go down the same path.
I want to go back to the MRA. Why couldn't we, instead of
all-or-nothing scenario that Senator Cortez Masto is
suggesting, why couldn't we simply say that for financial
institutions who simply want to have the MRA review, they can
actually have a redacted version of it reviewed so that people
like me and other third parties, an IG, could take a look at it
and see if it was an appropriate supervisory examination
process? Why wouldn't that work? I do not know necessarily the
rules, if that runs afoul of the rules, but why couldn't they
do that, almost like a whistleblower, like this was an
inappropriate set of behaviors and instructions between a
supervisor and an examiner, and we actually want this to see
the light of day? What would be wrong with a concept like that,
Mr. Baer?
Mr. Baer. I think this gets to sort of what Senator Moran
was saying. You could certainly envision an appeals process
around MRAs where you could have a more neutral arbiter and
perhaps better assurance that there would not be future
retaliation. Again, I am a little dubious on that second point.
I think, you know, institutions that were in the habit of
appealing their MRAs would, again, if that is a public appeal--
and we have not even talked about this component--you would
have the reputation as someone who could not get along with
your regulator, which from an investor relations perspective is
not a good thing. And I think that is also a factor here.
Senator Tillis. That is a great point. What we are really
trying to do, if you talk about 10,000 people in the mix on
this, then obviously you know there are some number who,
through their personality or personal preferences, are probably
abusing their authority. So my goal is to try and figure out
how you actually weed out the minority, significant minority of
people doing this every single day, so that we are just not
shifting our focus away from having a safe and sound financial
services industry. That is all I care about.
And, incidentally, industries that are regulated to the
appropriate level but not regulated to death have more
resources to provide loans, to provide housing, to do the kinds
of things they want to do ultimately for consumers. We talk
about more and more regulation here, but we do not talk about
at the end of the day that it has to be paid for. It is not
paid for by the bank. It is paid for by the people who take
loans, who get credit cards, and who need financial services to
make ends meet.
I want to talk about maybe a couple of other ones that I
should take a look at, Mr. Baer, in terms of my list of other
actions that I may take through the GAO and the CRA. I think
one--well, actually, I am not going to talk about this one. I
had one on the list. Oh, yeah, the SR letter, 1402, bank
expansion, are you familiar with that one?
Mr. Baer. Yes.
Senator Tillis. What do you think? Is that something that I
should take a look at and get a consultation with the GAO to
see if that was something that should have been done through
rulemaking?
Mr. Baer. Senator, I could certainly see that being
appropriate. I would hope--and it is not really clear what the
status of that is. I mean, I think the Federal Reserve
recently, to their credit, has been indicating that they are
more inclined to stick to the statutory factors for reviewing
applications.
Senator Tillis. That is awfully good of them.
Now, I would also say I think Chair McWilliams has done a
good job of rescinding a number of guidances over in the FDIC.
Do you think there is equal opportunities to do that in OCC and
with the Federal Reserve?
Mr. Baer. Yes, Senator, again, this sort of gets to the
core of what we are seeking through our petition for
rulemaking, along with the ABA, which is simply, you know, a
clarification that if you are going to have an MRA, it is going
to be based on a violation of law or an unsafe and unsound
practice, not guidance. And that cures a lot of ills because at
that point guidance is, as I think some here have described it,
nonbinding as an indication of the priorities or concerns of
the agency but not a rule.
Senator Tillis. Yeah, and when used in that spirit, it can
be helpful. When abused, it can be harmful.
Mr. Baer. Absolutely.
Senator Tillis. And people should do their jobs and go
through the right processes.
I know I am over time. I almost never go over time, but the
Chair and Ranking Member are talking, so I am going to try and
get one more question in.
[Laughter.]
Senator Tillis. I wanted to go back because I had one that
was actually my--I have got two banking institutions who have
decided that they are going through the merger process,
SunTrust and BB&T. I personally think it would be good for the
country. After we implemented S. 2155, I think those are two
banks that are right in that middle ground that actually give
them the scale to be able to deal with what larger banks have
to do with respect to footprint and banking operations,
regulatory burden.
Should I be worried as we go through this review process
that we could get caught up in things that are not necessarily
things that they should be subjected to to get approval for
this bank merger?
Mr. Baer. Senator, I think----
Senator Tillis. And do you think we will ever know the
specifics of the negotiations that occur?
Mr. Baer. I would just say, I mean, fortunately, when
evaluating bank mergers, the Federal Reserve looks at an
objective measure of that, the Justice Department measure, the
HHI, or Herfindahl-Hirschman Index, which I think shows--and we
have looked at this particular merger and published on it--
shows banking to be an unconcentrated industry, both as an
absolute matter and relative to other industries. I think the
numbers show that this merger would not materially add to the
concentration of that industry.
Senator Tillis. Just intuitively, can you imagine why it
would take a year or more to review this and make a decision on
this merger? It seems to me it should be something that should
be done in a matter of months. I think that the Federal Reserve
is trying to greatly compress the length of time for doing
these reviews. But can you imagine any scenario why it should
be next year before we get a decision on this merger in your
professional opinion?
Mr. Baer. That is kind. I do not know if there are any
complications around the merger of which I am unaware. I would
think in the ordinary course it would not take that long.
Senator Tillis. Well, I do not think that there are, so I
am looking forward to a quick decision on the part of the
regulators so that we can move forward. Thank you all.
This is the first time I have gone over my time, Mr. Chair,
and I appreciate your indulgence.
Chairman Crapo. Thank you. You are welcome.
Senator Brown.
Senator Brown. First time Senator Tillis went over this
week.
[Laughter.]
Senator Brown. Thank you.
Chairman Crapo. He has been really good.
Senator Brown. Thanks. My staff--a question to Mr. Baer. We
are going to follow up with written questions. We found several
instances in which the Financial Services Roundtable took a
position on indirect auto lending, so we would like to get some
clarification. We will send you a letter, if you would respond
as quickly as possible, Mr. Baer.
Mr. Baer. Thank you, Senator. As I said, my statement was
based on my recollection. I actually never worked at the
Financial Services Roundtable, so I take your word for that.
Senator Brown. Thank you.
Chairman Crapo. All right. Thank you, and that concludes
our questioning for today's hearing. I again thank our
witnesses for your time and for your expertise and for coming
here and participating in this hearing.
For Senators who wish to submit questions for the record,
those questions are due to the Committee by Tuesday, May 7th,
and I ask the witnesses to respond to those questions as
promptly as you can once you receive them.
Again, we thank you for being here, and this hearing is
adjourned.
[Whereupon, at 11:06 a.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF CHAIRMAN MIKE CRAPO
Today, the Committee will turn its focus to guidance, supervisory
expectations, the rule of law, and how banking agencies regulate and
supervise institutions.
Banks receive significant forms of Government support and benefits,
including deposit insurance and access to the Fed's discount window.
In exchange for these benefits, which ensure that American
consumers have stable access to their deposits, banking agencies
supervise banks and in return expect them to operate in a safe and
sound manner.
The nature of the supervisory process and the need for trust
between supervisor and supervised institution means that sometimes
supervisory expectations are communicated in an informal and
confidential manner between supervisor and supervised institution,
which can be appropriate in certain circumstances, especially when
protecting Confidential Supervisory Information.
With that being said, there appears to be a number of situations
where the banking agencies have enacted guidance or other policy
statements that are being enforced as rules and therefore do not comply
with notice-and-comment rulemaking processes and do not comply with the
Congressional Review Act (CRA).
In addition, there are a number of situations where supervisors
make verbal ``recommendations'' to banks that are inappropriate given
the tremendous power supervisors have over banks.
All rulemaking authority at the banking agencies derives from
authority delegated to the banking agencies by Congress, which means
Congress has the authority to disapprove any rule a banking agency
enacts.
In addition to the absolute authority Congress has to disapprove
any agency action, Congress enacted the CRA in 1996 to provide Congress
with an expedited process to disapprove agency rules.
Under the CRA, before a rule can take effect, agencies must submit
it to Congress for review.
Congress then has 60 days to disapprove the rule with a majority
vote.
A rule is defined, with a few exceptions, as ``the whole or a part
of an agency statement of general or particular applicability and
future effect designed to implement, interpret, or prescribe law or
policy or describing the organization, procedure, or practice
requirements of an agency.''
That is a very broad definition.
The CRA applies to more than just notice-and-comment rules. It
encompasses a wide range of other regulatory actions, including, among
others, guidance documents, general statements of policy, and
interpretative rules.
Even though the text itself is clear about the broad scope of what
constitutes a rule, during the floor debates leading up to the passage
of the CRA, then-Senator Reid reinforced this point and said: ``[t]he
authors are concerned that some agencies have attempted to circumvent
notice-and-comment requirements by trying to give legal effect to
general statements of policy, `guidelines,' and agency policy and
procedure manuals. The authors admonish the agencies that the APA's
broad definition of `rule' was adopted by the authors of this
legislation to discourage circumvention of the requirements'' of it.
Too often, we see banking regulators implementing policy through
guidance and other informal means without following the requirements in
the CRA.
For instance, some in the agencies may argue that guidance is not
binding, but as a practical matter, supervised institutions and
supervisors know that informal guidance and other communications
between supervised institutions and supervisors change behaviors within
institutions.
Legal departments at the banking agencies often assert that
guidance is nonbinding, but the language the supervisors at the
agencies use often suggest that supervisors treat guidance as binding
and expect supervised institutions to treat it as binding.
Actions like this within agencies are problematic and require
Congressional oversight, including by ensuring banking agencies comply
with the CRA.
Recognizing the importance of agencies complying with the CRA,
Acting Director of the Office of Management and Budget (OMB) Russell
Vought issued a memorandum recently, which ``reinforces the obligations
of Federal agencies under the CRA in order to ensure more consistent
compliance with its requirements across the Executive Branch and sets
forth guidelines for analysis that the Office of Information and
Regulatory Affairs (OIRA) will use to properly classify regulatory
actions for purposes of the CRA.''
This memorandum is a step in the right direction.
The abuse of Government and agency power should not be a partisan
issue and no Administration or agency should be able to use their
powers to influence the private market.
I continue to encourage the regulators to follow the CRA and submit
all rules to Congress, even if they have not gone through a formal
notice and comment rulemaking.
In addition, I encourage the banking regulators to provide more
clarity about the applicability of guidance and ensure that supervisors
throughout the agencies (especially outside of Washington, DC) know
about how guidance should be treated and do not inappropriately use
their significant discretion.
As a final note, during the Obama administration, I fought against
Operation Choke Point, an initiative in which Federal agencies
pressured banks to ``choke-off'' politically disfavored industries'
access to payment systems and banking services.
Operation Choke Point initially began in the supervisory process.
Operation Choke Point was inappropriate, and demonstrates why
supervisory staff at the agencies need to be transparent and
accountable.
I look forward to hearing from each of you on your views of what
can be done to ensure that there is greater transparency and
accountability in the regulatory and supervisory process.
______
PREPARED STATEMENT OF SENATOR SHERROD BROWN
This is a hearing to talk about guidance--the nonbinding advice
from Federal agencies that's supposed to make it easier for the banking
industry to follow the rules.
There's a reason we have a lot of banking laws--it's a complicated
industry that affects everyone's lives, and with a great deal of
potential for special interests to do a whole lot of harm. It takes a
lot of oversight to prevent terrorist financing and protect consumers
and stop discrimination in lending and keep Wall Street from taking
down the economy again.
And banks need guidance to help them comply with those laws.
In fact, industry begs for guidance all the time.
So why hold this hearing at all?
The same reason we always seem to have hearings in this town--to
make life a little easier for Wall Street.
Chair Crapo, I am concerned this hearing isn't actually about
making it easier for big banks to follow the rules--that it's really
about making it easier for big banks to get around them.
It's about what kind of guidance the industry wants, and the kind
of guidance it doesn't.
Big banks love guidance that makes it easier to trade derivatives
with big foreign banks. They love guidance that tells them how to track
their capital or how to prepare for the stress tests. They love
guidance that makes sure they can keep lending when a town is hit by
floods or wildfires.
The guidance big banks hate--the guidance we're actually talking
about at this hearing today--is the kind that makes it harder for them
to skirt the laws or take advantage of their consumers.
And as usual, Wall Street has plenty of senators lining up to help
them.
Big banks hate guidance that explains how regulators are going to
enforce the laws that say you can't discriminate against people of
color. They hated that one so much they persuaded Republicans to repeal
it.
Guidance had never been repealed before. But Congress used the
Congressional Review Act to repeal instructions from the Consumer
Protection agency that would have made it harder for auto dealers to
charge people of color more for car loans.
Big banks also hate guidance that says they should be cautious
about risky leveraged loans that might crash the economy. They hate it
because it cut into the huge fees they were getting for making these
types of loans to corporations.
And they hate guidance that explains how the regulators are going
to keep tabs on Wall Street. Last week Senator Tillis sent a letter to
the GAO to start the process of having Congress step in, and tell
regulators to take it easy on the very largest banks in this country.
And 2 weeks ago, the Office of Management and Budget announced they
want the President to have direct influence over the guidance that
independent banking agencies put out.
That means the President can lean over to his Chief of Staff Mick
Mulvaney, who is also the head of OMB, and tell independent agencies
what to do. And we saw how Mick Mulvaney ran the CFPB.
These agencies are supposed to be independent for a reason. We know
how corporate special interests spread their influence around
Washington.
The agencies policing Wall Street are supposed to be independent to
guard against that influence. But now the same president whose cabinet
looks like a Wall Street executive retreat wants to meddle.
And remember 2155--the bill that gutted many of the rules for the
biggest banks in the country, and for foreign megabanks?
Right in that bill, in section 109 to be exact, the bill that
Chairman Crapo wrote and skillfully shepherded to the floor and that
President Trump signed into law, Congress instructed the CFPB to give
guidance on filling out mortgage forms. Republicans demanded, insisted,
and fought for language instructing agencies to give more guidance.
This is the kind of guidance they pretend to be opposed to today.
This isn't about guidance--it's about getting rid of the rules that
Wall Street doesn't want to follow.
And everyone else will end up paying for it.
______
PREPARED STATEMENT OF GREG BAER
President and Chief Executive Officer, Bank Policy Institute
April 30, 2019
My name is Greg Baer, and I am president and CEO of the Bank Policy
Institute. \1\ I am here to testify about how legal process has broken
down in the regulation and examination of banks. I will not today
generally discuss the substance of postcrisis requirements imposed by
the Federal banking agencies; instead, my focus will be on a process
that has prevented stakeholders in banking policy--not only banks but
also their customers, academics, and even Members of Congress--from
learning what many of those requirements are, and having a say in their
content.
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\1\ The Bank Policy Institute (BPI) is a nonpartisan public
policy, research and advocacy group, representing the Nation's leading
banks. Our members include universal banks, regional banks, and the
major foreign banks doing business in the United States. Collectively,
they employ nearly 2 million Americans, make 72 percent of all loans
and nearly half of the Nation's small business loans and serve as an
engine for financial innovation and economic growth.
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In so doing, I bring to bear not only my perspective as CEO of the
Bank Policy Institute, a trade association representing America's
leading banks, but also that of a lawyer and sometime law professor.
Over time, the laws and regulations I learned, teach, and in some cases
wrote have become decreasingly relevant in practice. The procedural
rights and protections that those laws provide are generally
obsolescent, as regulation and examination have become increasingly
subjective, opaque, and unappealable.
So, this hearing is a welcome development, and I thank the
Committee for devoting its valuable time to these issues.
In my testimony, I will describe the laws enacted by Congress to
govern the regulatory, examination and enforcement process. I will then
describe the actual status quo, and how it diverges significantly from
the laws as written. Finally, I will describe recent actions by the
Government Accountability Office and some of the financial regulators
that hold the potential for reform in this area, and some additional
steps that could be taken to restore the rule of law as enacted by
Congress.
My testimony today describes how examination reports have been
effectively turned into enforcement actions, as their mandates--Matters
Requiring Attention and Matters Requiring Immediate Attention, or MRAs
and MRIAs--are treated as binding regulations or orders. Furthermore,
the basis of those MRAs frequently is not a violation of law but rather
a ``violation'' of guidance that under the law is actually nonbinding,
or of other standards that also have neither a legal basis nor an
evidentiary foundation. Finally, the reason these examination mandates
are treated as binding regulations or orders is because a shadow
enforcement regime has grown up postcrisis whereby firms with any
unresolved MRA are subject to limitations on their growth--limitations
never authorized by Congress.
I should note that my testimony generally does not focus on capital
and liquidity rules. Clearly, these are the most important components
of banking regulation and universally regarded as the core protection
for taxpayers and financial stability. And they generally have been
adopted in accordance with the Administrative Procedure Act, and are
enforced in a transparent, objective way. \2\ Rather, ironically, it is
the regulatory requirements that matter the least that are the most
opaque and come with the fewest checks and balances--requirements about
how banks manage their vendors, minute their meetings, update
spreadsheets, structure reporting lines, or monitor transactions. Those
requirements, not the core capital and liquidity requirements, are what
have built a vast compliance bureaucracy, and it is those requirements
that frequently have prevented banks from branching, investing and
otherwise serving new customers and offering new products postcrisis.
Over the past few years, many banks that met all of the dozens of
capital and liquidity requirements to which they are subject have been
unable to open a branch because of perceived failures in areas that are
immaterial to their safety and soundness.
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\2\ One notable exception, however, is the Federal Reserve's
stress testing regime. See, e.g., Jeremy Newell, The Fed's ``2018 CCAR
Scenarios: A Look at Process'', Underwritings: The BPI Blog (March 2,
2018), https://bpi.com/the-feds-2018-ccar-scenarios-a-look-at-process/.
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If I could stress one theme, though, it would be this: the erosion
of the rule of law in banking should not be a concern just to lawyers
and bankers. Decisions made behind the examination curtain
significantly affect the ability of consumers and businesses to access
credit and other financial services, and the terms and price of credit
and services. They have every right to comment on the currently
nonpublic and sometimes unwritten rules that affect them. So, too, do
academics and other policy experts whose views would be helpful in
making those rules better. This, of course, is precisely why Congress
enacted the Administrative Procedure Act: not as a sop to regulated
entities, but rather out of a genuine and well-founded belief that
rules are better made when they are informed by an open and public
comment process than when they are made in secret, without fear of
public scrutiny or challenge.
The Law as Written
Under the law, banks are examined by the Federal banking agencies.
\3\ By law, an examination report is not an enforcement action, and is
in no way legally binding. Rather, it is a statement of an examiner's
views, and the beginning of a dialogue between examiner and banker. To
be sure, bankers generally accept examiner criticisms, and strive to
resolve any problems identified. But they sometimes disagree.
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\3\ See 12 U.S.C. 248(a)(1) (Federal Reserve); 12 U.S.C. 481
(OCC--national banks); 12 U.S.C. 1463, 1464 (OCC--Federal savings
associations); and 12 U.S.C. 1820(b) and (c) (FDIC). State-chartered
banks are also subject to examination by the relevant State banking
agency.
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In that case, the law is clear. If the agency wishes the bank to
conform to its prescriptions, it must initiate an enforcement action.
Congress has provided multiple legal mechanisms for doing so. For
example:
Under section 8 of the Federal Deposit Insurance Act, a
Federal banking agency may issue an order to halt, remediate,
or penalize a violation of a law, rule, regulation, or final
agency order, an ``unsafe or unsound practice,'' or a breach of
fiduciary duty. \4\
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\4\ 12 U.S.C. 1818.
Under section 39 of the FDI Act, each Federal banking
authority has prescribed safety and soundness standards
relating to internal controls, loan documentation, credit
underwriting, interest rate exposure, asset growth,
compensation, and other topics. If an institution fails to meet
the applicable standards, the regulator may issue an order
compelling remediation. \5\
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\5\ 12 U.S.C. 1831p-1.
If the issue relates to capital, under section 38 of the
FDI Act, the banking agencies may impose sanctions on a banking
institution whose capital levels fall below predefined levels.
Alternatively, a Federal banking agency may issue a capital
directive to require a bank to maintain a level of capital
deemed reasonable by the regulator. \6\
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\6\ 12 U.S.C. 3907(b); see also 12 CFR 3.601 et seq. (OCC); 12
CFR 263.83 (Federal Reserve); and 12 CFR 324.5 (FDIC).
For individual employees and directors who engage in
misconduct, the Federal banking regulators have the authority
to bar them from a firm (or the industry) and assess monetary
penalties. \7\
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\7\ 12 U.S.C. 1818.
In each of the above cases, the affected bank or individual has
clearly delineated procedural rights, which generally include the right
to be notified of the basis of the order, respond on the merits, and
ultimately contest it before an Article III court. \8\ Notably, these
procedural rights incentivize both regulator and regulated to negotiate
an agreement in lieu of litigation.
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\8\ See 12 U.S.C. 1818(h).
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Another important procedural right was provided by Congress when it
required each banking agency to establish a process for administrative
appeal of any material adverse supervisory determination--that is,
actions for which there was no formal appeal under the law. \9\ This
might include a CAMELS rating or a loan classification.
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\9\ 12 U.S.C. 4806.
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Finally, all of these procedural rights are supplemented by section
706 of the Administrative Procedure Act, which governs the rulewriting
process for all Federal agencies and gives any affected person the
right to seek judicial review of any final agency action. \10\ It
serves as the ultimate guarantee that the regulations against which
banks are being examined are adopted and administered with due process
of law.
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\10\ 5 U.S.C. 706.
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The System in Practice
Unfortunately, the laws that I have just described, and the
procedural rights that Congress provided in them, have become
increasingly irrelevant in practice, supplanted by an alternative,
nonpublic examination and enforcement regime where they are
unavailable.
The Shift From Regulation to MRAs Based on Guidance and Ad Hoc Mandates
First, the banking agencies have increasingly avoided notice and
comment rulemaking, which under the APA requires the agencies to give
prior notice of the rule they propose to issue, seek public comment on
that proposal, and explain in any final rule why they have disregarded
any comment. Instead, they have (i) issued guidance generally without
opportunity for public comment or Congressional review or (ii) imposed
mandates through the examination process, and then proceeded to treat
each examination mandate as binding as a regulation, contrary to law.
MRAs and MRIAs
A Matter Requiring Attention, or MRA, is the vernacular by which
bank examiners communicate criticisms to a bank's management or
(increasingly) to the board of directors. MRAs and MRIAs have no basis
in law--there is no reference to them in any statute--and they are
unenforceable as a legal matter (in contrast to agency orders, which
are enforceable and subject to due process). In essence, MRAs create a
to-do list for the bank that comes at the end of examination report.
Make no mistake, however: the banking agencies take the position
that MRAs must be remediated. \11\ And ask any banker whether
remediation of MRAs or MRIAs is optional, and the answer will be no.
\12\ But you really can't ask any banker, because MRAs and MRIAs are
included in an examination report, which the banking agencies consider
Confidential Supervisory Information; therefore, it is a Federal crime
for a banker to complain publicly about an MRA.
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\11\ The bank enforcement section of the OCC's ``Policies and
Procedures Manual'' states that an examination report may contain
``concerns,'' which are expressed in an MRA. It then states: ``The
actions that the board and management take or agree to take in response
to violations and concerns are factors in the OCC's decision to pursue
a bank enforcement action . . . A bank's board and management must
correct deficiencies in a timely manner.'' See Office of the
Comptroller of the Currency, ``Policies and Procedures Manual'', PPM
5310-3 (Nov. 13, 2018) at 3 (emphasis added), available at https://
www.occ.treas.gov/news-issuances/bulletins/2017/ppm-5310-3.pdf.
Similarly, in its Supervision and Regulation Report, the Fed states:
``In the event that holding companies do not address MRAs in a timely
or complete manner, examiners may determine that the related weaknesses
represent a significant threat to the safety and soundness of the
company or its ability to operate in compliance with the law and may
recommend further action.'' Federal Reserve, Supervision and
Examination Report (Nov. 9, 2018) at 16, available at https://
www.federalreserve.gov/publications/supervision-and-regulation-
report.htm. The Federal Reserve also states, ``MRIAs are matters of
significant importance and urgency that the Federal Reserve requires
banking organizations to address immediately.'' Id. at Appendix A
(emphasis added).
\12\ Greg Baer and Jeremy Newell, ``The MRA Is the Core of
Supervision, But Common Standards and Practices Are MIA'',
Underwritings: The BPI Blog (Feb. 8, 2018), https://bpi.com/the-mra-is-
the-core-of-supervision-but-common-standards-and-practices-are-mia/.
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Consider the number of MRAs they are prohibited from talking about:
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Consider, in contrast, the use of the enforcement mandates actually
prescribed by statute and described above. For the Federal Reserve and
the OCC over the past 10 years:
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\13\ Data taken from the Federal Reserve's ``Supervision and
Regulation Report'' dated November 2018, available at https://
www.federalreserve.gov/publications/files/201811-supervision-and-
regulation-report.pdf and OCC's 2018 Annual Report, available at
https://www.occ.gov/annual-report/download-the-full-report/2018-annual-
report.pdf. Federal Reserve data includes MRAs for BHCs, SLHCs, and
FBOs. Figures for 2018 are as of the end of Q2 2018. OCC data includes
MRAs for national banks and Federal savings associations. Figures for
2018 are as of the end of Q3 2018.
The Federal Reserve has issued 34 safety and soundness
---------------------------------------------------------------------------
orders; the OCC has issued zero.
The Federal Reserve has issued only 20 prompt corrective
action orders; the OCC has issued 34.
The Federal Reserve has issued 211 capital directives; the
OCC issued 9.
The Federal Reserve has issued 75 removal actions against
individuals; the OCC issued 246.
The case of safety and soundness orders is particularly telling.
These are orders that specifically relate not to capital or liquidity
levels but rather exactly to the sorts of issues examiners consider
during an examination--risk management, credit underwriting, etc. Over
the past 10 years, the OCC has not issued a single such order, but it
has issued tens of thousands of MRAs.
What, then, are the bases for the thousands of MRAs and MRIAs being
issued to banks?
``Guidance''
Postcrisis, there has been issuance of a massive volume of
``guidance'' in the form of supervisory letters, bulletins, and
circulars. Guidance also includes examination handbooks (which
previously were designed for examiners, not banks) and even enforcement
actions (where the standards enforced on one bank through a consent
order have at times been treated as binding on all banks). \14\
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\14\ This stance is contrary to Supreme Court precedent. United
States v. Armour and Co., 402 U.S. 673 (1971); Local No. 93, Int'l
Ass'n of Firefighters v. City of Cleveland, 478 U.S. 501 (1986)
(holding that settled cases have no precedential effect).
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The volume of guidance is in some ways inestimable, as it takes so
many forms. By one estimate, since 2013, the OCC has issued 330 pieces
of OCC-only or interagency guidance in the form of bulletins; the
Federal Reserve has issued 103 pieces of Federal Reserve-only or
interagency guidance in the form of Supervision and Regulation (SR)
letters. \15\ But this dramatically understates the volume, because the
agencies (and therefore bank compliance teams) treat numerous other
agency statements as binding.
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\15\ The Federal Reserve Bank of St. Louis maintains a public
compendium of these and other agency issues at https://
www.stlouisfed.org/federal-banking-regulations/.
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Consider, as an example, vendor management. The OCC in 2013 issued
a voluminous bulletin, which itself referenced and reinforced over 50
previous bulletins, advisory letters, and banking circulars, that
describes how federally chartered banks should deal with their vendors
and contractors. \16\ It applies to a wide range of vendor--and many
other types of business relationships (other than customer
relationships)--everything from key IT vendors to corporate wellness
vendors--and its expectations are granular and prescriptive. The result
has been a cottage industry, requiring the retention of large teams of
people, both internal and consultants, to act as gatekeepers to any
contract with a third party and to draft policies and procedures for
practically any interaction with a third party, and to document
compliance with those policies on an ongoing basis. \17\
(Unfortunately, but not surprisingly, one effective means to compliance
is to concentrate one's most critical vendor relationships with fewer,
larger firms that are able to handle the associated compliance burdens,
at the expense of small businesses who cannot.) \18\
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\16\ OCC Bulletin 2013-29.
\17\ This consultant-industrial complex frequently includes
retention of former regulators.
\18\ In a 2017 ``Semi-Annual Risk Report'', the OCC itself
observed that ``[c]onsolidation among service providers has increased
third-party concentration risk, where a limited number of providers
service large segments of the banking industry for certain products and
services.'' See https://www.occ.gov/publications/publications-by-type/
semiannual-risk-perspective/pub-semiannual-risk-perspective-spring-
2017.pdf.
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Banks generally treat all of those utterances as legally binding
because a ``violation'' of any of them can form the basis for an MRA.
And these guidance documents not only impose meaningful restrictions on
banks internal operations but also proscribe or circumscribe specific
products and offerings (e.g., small-dollar credit or leveraged
lending).
To be sure, recent pronouncements by the GAO and statements by the
agencies have sent a message that guidance is not to be treated as
binding. One could read a recent interagency statement as stating as
much, though it does not include a specific reference to MRAs and
rather refers to agency ``citations,'' which has prompted confusion.
This area therefore appears to be one where, as suggested later in my
testimony, clarity is required.
``Safety and Soundness''
In some cases, MRAs are based not on any law, regulation or even
written guidance, but simply on examiner preference. In some cases,
they take the form of ``industry MRAs,'' which are identical
examination mandates issued to multiple banks--basically, an ultra
vires regulation without the process required by the APA. Increasingly
those preferences derive from ``horizontal reviews,'' where examiners
review practices across a variety of banks, decide which one they
prefer, and then require the remainder to adopt what examiners have
determined to be best practice. A primary source of many such reviews
is the Federal Reserve's Large Institution Supervision Coordinating
Committee (LISCC), a supervisory committee it uses to oversee the
supervision of large banks. Notwithstanding the LISCC's significance,
the Federal Reserve has never established a process or meaningful
criteria for how firms become subject to (or exit from) LISCC
designation and its requirements. Yet LISCC designation triggers a wide
range of heightened requirements related to capital adequacy and
capital planning, liquidity sufficiency, corporate governance, and
recovery and resolution. (In turn, these significant requirements
generally flow from guidance, not law or regulation.)
Asked for the legal basis for such actions, examiners often cite
``safety and soundness.'' Indeed, they are doing so increasingly, as
the law has become clearer that guidance is nonbinding and cannot serve
as the basis for an MRA.
But ``safety and soundness'' is not a magical phrase. Rather, it is
shorthand for an ``unsafe and unsound banking practice'' that the
banking agencies are authorized (after appropriate procedural process)
to prohibit under 12 U.S.C. 1818. And that phrase has a well-defined
legal meaning. As explained by the DC Circuit Court of Appeals, an
unsafe or unsound practice for purposes of section 1818 ``refers only
to practices that threaten the financial integrity of the
institution.'' Johnson v. OTS, 81 F.3d 195, 204 (DC Cir. 1996); see
also Gulf Federal Savings and Loan Association v. Federal Home Loan
Bank Board, 651 F.2d 259 (5th Cir. 1981) (``The breadth of the `unsafe
or unsound practice' formula is restricted by its limitation to
practices with a reasonably direct effect on an association's financial
soundness.''); Seidman v. Office of Thrift Supervision, 37 F.3d 911 (3d
Cir. 1994) (``The imprudent act must pose an abnormal risk to the
financial stability of the banking institution . . . . Contingent,
remote harms that could ultimately result in `minor financial loss' to
the institution are insufficient to pose the danger that warrants cease
and desist proceedings.''); Hoffman v. FDIC, 912 F.2d 1172, 1174 (9th
Cir. 1990) (requiring ``abnormal risk or loss or damage to an
institution, its shareholders, or the agencies administering the
insurance funds''). \19\
---------------------------------------------------------------------------
\19\ There is a minority of circuits that has a somewhat lower
standard for what constitutes an unsafe and unsound practice, but even
there the bar is still extremely high. These circuits primarily endorse
the so-called Horne standard--named after the Federal Home Loan Bank
Board Chairman who, in material provided to Congress in 1966 in support
of the legislation that employed the term, described it as: ``any
action, or lack of action, which is contrary to generally accepted
standards of prudent operation, the possible consequences of which, if
continued, would be abnormal risk or loss or damage to an institution,
its shareholders, or the agencies administering the insurance funds.''
See, e.g., First National Bank of Eden v. Department of the Treasury,
568 F.2d 610 (8th Cir. 1978). That said, the law of the DC Circuit is
effectively dispositive, given that the defendant in any action under
12 U.S.C. 1818 has the option of appealing to the DC Circuit, in
addition to the relevant circuit for traditional venue purposes. Thus,
a bank seeking to challenge an action can do no worse than the law of
the DC Circuit.
---------------------------------------------------------------------------
Clearly, given the sheer number of MRAs it seems highly unlikely
that all or even most of them meet that standard. The fact that they
come at a time when the vast majority of banks are in compliance with
all relevant capital and liquidity requirements makes it still more
unlikely. Indeed, I wish that I could provide the Committee examples of
MRAs that deal with matters that are beyond immateriality to the point
of irrelevancy. Again, however, the banking agencies take the position
that doing so is a criminal violation, so I cannot. The Committee
itself would need to investigate the extent to which banking agency
MRAs meet this standard--perhaps by requesting a sample of anonymized
MRAs from exam reports issued over the past 5 years. Furthermore, it is
deeply unfortunate that, other than reporting the total number, the
agencies report no aggregate or anonymized data on the subject of those
MRAs--reporting that no reading of the law would prohibit.
Examination Versus Supervision
The breakdown in legal process goes hand in hand with a broader
trend. By law, the job of the regulatory agencies is to establish ex
ante regulations, and then to examine the books and records of banks to
ensure that they are operating in accordance with those regulations and
that they are not engaged in practices that pose the risk of a
substantial loss to the firm--that is, losses that could materially
erode their capital and liquidity position. It is a system of
regulation and examination.
Notably, the word supervision does not appear in the authorizing
statues for the examination process. There is a large difference
between examining a firm and supervising it. Congress authorized the
former, but the current system is all about the latter. It is less and
less about protecting taxpayers--that goal is primarily served through
capital and liquidity requirements--and more about protecting
shareholders by attempting to comanage the firm. Thus, we see constant
references to ``reputational risk''--another term that does not appear
in law or regulation, but which has become shorthand for a practice
that is legal and creates no material financial risk but which is
disfavored by examiners. And as I will now describe, there is now a
shadow enforcement regime that allows regulators to ``supervise''
without due process.
The Shadow Enforcement Regime
At this point, one should wonder: if all the MRAs are legally
unenforceable and, moreover, based on unenforceable guidance and vague
references to safety and soundness, why are they treated as binding
rules by banks, and particularly their compliance teams? Why are they
diverting extraordinary resources to comply with mandates that are
often immaterial to their safety and soundness and in many cases
against their better judgment?
The answer is: because a new, shadow enforcement regime has grown
up postcrisis. It relies on growth and investment restrictions never
authorized by Congress in place of written agreements, formal orders,
and capital directives that were so authorized. Those restrictions are
immediately effective, effectively unreviewable and therefore
practically uncontestable by the bank. It is why those tens of
thousands of MRAs should not be viewed as examination findings but
rather as de facto enforcement actions.
Shadow Growth Restrictions
Thus, the Federal Reserve's Supervisory Letter 14-02, issued in
2014, describes factors the Federal Reserve will consider in acting
upon bank applications to engage in a wide range of proposed
transactions, including mergers, acquisitions, asset purchases,
investments, new activities, and branching. \20\ SR 14-2 states that
banking organizations that are rated below ``satisfactory'', that are
subject to any enforcement action, or that have any significant
consumer compliance issues or other ``outstanding supervisory issues''
should not even file an application until they resolve their
supervisory issues. Although the literal terms of SR 14-2 suggest that
various of these prohibitory conditions can be overcome, the general
prohibitions have been virtually absolute in practice. Yet none of them
is articulated in the relevant governing statutes. And, for good
measure, SR 14-02 itself was never published for notice and comment or
submitted for Congressional review under the Congressional Review Act.
By all accounts, the practices at the other Federal banking agencies
have generally been similar, though generally not codified in writing.
\21\
---------------------------------------------------------------------------
\20\ SR 14-2/CA14-1: ``Enhancing Transparency in the Federal
Reserve's Applications Process'' (Feb. 24, 2014). Most large
transactions involve a Federal Reserve review and therefore SR 14-2 may
well directly affect many bank-level (in addition to bank holding
company level) applications in that context.
\21\ Applicable OCC and FDIC guidance--which like SR 14-2 have
never been subject to public comment--differ from 14-2 in some respects
and are less detailed. The OCC's Comptroller's Manual, Business
Combinations (July 2018) states that in the context of MRAs and program
deficiencies, the OCC assesses the nature and duration of the issues,
the institution's progress in remediating identified program
deficiencies, and whether the proposed combination would detract from
the remediation, exacerbate existing problems, or create new problems
for the resulting institutions. In the context of an enforcement
action, the Manual simply states that in these circumstances the bank
should consult with its supervisory office and Licensing Division
before pursuing any plans for a transaction. See ``Comptroller's
Manual'' at 7-8. The FDIC's 1998 ``Statement of Policy on Bank Merger
Transactions'' simply provides that ``[a]dverse finding may warrant
correction of identified problems before consent is granted, or the
imposition of conditions.''
---------------------------------------------------------------------------
For perspective on how odd this new enforcement regime is, consider
that we routinely see serious compliance violations across a wide range
of American industries. Those companies are subjected to enforcement
proceedings and are required to pay fines and remediate their
practices, but no one ever suggests that while those proceedings are
pending they should be stopped from opening new franchises, building
new plants, developing new drugs, designing new cars, or launching new
apps. Yet in banking, regulators often prohibit any type of expansion
by the bank as a reaction to any compliance failure.
Thus, SR 14-02 states that covered banks seeking to expand must
``convincingly demonstrat[e] that the proposal would not distract
management from addressing the existing problems of the organization or
further exacerbate these problems.'' Again, it is very difficult to
imagine how senior management could not simultaneously oversee, for
example, one group of employees mailing reimbursement checks to
consumers under a consumer compliance settlement and another group of
employees opening a branch in Philadelphia or buying an asset manager
in Los Angeles. In other industries, one presumes that a retailer with
a data breach can still open new stores, or that an auto company with a
fatal defect in its ignition switch can still open new dealerships. Yet
over the past 10 years, a contrary illogic has significantly impaired
the ability of banks to invest and expand to serve their customers
better.
The unique reliance on growth restrictions in banking is even more
remarkable when one realizes that banks already are subject to more
potential penalties, imposed by more potential regulators, than
practically any other industry. The inability to open a new branch is
not necessary as a deterrent.
Thus, under agency practice, any unresolved consumer compliance
issue or any unresolved supervisory issue can prevent a bank from
expanding in any way. There are two results. First, obviously, bank
expansion and investment in new technologies has been curtailed to an
unhealthy extent. Second, and more importantly, this arrangement has
given examiners powers never contemplated by Congress, without any
procedural check or balance.
To be clear, Congress has authorized the banking agencies to
restrict the growth of financial institutions under some circumstances,
but those circumstances were intended to be quite limited. Under
section 4(m) of the Bank Holding Company Act and implementing
regulations, and the Board's Regulation Y, a financial holding company
which receives either a rating of Deficient-1 or Deficient-2 on any
component under the LFI rating system or whose subsidiary bank receives
a CAMELS ``3'' composite or Management rating must receive Federal
Reserve approval to conduct certain nonbanking activities. \22\ A
related provision requires the Board to consider a company's
effectiveness in combatting money laundering activities in connection
with applications to acquire bank shares or assets. \23\ Similarly,
under the law governing interstate mergers and branching, for a bank to
open a branch in any State in which it does not already have a branch,
the bank must satisfy certain statutory standards and requirements for
the bank to be ``well capitalized'' and ``well managed.'' \24\
---------------------------------------------------------------------------
\22\ 12 U.S.C. 1843(m)(3); 12 CFR 225.83(d)(2).
\23\ 12 U.S.C. 1842(c)(6).
\24\ 12 U.S.C. 1831u. A similar requirement exists for approval
of interstate mergers.
---------------------------------------------------------------------------
These provisions have been extended far beyond their statutory
intent and become part of the shadow enforcement regime. First, as
noted above, the requirement to consider anti- money-laundering
effectiveness in connection with some applications became a bar to any
expansion by any institution with an outstanding AML consent order,
regardless of whether the alleged problems were minor or major, or what
their State of remediation was. \25\ Second, in conditioning certain
nonbanking activities on a ``3'' rating, Congress understood that
rating to reflect the management of the overall organization. Indeed,
by its own terms, the Management rating is intended to reflect ``the
capability of the board of directors and management, in their
respective roles, to identify, measure, monitor, and control the risks
of an institution's activities and to ensure a financial institution's
safe, sound, and efficient operation in compliance with applicable laws
and regulations.'' \26\ Postcrisis, however, the Management rating has
become less about the financial condition of the bank and more about
compliance with banking agency rules, guidance, and examiner
preference. This represents a fundamental change.
---------------------------------------------------------------------------
\25\ According to Federal Reserve SR 13-7, which addresses de novo
branching by State member banks rated ``3'', ``In all cases, the bank's
Bank Secrecy Act/Anti- Money-Laundering program needs to be considered
satisfactory.''
\26\ Uniform Financial Institutions Rating System, 61 FR 67021,
67027 (Dec. 19, 1996).
---------------------------------------------------------------------------
The direct result of this shift (lower ratings) was less important
than its indirect result: adding an enforcement mechanism for MRAs that
Congress never considered. Once the Management rating became subjective
and untethered to financial condition, the threat of a downgrade to a
``3'' rating became as powerful an enforcement tool as any formal
order. So, too, did an actual downgrade, with the need for Federal
Reserve approval to continue conducting nonbanking activities unless
the bank remediate exactly as instructed.
Again, though, section 4(m) relates only to nonbanking activities
conducted by bank affiliates. It has nothing to do with the
establishment of branches, or even the acquisition of or merger with
other depository institutions or bank holding companies. Congress has
never conditioned the opening of a branch on a particular management
rating of the bank. Yet in practice, the agencies have done that
themselves. \27\
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\27\ See Louisiana Public Service Comm'n v. FCC, 476 U.S. 355, 375
(1986) (``[A]n agency literally has no power to act . . . unless and
until Congress confers power upon it . . . . Thus, we simply cannot
accept an argument that the FCC may nevertheless take action which it
thinks will best effectuate a Federal policy. An agency may not confer
power upon itself.'')
---------------------------------------------------------------------------
Examination Appeals
As the banking agencies have avoided statutory enforcement
mechanisms that come with congressionally established procedural rights
in favor of informal but equally binding examination mandates, the
importance of the examination appeals process, and the agency
ombudsman, has grown significantly.
Sadly, for both structural and practical reasons, these tools are
effectively dead letters for banks, and thus almost never used. Between
1995 and 2012, the OCC issued 157 decisions, and the Federal Reserve
issued 25. \28\ Consider that against a backdrop of tens of thousands
of MRAs, and clearly something is very, very wrong.
---------------------------------------------------------------------------
\28\ Julie Anderson Hill, ``When Bank Examiners Get It Wrong:
Financial Institution Appeals of Material Supervisory Determinations'',
92 Wash. U. L. Rev. 1101 (2015). The author notes that data from 1995-
2000 was unavailable for the Federal Reserve.
---------------------------------------------------------------------------
The reasons for the paucity of appeals are not hard to divine.
First, every banker and bank counsel is taught that ``examiners have
long memories,'' such that potential for retaliation is always a
concern. \29\ Second, appeals are made to the same agency that assigned
the rating. For example, at the Federal Reserve, the ultimate arbiter
in an appeal is a designated Federal Reserve Board Governor, while at
the FDIC, appeals are ultimately decided by the agency's Supervision
Appeals Review Committee.
---------------------------------------------------------------------------
\29\ In recognition of this tendency to retaliate, the agencies
have adopted internal policies criticizing examiner retaliation against
institutions for pursuing supervisory appeals. One can question their
effectiveness in practice, however.
---------------------------------------------------------------------------
To their considerable credit, some of the agencies have recently
sought public comment on their internal appeals processes. My
suspicion, though, is that the problem cannot be solved without related
reforms of the type discussed in this testimony.
Attorney-Client Privilege
A case study in the examination status quo concerns the attorney-
client privilege. Examiners take the position that they can override
attorney-client privilege, whether in the course of an ordinary
examination of a bank or of an enforcement action. Thus, for example,
in the latter case, the agencies take the position that they can begin
their investigation by seeking the interview notes of inside and
outside litigation counsel who have been defending the case. This is
remarkable. So too is the fact that the SEC and the Department of
Justice take the opposite position in the enforcement context.
What is more remarkable is that there is no legal basis for this
position. Seven of the Nation's leading law firms have done a joint
opinion that concludes ``There is no valid legal basis for the Agencies
to demand that supervised institutions disclose privileged material. As
discussed, all the relevant case law and fundamental legal principles
compel this conclusion.'' \30\ The American Bar Association in a 2012
letter to the CFPB agreed that the examination powers of the agencies
do not allow them to invade the privilege, finding ``the ABA is not
aware of any reported Federal appellate court case holding the Federal
Banking regulators--or any other Federal agencies--can require
production of privileged materials, nor do the Federal banking statutes
contain such authority.''
---------------------------------------------------------------------------
\30\ See ``Banking Regulators' Examination Authority Does Not
Override Attorney-Client Privilege'', Opinion of Cleary Gottlieb Steen
and Hamilton; Covington and Burling; Davis Polk; Debevoise and
Plimpton; Simpson Thacher and Bartlett, Sullivan and Cromwell; and
Wilmer Cutler Pickering Hale and Dorr, available at https://
www.sullcrom.com/siteFiles/Publications/SC-Publication-Banking-
Regulators-Examination-Authority-Does-Not-Override-Attorney-Client-
Privilege.pdf.
---------------------------------------------------------------------------
Of course, the agencies state that the privilege still holds with
respect to all other third parties, and that providing privileged
material to examiners or enforcement lawyers does not constitute a
waiver of the privilege. While this is true, it is akin to saying that
only the Government will be reading your email or searching your house,
not other third parties. The fact that the Government is potentially
accessing any and all privileged information absolutely vitiates the
goal of the privilege, which is to ``encourage full and frank
communication between attorneys and their clients and thereby promote
broader public interests in the observance of law and administration of
justice.'' \31\
---------------------------------------------------------------------------
\31\ Upjohn Co. v. United States, 449 U.S. 383, at 389, citing
Hunt v. Blackburn, 128 U.S. 464, 470 (1888).
---------------------------------------------------------------------------
Notably, none of the banking agencies has contested the legal
merits of the seven-firm memorandum in any venue at any time. Rather,
they have continued their practice unabated. And banks have almost
universally complied.
Why? This question really gets to the heart of the postcrisis
hidden regime. First, it is unlikely that any bank (or trade
association) would have standing to bring a declaratory judgment action
against the agencies. A court's likely response would be that a case or
controversy would exist only if a bank refused to provide privileged
material and the agencies served a subpoena for it. But no bank is
going to take that step, because of concerns about retaliation and
reputational harm if labeled as uncooperative. For that reason, the
Department of Justice and SEC affirmatively state that a bank's failure
to provide a ``voluntary'' waiver will not be considered against it in
assessing cooperation and penalties. Neither, importantly and
conversely, will a company be rewarded for a waiver. \32\
---------------------------------------------------------------------------
\32\ 28710-20; SEC Division of Enforcement Office of Chief
Counsel, ``Enforcement Manual'' (Oct. 28, 2016).
---------------------------------------------------------------------------
As a result, banks (and indeed, banks alone) operate without the
benefit of the candid legal advice that the attorney-client and work
product privileges have ensured for centuries. Examiner pressure on
keeping minutes of all management committee meetings and criticizing
banks when the minutes are not specific enough are another means to
chill candid conversations within the banking organization itself.
The Results
The results of this new supervisory regime are significant. Many
banks of all sizes have been restricted from branching, investing in
new businesses, or merging for reasons that are neither public nor
assessable. (Indeed, the Committee might consider asking the banking
agencies for a list of all banks that have been subject to a nonpublic
growth restriction over the past 5 years, to be reviewed in camera.)
Bank technology budgets often are devoted primarily not to innovation
but to redressing frequently immaterial compliance concerns. Indeed, an
underrated cause of the rise of FinTech companies over the past 10
years has been the fact that banks were spending their innovation
budgets on compliance systems geared towards immaterial issues.
Board and management time has been diverted from strategy or real
risk management and instead spent remediating frequently immaterial
compliance concerns and engaging in frequent meetings with examiners to
ensure that they are fully satisfied.
In effect, Congress has said that banks are free to develop
different and competing practices, so long as they do not rise to the
level of unsafe or unsound. But ``unsafe and unsound'' is a high bar
from an evidentiary perspective, and due process can be a bother; thus,
bank supervision has shifted away from this legal concept to a more
malleable and supple one--``best practices'' enforced by MRAs (Matters
Requiring Attention) that are effectively unappealable.
A Way Forward
Notwithstanding the problems and concerns I have articulated, it is
important to acknowledge several recent developments that suggest more
attention is being paid to these issues:
The General Accountability Office in a series of opinions
requested by Members of Congress has ruled that various types
of agency action self-described as ``guidance'' are in fact
rules under the Congressional Review Act; they are therefore
unenforceable until they are submitted for Congressional review
and not invalidated. Furthermore, these decisions have served
to highlight the fact that rules the agencies have clearly
treated as binding \33\ not only were not submitted to Congress
but also were never published for public comment, in violation
of the Administrative Procedure Act.
---------------------------------------------------------------------------
\33\ See, e.g., Ryan Tracey, ``Feds Win Fight Over Risky-Looking
Loans'', Wall Street Journal (Dec. 2, 2015), available at https://
www.wsj.com/articles/feds-win-fight-over-risky-looking-loans-
1449110383.
Last September, the Federal banking agencies and CFPB
issued an ``Interagency Statement Clarifying the Role of
Supervisory Guidance'', which reaffirmed that supervisory
guidance ``does not have the force and effect of law, and the
agencies do not take enforcement actions based on supervisory
guidance.'' \34\ This represented an important step forward in
ensuring that agency guidance is issued and applied in a manner
consistent with the APA and the Congressional Review Act and,
more broadly, that formal examination criticisms focus on
matters material to the financial condition of a bank.
Unfortunately, there are numerous reports that the statement
(which is itself nonbinding guidance) is not being followed in
practice.
---------------------------------------------------------------------------
\34\ See, e.g., Federal Reserve Supervisory Letter SR 18-5 / CA
18-7, Interagency Statement Clarifying the Role of Supervisory Guidance
(Sept. 12, 2018).
Also last year, the CFPB issued a bulletin that established
two categories of examiner mandates--a step that could serve as
a model for the Federal banking agencies. The bulletin notes
that the CFPB would continue to use MRAs going forward, but
only to address and correct issues that are ``directly related
to violations of Federal consumer financial law''; \35\ the
bulletin then establishes a separate and distinct category of
communication, the ``Supervisory Recommendation'' (SR), which
will be used ``to recommend actions for management to consider
taking . . . when the Bureau has not identified a violation of
Federal consumer financial law, but has observed weaknesses in
CMS.'' \36\ Thus, the CFPB statement allows for an important
dialogue to continue between examiners and the institution with
respect to nonmaterial matters, but without legal sanction. In
other words, with respect to matters that do not involve a
violation of law, a bank's management is free to design and
innovate, while examiners remain free to identify best
practices and provide input.
---------------------------------------------------------------------------
\35\ BCFP Bulletin 2018-01, ``Changes to Types of Supervisory
Communications'' (Sept. 25, 2018) (emphasis added).
\36\ Id.
Last November, the Federal Reserve finalized a new ratings
system for large financial institutions that was substantially
clearer, more objective, and better focused on core matters of
financial condition than its predecessor. Although not perfect,
this new framework not only represents a meaningful shift
closer to transparency and the rule of law for those
---------------------------------------------------------------------------
institutions.
The FDIC has recently withdrawn hundreds of Financial
Institution Letters, its version of regulatory guidance.
In general, there has been a recent trend towards
publishing more regulatory requirements for public comment. As
the numbers show, the number of outstanding MRAs has reduced
over the past few years. Still, the numbers remain
extraordinarily high, particularly given that by every possible
objective measure the banking industry is in good health.
Furthermore, we cannot know whether those lower numbers reflect
a greater focus on material safety and soundness matters by
examiners, or simply the fact that banks have spent billions of
dollars redressing every possible examiner concern for the past
few years.
More broadly, some banks have reported that examinations have
recently become more focused on material issues. Others, though, have
not. But the primary concern remains: when the great majority of
requirements are imposed in secret, with no process, they can vary
across banks and across time because there simply are no checks or
balances. So, this fundamentally is not an issue of tighter regulation
or looser regulation (deregulation) but an issue of consistent and
predictable regulation that is consistent with the law.
Potential Next Steps
How could matters be improved?
First, the banking agencies should grant the petition for
rulemaking filed by the Bank Policy Institute and the American Bankers
Association, follow the example set by the CFPB, and confirm what they
have already said in a recent statement: that guidance is not binding
and will not form the basis for an MRA, and that only violations of law
(including an unsafe and unsound practice) will form the basis for an
MRA. This step is necessary because by numerous accounts their earlier
statement is being disregarded in practice.
Second, more broadly, the agencies should seek public comment on
what an MRA is. If an MRA is an unenforceable suggestion, with no
consequences for a company's ability to grow or invest, then they
should make that clear. If it is a de facto order, then it should be
issued only when there is a legal basis for it--a violation of law or
an unsafe or unsound banking practice--and the bank should receive APA-
prescribed process.
Third, a zero-based review of the application process should be
undertaken by each banking agency. Pending such a review, the Federal
Reserve should rescind its SR Letter 14-02 (establishing a series of
ultra vires rules for bank expansion) and formally return to applying
statutory standards for branching, merger, and investment applications.
The OCC, which has acted similarly but without issuing public guidance
to that effect, should do likewise. Any resulting application process
should emphasize transparency and accountability. For example, the
Governors of the Federal Reserve Board, the Comptroller of the
Currency, and the Directors of the FDIC personally should receive
regular reports on applications that have been pending for more than a
given period--say, 75 days--along with the reason for the delay. The
pendency of an investigation should not constitute grounds for delay
absent extraordinary circumstances.
Fourth, the CAMELS rating system should be rethought entirely. \37\
The Federal Reserve Board has recently adopted a significant rethinking
of holding company ratings, and the banking agencies/FFIEC should do
likewise. Such a review should emphasize the benefits of objective,
transparent, consistent standards over subjective, opaque, and ad hoc
standards. In particular, a management component, if retained, should
not be a highly subjective wild card that can be used to deem a bank
with solid capital, liquidity, and earnings to be unsafe and unsound,
and thereby subject to an expansion ban. Any assessment of management
should focus on financial management. A meaningful appeals process
should be instituted.
---------------------------------------------------------------------------
\37\ The expansion of bank supervision is having an impact on the
economy. See Greg Baer and Jeremy Newell, ``How Bank Supervision Lost
Its Way'', Underwritings: The BPI Blog (May 25, 2017), https://bpi.com/
how-bank-supervision-lost-its-way/.
---------------------------------------------------------------------------
Conclusion
Many thanks for the opportunity to appear before you today.
______
PREPARED STATEMENT OF MARGARET E. TAHYAR
Partner, Davis Polk and Wardwell LLP
April 30, 2019
Many sectors of the economy are regulated. Only the banking sector
is also supervised. The legal framework that governs the banking sector
and the banking agencies is written and public. Whether you agree or
disagree with the policy choices, the legal framework is made in full
sight of all. Supervision happens behind closed doors. It relies upon
secrecy and involves a system of discretionary actions by supervisory
staff. This zone of secrecy is traditionally justified for the sake of
financial stability and bank safety and soundness. There has long been
an uneasy truce between the transparency and accountability required by
the rule of law and the secrecy and discretion of supervision.
That uneasy truce has become untenable. One canary in the coal mine
is the increase in leaks of confidential supervisory information. The
melody that canary is singing is changed societal mores about
transparency. It also matters that confidential supervision can be a
shield that makes it more difficult to hold the banking supervisors
accountable. The public, including the Congressional oversight
committees, scholars and others, has limited information about the work
of the banking supervisors. Should they be praised or criticized? \1\
Nobody knows. The public debate, and academic scholarship, is
critically underinformed.
---------------------------------------------------------------------------
\1\ Banking supervisors are highly professional men and women
acting in good faith to carry out an important mission in monitoring
the banking sector for safety and soundness and compliance with the
law. The pressures on the supervisory staff during and since the
Financial Crisis have been enormous. I am convinced that more openness
will lead to as much praise as criticism.
---------------------------------------------------------------------------
As Hyman Minsky has noted, ``Perfection is out of the question, but
better is possible.'' \2\ Understanding that some secrecy is necessary
for bank safety and soundness and candid conversations, I recommend
beginning with three changes.
---------------------------------------------------------------------------
\2\ Hyman P. Minsky, ``Financial Instability and APT Bank
Supervision'', Hyman P. Minsky Archive Paper 470, 24 (1992).
---------------------------------------------------------------------------
First, the regulations governing confidential supervisory
information need to be modernized. Their core framework was put in
place during the late 1960s and only lightly updated in the mid-1990s.
They no longer match the reality of the digital age. The realm of
confidential supervisory information should be narrowed to the core
minimum necessary to protect financial stability or individual bank
safety and soundness.
Second, we should recognize that one of the aftereffects of the
Financial Crisis has been a vast expansion in the nature of supervision
and its zone of secrecy and discretion. Social and economic policy
choices are being made within a shadow regulatory system. From ``moral
suasion'' to the matters requiring attention and matters requiring
immediate attention that come out of the examination process, as well
as horizontal reviews, banking organizations are subject to both a
public and a nonpublic web of guidance and expectations. Sensible
guardrails are needed so that supervision does not make economic and
social policy choices that impact credit, jobs and growth in an ad hoc
manner free from oversight. We should also recognize that secret lore
\3\ and guidance have a troublesome placement in the legal framework
since the concept of secret law in a democracy is on shaky ground.
---------------------------------------------------------------------------
\3\ I prefer the term ``secret lore'' to ``secret law'' even
though many banking lawyers, myself included, will, in conversation
refer to ``secret law.'' We do well to remind ourselves that, in a
democratic country, law cannot be secret. And, under the Administrative
Procedure Act, it is not.
---------------------------------------------------------------------------
Third, Congress and the banking agencies need to think clearly
about how to create an environment where the supervisory staff are
given the training, resources and tools that would permit them to do
their jobs in a way that is more transparent to the world, where there
is more accountability and where there is more consistency with the
rule of law. As the zone of secrecy and discretion has widened, it has
increasingly become delinked from the legal framework of the regulatory
State. One way to increase those tools and resources, in light of the
increased complexity of both the legal framework and the banking
sector, is that training for the supervisory staff should be expanded
to include core modules on the rule of law in a Constitutional
democracy and the legal framework that governs the regulatory State.
The time has come for a rebalancing of how the banking regulators
supervise banking organizations. The extensive scope of the shadow
regulatory system, which operates without transparency and with limited
accountability, has become untenable in the digital age. The
rebalancing should be in favor of more transparency, accountability and
observance of the rule of law by the banking supervisors. We need to
get this balance right as we move toward a more digital world with
increasing reliance on algorithms. If the norms of the rule of law,
transparency, and accountability are not part of supervisory culture,
they will not find their way into new technology.
We should not jettison confidential supervision but we ought to
reform it for the 21st Century digital era.
The need to rethink the theory of supervision and how we might go
about it are inextricably linked to its history. I therefore begin in
Part I by describing that history and suggesting principles for how to
reform the regulators' approach to confidential supervisory
information. In Part II, I set forth my view that supervisory staff
have not been trained in the legal framework at a time when their jobs
have grown tougher and the legal framework itself has become more
complex.
I. The Need To Reform Confidential Supervisory Information
The Federal banking regulators have long operated under a cultural
mindset different from other independent Federal agencies both in the
financial sector and in the larger regulatory State. \4\ History
explains why the separate cultural tradition exists. This Part examines
two regulatory traditions--a tradition of secrecy and discretion unique
to banking supervision and a New Deal tradition of transparency in the
regulatory State more broadly.
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\4\ For the purposes of this testimony, the concept of a banking
regulator is limited to the Federal Reserve, the OCC and the FDIC. The
CFPB operates under newer, more transparent cultural norms.
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A. The Tradition of Secrecy and Discretion
In banking supervision, two regulatory traditions have lived in an
uneasy truce since the New Deal. The central core and direct ancestor
of Federal banking supervision is the confidential bank examination,
which dates back to at least the mid-19th Century. \5\ Many do not
realize, however, that these traditions of secrecy and discretion
developed at a time when there was limited Federal regulation of any
sector, long before Federal deposit insurance, the creation of the
Federal Reserve as the lender of last resort, the New Deal
administrative State of the 1930s and the Administrative Procedure Act
(APA) of 1946. The lack of a solid foundation in Federal law for many
of the secrecy traditions of the banking regulators will surprise many
who have accepted them as if they were contained in hallowed texts.
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\5\ As Professor Conti-Brown has noted, ``the Examination Report
from the Comptroller of the Currency for each bank remained the same in
general form from 1865 to 1953--an extraordinarily stable institutional
arrangement across a long period of economic, political, legal, and
financial tumult.'' Peter Conti-Brown, ``Stress Tests and the End of
Bank Supervision'', The Regulatory Review (Apr. 21, 2016), available at
link.
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There is another, more recent policy tradition, dating from the New
Deal, which created Federal securities disclosure laws and put in place
a legal framework that favors transparency and accountability by
administrative agencies. Both traditions must abide by the rule of law
in our Constitutional democracy.
The truce remained workable when banks were engaged almost
exclusively in taking demand deposits and making commercial loans. But,
as market competition and technological change made the banking sector
more complex, the uneasy and unexamined truce was, counterintuitively,
sustained by the expansion of both the tradition of secrecy and
discretion and that of transparency and the rule of law. In today's
complex times, we have both more secrecy and discretion and more
transparency. The problem is that we have them randomly and without
serious thought about how the zone of secret supervision ought to work
in the 21st Century digital era.
The bank examination, where an outside person appointed by the
State examines the books and records of the bank, has a long history.
The 19th Century bank examiner's job was to look closely at the loans
and liabilities of each individual bank and to make sure that vault
cash and reserves really existed. \6\ He, and in the 19th Century it
was always a he, performed his task in conditions of utmost secrecy.
\7\ His critically important job was to assess whether the bank was
safe and sound in an era when rumors could lead to deposit runs and
bank panics were frequent. \8\ Thus developed the tradition of the
secret bank examination, the crime of spreading false rumors about a
bank \9\ and the view that bank supervision was best done inside a cone
of confidentiality to preserve the stability of the financial system
and avoid triggering a bank panic.
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\6\ Simpler times exemplified in ``It's a Wonderful Life'' by Mr.
Carter, a diligent bank examiner checking whether the Bailey Building
and Loan had cash in its vault.
\7\ The first woman bank examiner was Adelia M. Stewart who
officially become a bank examiner in 1921, after having gone to law
school at night and having worked as a ``clerk-stenographer'' at the
OCC since 1892. In 1922, the year after she was the first woman to pass
the test for national bank examiners, she was promoted to head of the
examination division. See Office of the Comptroller of the Currency,
``The Changing Role of Women in the Workplace'', available at link. I
like to imagine that the first woman examiner understood the tight link
between the legal framework and supervision.
\8\ Panics took hold of the American banking sector in 1819, 1837,
1857, 1873, 1893, 1901, 1907, 1929, and 1933, as well as in 2007-2008.
\9\ N.Y. Banking Law 671 False Statements or Rumors as to Banking
Institutions.
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Central to the concept of a confidential bank examination is the
need for a free flow of communication in conditions of high trust
between a bank's management, its board of directors and supervisory
personnel. Bank examiners and the banking sector feel strongly about
the need for this candid conversation, which has contributed to the
creation of a common-law bank examiners' privilege that keeps reports
out of the public domain and out of the hands of the plaintiff's bar.
\10\ The other justification for a confidential bank examination report
has been that it contains private personal information about bank
customers and unvarnished views about the creditworthiness of
borrowers. The free flow of information, much of it deliberately and
appropriately leaning toward the negative and critical, and the
protection of personal information are policy goals to be taken
seriously today.
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\10\ The need for candid conversations in the supervisory context
is hotly defended in the courts by banking regulators. By sharp
contrast, banking regulators frequently take the view that the
attorney-client privilege should be waived by the banks or limited in
supervisory communications. So, sometimes candid conversations are
encouraged and sometimes they are not.
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The Federal banking regulators used the passage of FOIA in the mid-
1960s, a statute meant to expand the scope of information available to
the public, to expand their zone of confidentiality beyond the scope of
the traditional bank examination. There is no Federal statute that
explicitly prohibits anyone other than bank examiners from disclosing
the bank examination or parts of it, \11\ such as CAMELS or other
ratings. \12\ Soon after the passage of FOIA, \13\ each of the Federal
Reserve, the OCC and the FDIC promulgated stern but ambiguous
regulations that contain additional constraints on the sharing of
confidential supervisory information. These regulations also introduced
the assertion of the Federal banking regulators that bank examinations
and other supervisory communications are the property of the banking
regulators.
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\11\ There is a Federal criminal statute that prohibits bank
examiners from disclosing the results of an examination. See 18 U.S.C.
1906. Few are aware, however, that the Comptroller may, if he is not
satisfied with the response of a national bank, disclose an
examination. See 12 U.S.C. 481.
\12\ CAMELS is used in this testimony for simplicity even though
there are other ratings systems with their own acronyms.
\13\ The precise words of the FOIA statute's exemption, which were
originally drafted by the banking regulators, encompass matters
``contained in or related to examination, operating, or condition
reports prepared by, on behalf of, or for the use of an agency
responsible for the regulation or supervision of financial
institutions'' from disclosure.
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The authority to treat confidential supervisory information as
property is less solid than one might think, relying on a general
Federal statute relating to Federal Government property. One suspects
that the general Federal property law was pressed into service by the
Federal banking regulators because no other statutory authority was
available. The result of viewing bank examinations or other supervisory
communications as the property of the State is that stealing them or
misusing them becomes a crime. It is solely from this source that the
criminal prohibitions on banking organizations revealing bank
examinations or other supervisory communications derive. With the
increased scope of confidential supervisory information along with the
changes in technology and societal mores, it is increasingly
uncomfortable for banking entities and their personnel to have to worry
about criminal liability for the ``property'' of the banking
regulators. \14\
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\14\ One of the elements of the confidential supervisory
information regulations that needs updating is the requirement that any
``property'' of the banking regulators be viewed on bank premises. This
made sense in the late 1960s, but with the development of email and the
cloud, it no longer does.
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The banking regulators have defined this type of ``property'' very
broadly in their regulations, the plain text of which could be read to
encompass a vast amount of information. Tracking the statute, the
Federal Reserve's definition of confidential supervisory information
includes any document prepared by a banking organization ``for the use
of'' the Federal Reserve. \15\ The FDIC's definition is similar. \16\
The Federal Reserve's definition excludes documents prepared by the
banking organization ``for its own business purposes and that are in
its possession.'' \17\ The FDIC does not have such an explicit
exclusion. The OCC's definition of confidential supervisory information
(in OCC parlance, ``nonpublic OCC information'') is broader and
includes any ``record'' that is ``obtained'' by the OCC in connection
with the OCC's performance of its duties, including ``supervision.''
\18\
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\15\ 12 CFR 261.2(c)(1)(iii).
\16\ See 12 CFR 309.5(g)(8).
\17\ 12 CFR 261.2(c)(2).
\18\ 12 CFR 4.32(b).
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These regulations were put in place before a world of email,
electronic files, the cloud and PowerPoint and at a time when the data
and information flow was much smaller. The line between data prepared
by the banking organization ``for the use'' of the agency or for its
own ``business purposes'' is a troublesome one in the supervisory
context today. It cannot be that, by some means of transubstantiation,
every bit of data or every PowerPoint sent to the regulators becomes
confidential supervisory information. \19\
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\19\ Even if such information were not considered confidential
supervisory information, other exemptions from FOIA disclosure may
apply, such as the exception for trade secrets, confidential commercial
or financial information and personal information.
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The Federal Reserve, the FDIC and the OCC all permit sharing of
confidential supervisory information within the banking organization.
Under the OCC's regulation, sharing within the banking organization is
permitted only ``where necessary or appropriate for business
purposes.'' \20\ The OCC has not defined what would be necessary or
appropriate for business purposes and criminal liability may hang on
this ambiguous phrase. These ambiguities will get more intense as we
enter into more technologically infused RegTech. There is a real
question whether these vague standards, along with the changes in the
world since the 1960s, ought to continue to contain the threat of
criminal liability.
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\20\ 12 CFR 4.37(b)(2). The Federal Reserve does not have this
limitation on sharing in the group. The FDIC's regulations require that
there be an annual board resolution for a bank to share a report of
examination with its parent, which must contain a number of archaic
requirements. These requirements include that the resolution
specifically name the parent holding company and state the snail mail
address to which the reports are to be sent. See 12 CFR
309.6(b)(7)(iii)(B).
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B. The Other Tradition of Transparency
The other regulatory tradition has as its central paradigm that of
the disinfectant of disclosure. \21\ Created in the New Deal or as an
immediate reaction to it, the norms of the securities disclosure laws
and the APA illustrate this cultural mode of transparency. These laws
take a very different approach to the relationship between the
Government and the governed.
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\21\ As Justice Brandeis famously said just before his time on the
court, ``[s]unlight is said to be the best of disinfectants.'' Louis D.
Brandeis, ``Other People's Money and How the Bankers Use It'' 93
(Frederick A. Stokes Company ed. 1914).
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The APA is properly viewed as a ``bill of rights for the new
regulatory State.'' \22\ It demands that regulations be public and
subject to notice and comment, and has transparency and accountability
as its central core. The APA was the end product of a decade's worth of
political wrangling between New Dealers, who fought for the expansion
of a discretionary administrative State, and those concerned with the
rule of law and transparency. A compromise was finally reached
following Truman's assumption of the Presidency, in a post-WWII
environment more sensitive to authoritarian tendencies. \23\ Public
choice scholarship since the New Deal has widely shown that the
regulators also have their own stakeholder interests.
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\22\ George B. Shepherd, ``Fierce Compromise: The Administrative
Procedure Act Emerges From New Deal Politics'', 90 NW. U. L. Rev. 1557,
1558 (1996).
\23\ See id. at 1683.
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It was not immediately clear whether or to what extent this new
approach would apply to banking regulators, at least from the
perspective of the supervisors accustomed to secrecy and discretion.
While for many readers the New Deal and the passage of the APA may seem
like long ago developments, it is important to understand that, by the
time of their passage, the cultural traditions and institutional path
dependency of the banking supervisors had already been set. Early
versions of the bill that became the APA excluded the Federal banking
agencies from its scope. \24\ The banking regulators might be forgiven,
in the early years after the APA, for thinking that the APA only
lightly applied to them. But we are now nearly 85 years since the
passage of the Securities Exchange Act and 73 years since the passage
of the APA. The impulse toward secrecy remains strong within the
banking regulators, even as transparency and accountability have become
foundational tenets of administrative law. \25\
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\24\ See id. at 1618.
\25\ As stated by Professor Gillian Metzger, ``Accountability is
administrative law's central obsession, which it furthers through
mechanisms for public participation, congressional oversight,
centralized White House regulatory review, and judicial review. Fear of
agency capture is a recurring theme, as is the concern that agencies
will wield their delegated powers arbitrarily.'' Gillian E. Metzger,
``Through the Looking Glass to a Shared Reflection: The Evolving
Relationship Between Administrative Law and Financial Regulation'', 78
Law and Contemp. Probs. 129, 130 (2015).
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A key question is how both of these regulatory traditions--the
long-standing secrecy of banking regulators and the 20th Century
paradigm of a transparent administrative State more broadly--have
managed to coexist in an uneasy truce for so long. One part of the
answer is counterintuitive: as the banking sector has become more
complex, both transparency and secrecy have expanded in scope.
For example, the scope of financial disclosure and its companion
market discipline has been expanding over the last 50 years vis-a-vis
banking organizations. \26\ In addition to the constraints of the
securities laws, Pillar 3 of Basel II, now in full implementation, also
requires more disclosure. The existence of enhanced capital and
liquidity requirements, subordinated debt, credit default swaps, and,
more recently, TLAC debt that might be bailed in, all push towards
market signaling functions.
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\26\ The long-standing spat between the banking regulators and the
SEC on the calculation of allowances for loan losses is an example of
the transparency and secrecy traditions clashing. See George J. Benston
and Larry D. Wall, ``How Should Banks Account for Loan Losses?'',
Federal Reserve Bank of Atlanta (2005), available at link. That clash
was resolved by an administrative detente in the early 2000s.
Nonetheless, so-called GAAP/RAAP debates sometimes show up in the
footnotes to call reports. It remains to be seen how the implementation
of CECL will impact this dynamic.
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The public nature of these disclosures has become so embedded in
our consciousness that many have forgotten that the requirements to
disclose hundreds of pages of information, whether in periodic reports
under the securities laws, Pillar 3 or the many public reports filed by
banking organizations, were once new and shocking in the banking
sector. Banking-sector requirements for disclosure lagged the
disclosure norms in other sectors by many years. Call reports were not
made public by the FDIC until 1972 and even then, it was upon request,
with a fee for search costs, \27\ bank stocks were not subject to
periodic reporting until 1964, \28\ the requirements of Guide 3 date
from 1976 \29\ and audited bank financial statements were not required
under Federal law until 1991. \30\ When CAMELS ratings were first
created, they were not even disclosed to bank management. \31\
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\27\ See 37 FR 28607, 28608 (Dec. 28, 1972).
\28\ See Alfred D. Mathewson, ``From Confidential Supervision to
Market Discipline: The Role of Disclosure in the Regulation of
Commercial Banks'', 11 J. of Corp. L. 139, 141 (1986).
\29\ See id. at 161.
\30\ See Eugene N. White, ``Lessons From the History of Bank
Examination and Supervision in the United States 1863-2008'', in
Financial Market Regulation in the Wake of Financial Crisis: The
Historical Experience Conference 15, 34 (2009), available at link.
\31\ See Ron Feldman, Julapa Jagtiani, and Jason Schmidt, ``The
Impact of Supervisory Disclosure on the Supervisory Process: Will Bank
Supervisors Be Less Likely To Downgrade Banks?'' in Market Discipline
in Banking: Theory and Evidence, edited by G. Kaufman in Research in
Financial Services, Elsevier, at 3 (2003), available at link.
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The formal and informal punitive actions of the banking regulators
against banking organizations have also become increasingly more
public. Banking regulators were not given formal enforcement powers
until 1966. Before that, moral suasion and ``jawboning'' were the main
powers of the banking supervisors, backed by the nuclear, and therefore
not used, threat to revoke a charter or terminate deposit insurance.
Even after the banking regulators were given the power to remove
directors and officers, impose civil money penalties and enter into
informal written memoranda or formal consent or cease and desist
orders, the tendency was to favor informal--that is, nonpublic--board
resolutions and memoranda of understanding (MOU). The long litany of
very public post-Financial Crisis consent orders shows that the old
custom has definitively changed to be more transparent. As a result,
there is an increasing tendency to disclose informal and private MOUs
in securities disclosure documents, with the express consent of the
banking regulators, when their contents are deemed material to
investors. \32\
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\32\ Requirements to raise capital and restrictions on dividends
are the core examples. Other MOUs remain undisclosed.
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Also on the side of transparency, the long-term trend has been
toward a greater tendency to publish guidance, interpretations, and
FAQs, and greater disclosure of informal and formal enforcement actions
against banking organizations. Many interpretive positions, even in the
form of written letters, were typically kept secret well into the
1990s. It was long a given that the only way to find out the
interpretive views of the Federal Reserve was to file a FOIA request
and hope for the best. \33\ The development of the Internet, which
brings with it increased expectations of transparency, has meant that
many, but not all, interpretive positions now find their way onto the
banking regulators' websites. There is more in the public domain than
ever before. This trend started even before the Financial Crisis and
the Dodd-Frank Act, which required 390 new rulemakings by the banking
agencies. \34\ A prominent pre- Dodd-Frank example is that the long
history of semipublic interpretations under Section 23A of the Federal
Reserve Act came to an end with the promulgation of Regulation W in
2002.
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\33\ As a young lawyer in the early 1990s, I was frequently given
the task of crafting a FOIA request to capture a secret interpretive
letter that was known by the bank regulatory bar to exist but that was
not public. Letters received under FOIA were carefully tended in paper
files and shared among banking lawyers. Contrast that cultural mode
with that of the SEC, which began publishing no-action letters in 1970.
See Donna M. Nagy, ``Judicial Reliance on Regulatory Interpretations in
SEC No-Action Letters: Current Problems and a Proposed Framework'', 83
Cornell L. Rev. 921, 948-49 (1998).
\34\ See Davis Polk and Wardwell LLP, ``Dodd-Frank Progress
Report'' (July 19, 2016), available at link.
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Yet, all of these advances in transparency and accountability are
not enough, either for the rule of law or for the norms of the digital
age. The disparate elements of increased use of the Congressional
Review Act, the GAO ruling that guidance can be subject to the
Congressional Review Act, an increased focus on cost-benefit analysis
in financial regulation and increased attention by the OMB on major
guidance issued by independent agencies each, in their own way, are
attempts to answer the call for more transparency and accountability.
C. The Increasing Scope of Secret Guidance and Lore
Against this recent societal backdrop of increased transparency and
accountability is the opposite tradition covered by confidential
supervisory information, secret guidance and secret lore. As a noted
administrative law scholar has argued:
The banking agencies of the Federal Government have long
maintained systems of secret evidence, secret law, and secret
policy. The result has been a degree of unchecked and
unstructured discretionary power that is far greater than it
should be. Sound principle calls for openness, so that
discretion may be checked and structured. To some extent the
systems the agencies have been following violate existing legal
requirements. The banking agencies can and should make
procedural changes that will increase both efficiency and
fairness. \35\
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\35\ Kenneth Culp Davis, ``Administrative Procedure in the
Regulation of Banking'', 31 Law and Contemp. Probs. 713 (1966).
What may come as a surprise is that these statements were made in
1966. They remain fresh today.
Indeed, I would posit that as supervision and the banking sector
have grown more complex, the amount of confidential supervisory
information shielded from public view has increased vastly not only
since 1966, but also at an accelerated pace after the Financial Crisis.
One reason for the expansion of confidential supervisory information is
that the traditional bank examination has morphed into something much
wider in scale and scope than its 19th and early 20th Century ancestor.
A regional banking organization will have up to 50 bank examinations on
different topics a year; a G-SIB will have hundreds. The annual roll-up
examination now covers multiple areas, and the number of matters
requiring attention or immediate attention have expanded into hundreds
for some banking organizations. It is a fair question, in a time of
high capital and liquidity, what these matters requiring attention are
covering and at what level of materiality. It goes without saying that
there is no sense of cost-benefit or proportionality. The lack of
public data is disturbing.
Economic and social policy, affecting financial stability, economic
growth and jobs, is being fashioned in the shadows of the confidential
supervisory arena. Some of these economic and social policy choices may
reflect the right tradeoffs, but, as they are made, Congress and the
public have no way of knowing. Before regulators act through matters
requiring attention, horizontal reviews, guidance or lore, we should
ask why a particular policy choice or regulatory interpretation is
being made under the rule of discretion rather than the rule of law. In
an era of increased transparency and accountability, policy choices
that have an impact on access to deposit services, credit allocation,
and investment in the banking sector--that is on jobs and growth--
should be open, not secret.
Today's supervisory culture has moved far away from the core of
examining the quality of a bank's loans or the amount of cash it has in
its vault. It is easy to understand how the supervisory theory of the
traditional bank examination translates into supervision over capital
and liquidity, including stress testing. The theory of supervision for
the 21st Century becomes muddled, however, once one leaves the realm of
qualitative judgements around a quantitative core. How should
compliance with law examinations be fashioned? What is the purpose
behind supervisors' focus on the internal governance structure of
management, the review of the minutes of management's discussions and
forced changes in reporting lines? \36\ On what basis was the ideology
of the three lines of defense imposed upon almost all banking
organizations? \37\ The word supervision, although longstanding,
appears nowhere in the legal framework governing the banking sector.
The only public source is the explanations published in agency reports
and on agency websites. These explanations are not helpful to
understanding the theory of banking supervision beyond logical
extensions of the traditional banking examination. \38\ Academic
scholarship on supervision is almost nonexistent and hard to do given
that what is happening is kept confidential. Congressional oversight is
also made more difficult.
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\36\ Since the Financial Crisis, the banking agencies have
required that compliance in larger institutions report to risk, not
legal. These decisions were taken without any public comment or
discussion, and the evidentiary basis for them was not developed. In
most smaller and regional banking organizations, compliance remains
within legal. The collateral consequences of two competing poles of
legal interpretation and judgement within the organization were not
considered.
\37\ The three lines of defense appears in only one place in the
legal framework in guidelines issued by the OCC in 2014. See 12 CFR pt.
30 app. D. It is otherwise not a part of the traditional bank
supervision. There was no cost-benefit analysis around its adoption in
the OCC's guidelines and it was imported from a position paper of The
Institute of Internal Auditors. See generally The Institute of Internal
Auditors, IIA Position Paper: ``The Three Lines of Defense in Effective
Risk Management and Control'' (January 2013), available at link.
\38\ The Federal Reserve describes supervision as follows: ``Once
the rules and regulations are established, supervision--which involves
monitoring, inspecting, and examining financial institutions--seeks to
ensure that an institution complies with those rules and regulations,
and that it operates in a safe and sound manner.'' Board of Governors
of the Federal Reserve System, The Federal Reserve System: Purposes and
Functions, at 73 (10th ed., Oct. 2016), available at link. Until
recently, however, the OCC included the promulgation of regulations in
its concept of supervision. The OCC's 2017 annual report, for example,
listed the power to issue regulations as one of its supervisory powers,
but that was removed from the 2018 report. Compare Office of the
Comptroller of the Currency, 2017 Annual Report, at 2, available at
link, with Office of the Comptroller of the Currency, 2018 Annual
Report, at 1, available at link. The FDIC's 2018 annual report does not
explicitly distinguish between supervision and regulation under its
``Supervision'' section. Federal Deposit Insurance Corporation, 2018
Annual Report, at 14-20, available at link. Moreover, it contains a
section titled ``Supervision Policy'' that groups together discussions
of supervision programs, rulemaking, and supervisory guidance. Id. at
20-26.
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The bias, for important policy choices affecting economic and
social conditions, should be toward the rule of law and transparency.
The realm of lore or secret constraints on banking organizations should
be narrowed to a core minimum of what is necessary to preserve
financial stability or the safety and soundness of any one banking
organization. Part of the challenge is that, a decade ago, the
supervisory staff, like the rest of us, lived through the Financial
Crisis and its aftermath on the economy. When the fire is raging, the
firefighters appropriately use whatever tools are handy, whether it is
by the stretching of legal texts or the need for tough supervisory
actions. But, long after the fire, when the house has been rebuilt on a
better foundation, it is time to leave behind the emergency culture of
firefighting and think in terms of regular maintenance.
As those within banking organizations will know, it is only
possible, because of the constraints of confidential supervisory
information, to speak about those examples that have randomly become
public. Those who are at banking organizations or the regulators will
know that there are many additional examples. This informal nonpublic
shadow system of regulation is neither transparent nor accountable.
For example, what became the leveraged lending guidelines, which
are meant to guard against the next asset bubble, started in the bank
examination. They were originally sent to banks as confidential
letters, and banks were not permitted to disclose to their clients such
letters' existence, or the reasons why banks were not making certain
loans. From the perspective of the banking regulators, the leveraged
lending guidelines were an advancement in transparency and disclosure.
They were, after all, public and had been subject to notice and
comment. From the perspective of those who have been thinking deeply
about the administrative law and its march towards transparency and
accountability, they did not go far enough. Similarly, there have been
attempts to take legal interpretations on the Volcker Rule in the
context of bank examinations.
As one more significant example of important policy being made in
the shadows, the Federal Reserve's lore on what constitutes a
``controlling influence'' and the so-called ``tear-down rules'' were
mostly secret for a long time. These are not ``rules'' at all, but a
series of oral principles, not made public nor written down, but which
reflect the views of some legal staff at a moment in time. In a welcome
development, the Federal Reserve last week announced a move from the
``Delphic and hermetic process'' for ordaining control to notice and
comment rulemaking. \39\ In announcing the proposed rulemaking, Vice
Chair for Supervision Quarles acknowledged that divining whether the
Board will find control under the existing framework requires
``supplication to a small handful of people who have spent a long
apprenticeship in the subtle hermeneutics of Federal Reserve lore,
receiving the wisdom of their elders through oral tradition in the way
that gnostic secrets are transmitted from shaman to novice in the
culture of some tribes of the Orinoco.'' \40\ As the Vice Chair for
Supervision implies with his colorful metaphor, the oral tradition from
shaman to novice is not good governance.
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\39\ Board of Governors of the Federal Reserve System, ``Federal
Reserve Board Invites Public Comment on Proposal To Simplify and
Increase the Transparency of Rules for Determining Control of a Banking
Organization'', Press Release (Apr. 23, 2019), link (statement of Vice
Chair for Supervision Quarles).
\40\ Board of Governors of the Federal Reserve System,
``Transcript Open Board Meeting on April 23, 2019'', at 2-3, available
at link.
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Another example arises because of the ability of the Federal
Reserve to impose limitations on the conduct and activities of a
financial holding company. To qualify as a financial holding company,
an institution and all of its insured depository institution's
subsidiaries must be both ``well managed'' and ``well capitalized.''
Under Section 4(m) of the Bank Holding Company Act, the Federal Reserve
may impose limitations on the conduct and activities of a financial
holding company that fails to satisfy either condition, and the
financial holding company is required to enter into a 4(m) agreement to
comply with those limitations. Because the Federal Reserve treats the
failure to be well managed as confidential supervisory information, the
existence and scope of 4(m) limitations are confidential if based on
the failure to satisfy the well managed condition. One study, which
examined the securities disclosures of 60 financial holding companies
(FHCs) between the years 2005 and 2017, noted that nearly all FHCs
disclose that they are well capitalized but many do not disclose if
they are well managed. \41\
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\41\ ``Ethics Metrics, Analysis of Bank Holding Company
Disclosures'', comments submitted May 8, 2017, to the SEC on its
Industry Guide 3, Statistical Disclosure by Bank Holding Companies, 8,
link.
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Another example has come about due to the informal ``penalty box''
rules of thumb that the banking supervisors have applied to banking
organizations as a result of CAMELS ratings, especially as to
Management ratings, BSA/AML compliance reviews and consumer compliance
reviews. Tacit principles in the evaluation of management include the
fact that any compliance problem resulting in an enforcement action
will result in a downgrade of the Management rating and that it is
often hard for a bank to obtain a Composite rating better than ``3'' if
it has a Management rating of ``3''. \42\ Bank expansion is not
possible as long as a consent order is pending, meaning banks of all
sizes devote board and management time as well as technology resources
toward even the most immaterial compliance concerns to ensure
regulators are fully satisfied. \43\ Appeals against adverse ratings
are rare because appeals must be made to the same agency that issued
the rating--part of evaluation is the readiness with which management
responds to regulator criticisms, and banks are warned that ``examiners
have long memories.'' \44\
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\42\ See ``Examination of the Federal Financial Regulatory System
and Opportunities for Reform'': Hearing before the U.S. H. Financial
Services Subcomm. on Financial Institutions and Consumer Credit, 115th
Cong. 10 (2017) (statement of Greg Baer, President, The Clearing House
Association), available at link.
\43\ See id. at 11.
\44\ See id. at 12.
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The evolution of the living wills guidance is also instructive.
Resolution plans and their guidance started out as largely
confidential, then morphed into a mix of confidential and public
feedback--all of which applied--and finally, over the years, regulators
nudged toward public guidance. The first set of public guidance was
issued without advance warning or notice and comment and stated that
all previous guidance, public and private continued to apply. For those
working on living wills, figuring out which parts of which years'
private guidance no longer applied--because it was not aligned with the
public guidance--was a puzzle. More recently, and in a welcome move,
the Federal Reserve and the FDIC have issued new guidance, subject to
notice and comment, that makes it clear that all previous guidance has
now been superseded. The point here is that banking organizations were
subject to a mix of private and public expectations, many of which were
not clearly aligned and all of which were perceived as binding.
The long tradition of regulation by negotiation in the applications
process is another type of shadow regulatory system. \45\ Conditions,
sometimes not linked to the pending application, are imposed.
Regulators strategically use delays and silence to encourage silent,
nonpublic withdrawals of applications. Some have called this regulation
by negotiation but it is more akin to regulation by threat or
intimidation. \46\ An illustrative example, which can be used because
it is one of the few to become public, comes from applications by
Citicorp, J.P. Morgan, and Bankers Trust New York Corporation in 1987
to underwrite and deal in municipal revenue bonds, mortgage related
securities and commercial paper. \47\ During negotiations with agency
staff, each applicant ``voluntarily'' consented to market share
limitations while protesting that they saw no need for them. When
considered for review by the Federal Reserve Board of Governors, the
banks admitted that they agreed to the limitations only to ``expedite
the applications.'' \48\ In this instance, the market share limitations
were ultimately overturned by the Second Circuit but normally such
``voluntary'' commitments do not come up in final orders and are
unlikely to be challenged in court or known to the public. \49\ As a
result, the staff conducting negotiations during the application
process wield an immense policymaking power.
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\45\ See Culp Davis, ``Administrative Procedure in the Regulation
of Banking'', supra n. 35, at 713 (arguing the OCC practice of making
decisions regarding charter applications without providing reasoned
opinions or findings of fact lends itself toward arbitrariness).
\46\ Daniel Schwarz and David T. Zaring, ``Regulation by Threat:
Dodd-Frank and the Non-Bank Problem'', 84 U. Chic. L. Rev. 1813, 1817
(2017).
\47\ See Alfred C. Aman, Jr., ``Bargaining for Justice: An
Examination of the Use and Limits of Conditions by the Federal Reserve
Board'', 74 Iowa L. Rev. 837, 894-95 (1989).
\48\ See id. at 895.
\49\ See id.
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Many have debated whether confidential supervision and its secret
lore are binding upon banking organizations. The recent ``guidance on
guidance'' from the banking regulators seeks to settle that debate by
stating that guidance is not binding unless it impacts safety and
soundness. In a world where the supervisor can punish the banking
organization and mold its behavior through these tools, from the
perspective of those who receive it, the secret guidance and lore may
as well be binding. Of course, banking organizations frequently seek
and are happy to receive nonpublic guidance, on a written or oral
basis, from the supervisory staff. The point is not to eliminate these
communications but to put more guardrails around them, as the guidance
on guidance begins to do.
D. Uneasy Truce Is Now Untenable--Tilt Towards Accountability and
Transparency
The uneasy truce between the tradition of secrecy and the tradition
of accountability has become untenable. The signal that the balance is
askew is the increase in leaks of confidential supervisory information.
By my count, there have been 7 leaks of confidential supervisory
information that have made their way into the media since 2011, some
but not all of which can be traced to regulators. In addition, in 2016
one judge released the CAMELS ratings of a bank \50\ and, near the time
of the Financial Crisis, two exam reports were released by the
Financial Crisis Inquiry Commission. Before 2011, leaks of confidential
supervisory information into the public square were virtually unknown.
So far, each of these releases has been treated as a one-off situation.
It is time to consider, however, whether they are a signal of the
pressures felt by humans living in a digital society where there is a
strong tilt towards transparency.
---------------------------------------------------------------------------
\50\ See Memorandum Opinion and Order, Builders Bank v. FDIC., No.
15-cv-06033 (N.D. Ill Apr. 25, 2016), ECF No. 26.
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There is also an increase in the officially sanctioned publication
of confidential supervisory information by the banking supervisors
themselves. Confidential supervisory information belongs to the
supervisors who can choose, when they so desire, to disclose it.
Although the Comptroller has not used his power to disclose examination
results to the public, that power exists. The New York Department of
Financial Services in 2017 used its power to release information in the
public interest to release its otherwise confidential ratings of Bank
of Tokyo-Mitsubishi as part of its ongoing spat with the bank and the
Comptroller over who should be the primary regulator of the bank's New
York branch. \51\ The decision about what is in the public interest and
its timing is entirely in the hands of the supervisors.
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\51\ Letter from Shirin Emami, Executive Deputy Superintendent-
Banking, N.Y. State Dept. of Fin. Servs., to Marva V. Cummings,
Director for District Licensing, OCC (Nov. 13, 2017), available at
link.
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Banking organizations, however, are silenced in the public arena
when the media or Congress make statements that might otherwise be
corrected but for the rebuttal being considered confidential
supervisory information, even when that information has been made
public by the regulatory staff. As one example of the potential
chilling effect, the OCC issued a bulletin reminding banking
organizations of their confidentiality responsibilities and potential
criminal liability just 2 weeks before the CEOs of the Nation's largest
banks were scheduled to testify before the House Financial Services
Committee. \52\
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\52\ See OCC, Bulletin 2019-15: Statement on Confidentiality (Mar.
25, 2019), available at link; United States House Committee on
Financial Services, Hearing: ``Holding Megabanks Accountable: A Review
of Global Systemically Important Banks 10 years after the Financial
Crisis'' (Apr. 10, 2019), available at link.
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E. What Policy Purpose Is Served by Confidential Supervision and
Discretionary Actions?
The question then becomes how to improve the existing situation by
narrowing the scope of confidential supervisory information. Following
in the footsteps of Minsky, we should aim for better, not perfect. We
are moving into an era where policy making will increasingly be driven
by data analytics and evidence in a technological environment. Going
forward, three key questions ought to be asked about confidential
supervision. Each one of these questions would involve a new way of
thinking.
1. Why is this topic being treated confidentially? Banking
regulators and banking organization should begin to ask themselves why
a given topic is being treated as confidential. There should be a tight
link to financial stability and the need for candid conversations.
There should be a serious reexamination, from first principles, of how
the obligations of the securities laws and confidential supervision
interact. It is fair to ask why shouldn't banks have the option to make
their CAMELS ratings public. After all, since 1990, the results of CRA
examinations have been made public. \53\ Or, one could ask why the
banking regulators don't publish examination findings and trends in
matters requiring attention in anonymous aggregate but with granular
detail. \54\ One thing is certain, however, and that is that any reform
of the confidential supervisory information regulations and culture
needs to be done on a systemic basis that applies equally to all
banking organizations. Right now, the practical reality is one where
some institutions sometimes are subject to random leaks or disclosures
and others are not. There is a deep unfairness in that situation.
---------------------------------------------------------------------------
\53\ See FFIEC Interagency CRA Rating File Specifications,
Community Reinvestment Act, FFIEC, link (last visited Apr. 22, 2018).
\54\ The Federal Reserve's recent ``Supervision and Regulation
Report'' is an excellent start. Board of Governors of the Federal
Reserve System, ``Supervision and Regulation Report'' (Nov. 2018),
available at link.
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2. Who or what is being protected by the confidentiality? Sometimes
confidentiality shields the supervisors' actions from the public
scrutiny. How is it that the confidential ``penalty box'' constraints
on a banking organization's activities can exist for years? \55\ Do
CAMELS ratings really judge individual institutions or do they follow
the trends of the business cycle? On what basis are matters requiring
attention and matters requiring immediate attention issued and what
patterns exist in them? Some of these examples are areas where the
supervisor fears that its actions would be controversial to the public
and so a confidential route is chosen, or sometimes the confidential
route is traveled just because it is familiar and is done without much
forethought. If confidentiality is chosen to protect the regulator from
public scrutiny, it is not appropriate. If, however, it is chosen for
financial stability, then it is appropriate.
---------------------------------------------------------------------------
\55\ Transcript of Q&A with Federal Reserve's Randal Quarles, WSJ
(Nov. 7, 2017), available at link (statement by Greg Baer) [hereinafter
Quarles Transcript].
---------------------------------------------------------------------------
3. Why is this policy choice or regulatory interpretation being
made under the confidential rule of discretion rather than the rule of
law? Why did the leveraged lending guidelines start as confidential
letters? What is one to make, for example, of Henry Paulson admitting
that he privately threatened to remove the management and board of Bank
of America if it did not complete a merger with Merrill Lynch? He has
since stated ``[b]y referring to the Federal Reserve's supervisory
powers, I intended to deliver a strong message.'' \56\ This message was
not disclosed at the time. The penalty box, and many nonpublic examples
involve similar threats of confidential supervisory actions. \57\ The
increasing number of banks requesting to strengthen their ability to
appeal examination results reflects the sense that confidential
supervision can look like a weapon when it is shrouded in secrecy. \58\
On what basis can new standards be imposed upon banking organizations
through horizontal reviews by supervisors that are not made transparent
to the organizations or the public?
---------------------------------------------------------------------------
\56\ Martin Kady II, ``Paulson Admits To Threatening Lewis'',
Politico (July 17, 2009), link.
\57\ Quarles Transcript, supra n. 55 (statement by Greg Baer).
\58\ Julia Anderson Hill, ``When Bank Examiners Get It Wrong:
Financial Institution Appeals of Material Supervisory Determinations'',
92 Wash. U. L. Rev. 1101, 1165-69 (2015).
---------------------------------------------------------------------------
We have recently seen helpful steps in the right direction toward
transparency and accountability. Vice Chair for Supervision Quarles has
stated that increases in transparency and a re-think of supervision are
high on his agenda, noting that ``one of the reasons for transparency .
. . is just a basic view of the right relationship between the
Government and the governed . . . I do think we can be much more
transparent about the regulatory process generally.'' \59\ Chairman
McWilliams has also focused on increased transparency with her Trust
through Transparency initiative at the FDIC.
---------------------------------------------------------------------------
\59\ Quarles Transcript, supra n. 55 (statement by Vice Chair for
Supervision Randal Quarles).
---------------------------------------------------------------------------
II. Training of Supervisory Staff in the Legal Framework of the
Regulatory State
Congress and the banking agencies need to think clearly about how
to create an environment where the supervisory staff are given the
training, resources, and tools that would permit them to do their jobs
in a way that is more transparent to the world, more accountable and
more consistent with the rule of law. \60\ Given that the legal
framework governing the banking sector has become much more complex,
the work of the examination staff has become more legally infused and
yet the supervisory culture has become increasingly unmoored from the
legal framework itself. \61\ The rise in compliance with law
examinations, the focus on risk and board governance and the increasing
use of matters requiring attention and matters requiring immediate
attention for violations of law mean that the examination staff are
increasingly making judgments that are legally infused, either
involving legal judgments or involving a mixture of facts and law.
---------------------------------------------------------------------------
\60\ One important resource, beyond the scope of this testimony,
is equipping the supervisors with more advanced technology, known as
RegTech or SupTech. See Jo Ann Barefoot, ``Regulation Innovation: Using
Digital Technology to Protect and Benefit Financial Consumers'',
Harvard Kennedy School Mossavar-Rahmani Center for Business and
Government Working Paper Series No. 110, at 10-11 (Mar. 2019),
available at link.
\61\ Of course, major elements of bank supervision are related to
credit, interest rate, liquidity, and other market driven elements
rather than the legal framework.
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At the same time, the legal departments and legal staff of the
Federal banking agencies remain quite slim, especially as compared to
other major agencies. \62\ It is fair to ask whether there is a deep
enough pool of lawyers at the agencies for the agency lawyers to be
able to guide the supervisory staff on the more complex legal framework
and to deal with all of the increased legally infused work that is
occurring. \63\ It is also fair to ask whether the budget, resources,
and stature of the agency legal departments is sufficient for the
increased legal complexity and the coming digital transformation. A
study should be done on whether increases in the legal staff have kept
pace with increases in supervisory staff and increases in legally
infused work by the supervisory staff. \64\
---------------------------------------------------------------------------
\62\ See Rory Van Loo, ``Regulatory Monitors: Policing Firms in
the Compliance Era'', 119 Columbia Law Review 369, 436-40 (2019)
\63\ The banking agencies have long been understood to be monitor-
or examiner-dominated in their personnel. Based on research by an
academic, some of which is estimated, the Federal Reserve is 95 percent
monitor staff, the OCC is 93 percent monitor staff and the FDIC is 86
percent monitor staff. See id. at 438-39. The higher proportion of
lawyers at the FDIC is likely linked to its work as the deposit insurer
and bank failures. Just a comparison of the number of lawyers to the
number of examination staff at each of the agencies tells us that deep
training on the law, legal interpretation and the legal framework has
not been possible. A memo published by two former Federal Reserve
staffers has pointed out that training on the legal framework has been
delegated to the regional Federal Reserve Banks. Richard K. Kim,
Patricia A. Robinson, and Amanda K. Allexon, ``Financial Institutions
Developments: Revamping the Regulatory Examination Process'', Wachtell,
Lipton, Rosen, and Katz (Nov. 26, 2018). That fact alone brings into
question the consistency of the training.
\64\ In the private sector it is well understood that increases in
the budget, resources and staffing of the in-house legal department
have not kept pace with the rise of risk management and the separation
of compliance from the legal function. See Thomas C. Baxter, Jr., ``The
Rise of Risk Management in Financial Institutions and a Potential
Unintended Consequence--The Diminution of the Legal Function'',
American Bar Association Business Law Today (Apr. 2, 2019), link.
---------------------------------------------------------------------------
Examples that I have seen in my practice, as well as examples that
have been relayed to me, lead me to believe that the current generation
of examination and supervisory staff, who are people of goodwill trying
to do a complex job under difficult circumstances, have not had in-
depth training in the legal framework. Some examiners were confused
about the fact that the First Amendment protects lobbying activity by
banking organizations, and attempting to stop such activity or subject
it to an examination is unconstitutional. \65\ There is confusion about
the fact that the Constitution and statutes are higher level
authorities than a regulation, guidance, or handbook. Some supervisory
staff mistakenly believe that guidance can override a statute. Some
supervisory staff are confused about what is part of the legal
framework and what is not. Some supervisory staff mistakenly believe
that guidance is not governed by the statutes or regulations and that
they can pick and choose among the applicable guidance or law. Some
supervisory staff seek to exclude in-house lawyers from meetings or
tasks.
---------------------------------------------------------------------------
\65\ See Semi-Annual Testimony on the Federal Reserve's
Supervision and Regulation of the Financial System, 115 Cong. 86 (2018)
(Statement of Randal K. Quarles, Vice Chairman for Supervision).
---------------------------------------------------------------------------
I believe that the training of supervisory staff for compliance
with law is heavily weighted towards the technical elements of
individual banking regulations and guidance in areas of subject matter
expertise. The training has been overfocused on compliance with the
technical aspects on a regulation-by-regulation basis and has
underweighted fundamental principles such as the rule of law in a
Constitutional democracy and the legal framework that governs the
regulatory State. The training has also not focused on basic grounding
statutes such as the APA or the Congressional Review Act. \66\ The
supervisory staff are also not trained in major case law that affects
their work. There is a large difference in what the supervisory staff
believe to be their authority under safety and soundness and the case
law that defines the term.
---------------------------------------------------------------------------
\66\ It is safe to say that none of the banking regulators, and
certainly not the banking bar, noticed or were aware of the passage of
the Congressional Review Act in 1996. In hindsight, the GAO ruling that
the leveraged lending guidelines are a ``rule'' under the APA is
completely obvious. See 5 U.S.C. 551(4) (defining ``rule''). Thinking
of guidance as requiring a stop at OMB or notice to Congress has thrown
a wrench into the traditional cultural mode.
---------------------------------------------------------------------------
There is no need for 3 years of law school to understand these
critical concepts. We also need not be purists worrying about the
unauthorized practice of law. Instead, it should be possible,
especially in light of the quality of the credentialed examination
staff and the base of the past training, to add more of the following
elements to the training of supervisory staff so that they are better
able, in light of the shortage of lawyers at the agencies, to handle
legally infused judgments: \67\
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\67\ I began my life in the law by taking, as is common in the
Midwest, a 6-week paralegal certification. I can attest that if a 22-
year-old from a small town in Michigan could grasp the basics of these
concepts in a paralegal certification course, then the much more highly
educated and mature supervisory staff should be able to with ease.
The principle of the separation of powers and how the
delegation of authority by Congress to agencies is based solely
on written statutory authority with their being no such thing
as ``inherent authority''; \68\
---------------------------------------------------------------------------
\68\ The safety and soundness statute, 12 U.S.C. 1831p-1, is
broad and delegates discretion to the banking agencies. It is not,
however, unlimited and does not create ``inherent authority.''
Fundamental principles of due process, including the
distinction between prospective and retroactive application of
---------------------------------------------------------------------------
rules, regulations, and other standards;
The legal hierarchy among the Constitution, statutes,
regulations and guidance, including the distinction between
binding law and nonbinding written public guidance;
The statutes, regulations, other laws and guidance that are
binding on the supervisory staff;
The key major cases that impact the work of supervisory
staff;
Why reading the legal framework involves cannons of
construction and deference, so that it is not like ordinary
reading; \69\ and
---------------------------------------------------------------------------
\69\ See Margaret E. Tahyar, ``Legal Interpretation Is Not Like
Reading Poetry--How To Let Go of Ordinary Reading and Interpret the
Legal Framework of the Regulatory State'', at 9-11 (Dec. 4, 2018,
Working Draft), available at link.
Why adhering to the rule of law and fundamental principles
of due process is fundamental in a representative democracy and
---------------------------------------------------------------------------
binding upon agency staff.
The lack of training about the legal framework, the principles of
how legal texts must be interpreted, the binding nature of court
decisions, and the regulatory State has real world consequences. One
real world consequence is the creation of matters requiring attention
and matters requiring immediate attention, with all that implies, based
on misunderstandings of the legal framework. Another consequence is the
historical failure to keep track of appeals from examinations \70\ or
not being sensitive to the fact that some examination judgments or
matters requiring attention are legally infused. \71\ One clue that
there is not enough sensitivity to the role of the rule of law is that
risk governance guidance on the role of risk and compliance did not
mention in-house legal departments at banking organizations. \72\
Another clue is the three lines of defense ideology, developed post-
Financial Crisis, which was drafted and adopted by the auditing
profession without consideration of the role of the rule of law or the
in-house legal function. \73\
---------------------------------------------------------------------------
\70\ See Hill, supra n. 58, at 1115-60 (describing appeals process
at OCC, Federal Reserve, FDIC and NCUA, and noting data issues).
\71\ See Davis Polk and Wardwell LLP, Comment Letter on Proposed
Amendments to Guidelines on an Internal Appeals Process for
Institutions Wishing to Appeal an Adverse Material Supervisory
Determination, Docket No. OP-1597, at 4-5 (Apr. 30, 2018), available at
link.
\72\ See Davis Polk and Wardwell LLP, Comment Letter on the
``Proposed Guidance on Supervisory Expectation for Boards of
Directors'', Docket No. OP-1570, at 9-11 (Feb. 15, 2018), available at
link (``The Management Proposal is similarly silent on the importance
of a firm having a sufficiently robust legal department with
appropriate resources, budget and independence and a general counsel
with sufficient stature and authority, instead addressing only risk
management, internal audit and compliance functions.'').
\73\ See generally The Institute of Internal Auditors, supra n.
37.
---------------------------------------------------------------------------
Increased training in the hierarchy of the legal framework, why
legal interpretation is not like normal reading and a wider
understanding of the separation of powers and the regulatory State
would, I believe, also have positive knock-on effects in the private
sector. Many in the growing professions of risk management and
compliance had their initial training in the banking agencies. They
take their confusion about the legal framework, the role of guidance
and the limits of secret lore with them to the private sector.
Conclusion
Change is hard but, the longstanding uneasy truce is now untenable.
I suspect that both banking organizations and supervisors might be made
a little uncomfortable by what I am saying here today. If, however, the
changes I recommend are made, and if both supervisors and banking
organizations are a little bit uncomfortable, the balance is moving in
the right direction.
______
PREPARED STATEMENT OF PATRICIA A. MCCOY
Professor of Law, Boston College Law School
April 30, 2019
Chairman Crapo, Ranking Member Brown, and Members of the Committee:
Thank you for inviting me here today to discuss nonbinding guidances by
Federal bank regulators. \1\
---------------------------------------------------------------------------
\1\ I use the term ``Federal bank regulators'' in this statement
to refer to the Board of Governors of the Federal Reserve System, the
Federal Deposit Insurance Corporation, the Office of the Comptroller of
the Currency, and the Consumer Financial Protection Bureau (CFPB).
---------------------------------------------------------------------------
Imagine a world in which Federal bank regulators did not provide
guidances. They would still have statutory responsibility to administer
and enforce the statutes and legislative rules under their
jurisdiction. Regulated firms would still have to obey those statutes
and rules. The only difference is, firms would not have insight into
the agencies' interpretations, priorities, or positions in the form of
guidances. In the process, financial providers would be deprived of an
essential source of transparency that they vocally want and benefit
from today.
Some are calling for changes that would require nonbinding agency
guidances to undergo notice-and-comment proceedings and Congressional
Review Act oversight. Such changes would be badly misguided. Agencies
would either respond by converting flexible, nonbinding guidances into
binding legislative rules or by continuing to discharge their
supervisory and enforcement responsibilities without the illumination
provided by guidances. In all likelihood, ``regulation by enforcement''
would become a self-fulfilling prophecy, for the reasons I explain.
I. Guidances Provide Vital Transparency in Banking Regulation
Guidances are informal agency statements that advise the public of
an agency's construction of its statutes or rules or the agency's
prospective plans to exercise discretion. As such, guidances are ``an
essential instrument of [F]ederal administration'' and ``facilitate[]
stakeholders' knowledge of agency positions and intentions ahead of
enforcement or similar actions.'' \2\
---------------------------------------------------------------------------
\2\ Bureau of Consumer Financial Protection, Request for
Information Regarding Bureau Guidance and Implementation Support, 83 FR
13959, 13959 (Apr. 2, 2018) (citations omitted) (hereinafter CFPB
Guidance RFI).
---------------------------------------------------------------------------
The term ``guidances'', the topic of this hearing, refers broadly
to a variety of nonbinding agency statements. Guidances encompass
interpretive rules, policy statements, guidance, supervisory bulletins,
opinion letters, frequently asked questions, and compliance guides,
among other things.
The APA requires interpretive rules and policy statements of
general applicability to be published in the Federal Register but
expressly exempts them from the notice-and-comment requirements for
legislative rules. \3\ Nevertheless, sometimes Federal bank regulators
solicit public comment on proposed guidances at their discretion in
order to refine the final versions. \4\ Guidances are nonpartisan in
nature and are issued by Republican and Democratic appointees alike.
\5\
---------------------------------------------------------------------------
\3\ 5 U.S.C. 552(a)(1)(D), 553(b)(A); see CFPB Guidance RFI,
supra n. 2, at 13960.
\4\ CFPB Guidance RFI, supra n. 2, at 13960.
\5\ See, e.g., Bureau of Consumer Financial Protection, ``Changes
to Types of Supervisory Communications'', BCFP Bull. 2018-01 (Sept. 25,
2018) (issued by the CFPB under former Acting Director Mick Mulvaney),
https://files.consumerfinance.gov/f/documents/bcfp_bulletin-2018-
01_changes-to-supervisory-communications.pdf; Office of the Comptroller
of the Currency, ``Description: Cyber-Related Sanctions'', OCC Bull.
2018-40 (Nov. 5, 2018) (guidance on the potential impact of Office of
Foreign Assets Control sanctions on financial institutions' operations;
issued under Comptroller Joseph M. Otting), https://www.occ.treas.gov/
news-issuances/bulletins/2018/bulletin-2018-40.html#; Securities and
Exchange Comm'n, TurnKey Jet, Inc., SEC No-Action Letter (Apr. 3,
2019), https://www.sec.gov/divisions/corpfin/cf-noaction/2019/turnkey-
jet-040219-2a1.htm.
---------------------------------------------------------------------------
Guidances are distinguishable from notice-and-comment legislative
rulemakings under Section 553 of the Administrative Procedure Act (APA)
in at least two important respects. First, unlike legislative rules,
which can affect individual rights and obligations, guidances are
nonbinding on third parties. \6\ Second, guidances are highly flexible
and allow agencies to more nimbly respond to changing market conditions
because they can be amended without going through a time-consuming
notice-and-comment process. \7\
---------------------------------------------------------------------------
\6\ See, e.g., Administrative Conference of the United States,
Agency Guidance Through Policy Statements, Recommendation 2017-5, at 1
(Dec. 14, 2017) (hereinafter Administrative Conference); CFPB Guidance
RFI, supra n. 2, at 13960.
\7\ Administrative Conference, supra n. 6, at 2.
---------------------------------------------------------------------------
Except in rare instances, Federal bank regulators are not required
to issue guidances. \8\ Instead, they do so to provide transparency for
what might otherwise be an opaque regulatory process. Agencies
increased their use of guidances before the 2008 financial crisis, in
response to industry requests for a ``principles-based approach'' to
regulation. Guidances have continued to be important post-2008.
---------------------------------------------------------------------------
\8\ Recently, however, in the Economic Growth, Regulatory Relief,
and Consumer Protection Act, Pub. L. No. 115-174 (2018), Congress urged
or required Federal agencies to provide additional guidance. Id.
109(b) (on integrated mortgage disclosures), 209(e) (on shared
waiting lists for public housing facilities).
---------------------------------------------------------------------------
Guidances serve an essential function, given the intricacy of
Federal banking law. Federal bank regulators administer the Federal
banking statutes and implement those statutes through binding, notice-
and-comment legislative rules. This thicket of banking statutes and
rules is voluminous and complex.
Against this backdrop of statutes and rules, regulated entities
find guidances valuable because they shed light on agencies'
supervisory perspectives and concerns. When they are issued as policy
statements, guidances can advise the public prospectively on how an
agency proposes to exercise one of its discretionary powers. \9\ When
issued as interpretive rules, guidances apprise the public of an
agency's construction of the statutes and rules it administers. \10\
Other types of guidances provide a useful possible roadmap for
compliance, while leaving companies free to propose alternative models
or interpretations or consideration of additional facts. In this way,
guidances ``can make agency decision making more predictable and shield
regulated parties from unequal treatment, unnecessary costs, and
unnecessary risk . . . .'' \11\ Finally, guidances can flag potential
compliance issues for regulated entities' attention.
---------------------------------------------------------------------------
\9\ Attorney General's Manual on the Administrative Procedure Act
30 n.3 (1947).
\10\ Id.
\11\ Administrative Conference, supra n. 6, at 2.
---------------------------------------------------------------------------
Guidances can emanate out of rulemaking or out of supervision.
During the rulemaking process, for example, it is common for regulated
firms to request guidance to help them comply with an agency's
legislative rules (particularly new rules). This was especially
important during the implementation of the Dodd-Frank Act, when
Congress instructed Federal bank regulators to adopt multiple complex
rules. These industry requests for guidance are often time-sensitive,
because firms are eager for guidance to be in place by a rule's
effective date.
Other guidances come out of supervision. Bank supervision requires
confidentiality, to protect regulated firms' sensitive proprietary
information and to prevent bank runs. For this reason, bank examination
reports and the findings of bank examinations are secret and may not be
released to the public, on pain of criminal sanction. \12\ Importantly,
other financial institutions are not privy to the examination reports
or findings of sister institutions. Against this backdrop, supervisory
guidances provide a crucial sightline into the supervisory process by
informing regulated companies of supervisors' viewpoints, priorities,
and concerns.
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\12\ See, e.g., 12 CFR 4.32(b), 7.4000(d), 261.21(a), 309.6(b),
1070.42. There are narrow exceptions permitting public disclosure of
the nonconfidential portion of Community Reinvestment Act examination
reports, 12 U.S.C. 2906(a)-(b), and of summaries of capital adequacy
stress test results, see, e.g., 12 CFR 252.17, 252.46, 252.58.
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For these reasons and more, regulated companies want guidance and
they are vocal about asking for it. As the National Association of
Realtors put it last year: \13\
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\13\ Letter from the National Association of Realtors to the CFPB
on Docket No. CFPB-2018-0013, at 1 (July 2, 2018) (hereinafter NAR
Comment Letter).
[I]t is imperative that necessary guidance, including
interpretive rules and nonrule guidance, be provided to
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regulated entities to ensure compliance across the industry.
The American Financial Services Association (AFSA) has emphasized
the importance of guidance to financial providers in similar terms:
\14\
---------------------------------------------------------------------------
\14\ Letter from AFSA to the CFPB on Docket No. CFPB-2018-0013, at
4 (July 2, 2018); see also id. at 3 (``There is a clear need for
guidance that is responsive to operational difficulties or unintended
consequences resulting from new regulations'').
There is undoubtedly a need for written, explanatory guidance.
Written guidance can be a useful tool to help financial
institutions obtain clarification on specific practices. With
many regulations, particularly long and complex regulations,
operational difficulties or unintended consequences arise. In
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these cases, clarifying guidance is need[ed] quickly.
As these industry statements stress, guidance serves important
functions and we should be wary of jettisoning it.
II. Regulated Entities Have Ample Recourse if Guidances Are Given
Binding Effect
Despite the many benefits of guidances, agencies are sometimes
criticized for penalizing third parties for failure to comply with
guidances. Whether this is really a problem or its extent is unclear.
Agencies are statutorily responsible for enforcing the statutes and
legislative rules with which they are charged. The fact that those
statutes and legislative rules may overlap with guidances does not
relieve agencies of that statutory responsibility.
Criticisms of guidance often assert that examination reports
downgrade companies for failure to follow guidance or that enforcement
actions are based on guidance violations. This might raise concerns
that guidances were being given binding effect against third parties
without prior public input into their substance through the notice-and-
comment process. In the more likely case, Federal banking regulators
base negative exam ratings, exam citations, and enforcement actions on
violations of statutes or rules, on unsafe or unsound practices (in the
case of the prudential banking regulators), or on unfair, deceptive or
abusive practices (in the case of the Consumer Financial Protection
Bureau), and not on any guidances that happen to overlap.
At this juncture, it is critical to dispel the mistaken impression
that financial institutions are helpless if they are penalized for
violating guidances alone. To the contrary, if financial institutions
are experiencing this problem, they already have ample recourse.
Regulated entities have multiple avenues of review if agencies seek to
penalize them for violating guidances:
Suits to invalidate guidances: Affected parties can sue to
invalidate guidances that are given binding effect for failure
to comply with the notice-and-comment provisions of Section 553
of the APA. \15\
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\15\ 5 U.S.C. 704, 706(2)(A), (2)(D); see, e.g., United States
v. Gypsum Co. v. Muszynski, 209 F. Supp. 2d 308, 310 (S.D.N.Y. 2002).
Informal meetings with regulators: In addition, regulated
entities can and do meet privately with Federal bank regulators
---------------------------------------------------------------------------
to request guidance, propose changes, and contest its use.
Agency ombudsmen: All Federal bank regulators maintain an
ombudsman that provides an independent, impartial, and
confidential resource to help firms resolve any problem they
may have resulting from the regulatory activities of an agency.
\16\
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\16\ See 12 U.S.C. 4806(d) (requiring every Federal bank
regulator to establish an ombudsman); Consumer Financial Protection
Bureau, ``Appeals of Supervisory Matters'' 5-6 (Oct. 28, 2015), https:/
/files.consumerfinance.gov/f/documents/
201508_cfpb_ApprovedSupervisoryAppealsProcess.pdf (CFPB Supervisory
Appeals).
Supervisory appeals: In the supervision context, proposed
citations go through special scrutiny and multiple layers of
agency review before they can be included in examination
reports. Informally, this gives companies the opportunity to
raise any concerns about the use of guidances with examiners'
supervisors. In addition, all Federal bank regulators provide
formal procedures in which companies can appeal examination
findings. \17\
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\17\ 12 U.S.C. 4806 (requiring every Federal prudential banking
regulator to establish a supervisory appeals process); CFPB Supervisory
Appeals, supra n. 16.
Judicial review of enforcement actions: In the enforcement
process, aggrieved respondents have the right to judicial
review to contest sanctions based on guidance violations. \18\
---------------------------------------------------------------------------
\18\ 12 U.S.C. 1818(h).
Legislation: Finally, financial providers can petition
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Congress to enact legislation overturning guidances.
In short, financial institutions already have ample recourse for
any agency misuse of guidances. Proposals to make it more difficult to
issue guidances would throw the baby out with the bath water, as I
discuss.
III. Recent Initiatives To Increase the Procedural Requirements for
Guidances
Recently, some have proposed stringent curbs on guidances issued by
Federal bank regulators. The two leading initiatives in this regard
involve Congressional reversal of agency guidances under the
Congressional Review Act and mandatory notice-and-comment requirements
for guidances akin to those for legislative rules in Section 553 of the
APA. Above, I discussed the current APA requirements for guidances. In
this section, I discuss the debate surrounding the Congressional Review
Act's applicability to guidances.
a. The Provisions of the Congressional Review Act
The Congressional Review Act (CRA) \19\ is a major vehicle for
Congressional oversight of agency rulemaking. Under the CRA, before a
rule can take effect, every Federal agency that promulgates a rule must
submit a copy of the rule, ``a concise general statement relating to
the rule,'' and the proposed effective date of the rule to each House
of Congress and the Comptroller General. \20\ In the case of major
rules, upon receipt, Congress has a statutorily specified time period
to enact a joint resolution of disapproval of the rule. \21\ If
Congress allows the statutory time period to expire without enacting a
joint resolution of disapproval, the rule will take effect. \22\ If
Congress enacts a joint resolution of disapproval and the joint
resolution survives any veto, the rule will not take effect. \23\
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\19\ 5 U.S.C. 801-808.
\20\ Id. 801(a)(1)(A). The CRA requires other accompanying
materials as well. Id.
\21\ Id. 801(b)(1), 802; see also id. 801(a)(4).
\22\ Id. 801(a)(3). The statute sets forth a timeframe for
effective dates. Id. 801(a)(3), (d)-(e), 808. The same result occurs
if the President vetoes a joint resolution of disapproval and Congress
does not override the veto. Id. A rule that Congress disapproved may
also take effect where the President makes a written determination that
the rule is necessary based on narrow statutory grounds or was issued
pursuant to any statute implementing an international trade agreement.
Id. 801(c).
\23\ Id. 801(b)(1); see also id. 801(a)(3), (f).
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Where Congress has struck down a major rule through a joint
resolution of disapproval that has withstood any veto, the rule may not
be reissued in substantially the same form unless it is specifically
authorized by a law enacted after the date of the joint resolution. The
same result holds for any new rule that is substantially the same as
the original rule that Congress disapproved. \24\
---------------------------------------------------------------------------
\24\ Id. 801(b)(2).
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The CRA's procedures for joint resolutions of disapproval only
apply to major rules. For purposes of CRA review, a ``major rule'' is
any rule that the Office of Information and Regulatory Affairs (OIRA)
of the Office of Management and Budget (OMB) finds has resulted in or
is likely to result in: \25\
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\25\ Id. 804(2).
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1. An annual effect on the economy of $100,000,000 or more;
2. A major increase in costs or prices for consumers, individual
industries, Federal, State, or local government agencies, or
geographic regions; or
3. Significant adverse effects on competition, employment,
investment, productivity, innovation, or on the ability of
United States-based enterprises to compete with foreign-based
enterprises in domestic and export markets.
The term ``major rule'' excludes any rule promulgated under the
Telecommunications Act of 1996 and the amendments made by that Act.
\26\ In addition, nothing in the CRA applies to rules concerning
monetary policy proposed or implemented by the Federal Reserve Board or
the Federal Open Market Committee. \27\
---------------------------------------------------------------------------
\26\ Id.
\27\ Id. 807.
---------------------------------------------------------------------------
No determination, finding, action, or omission under the CRA is
subject to judicial review. \28\
---------------------------------------------------------------------------
\28\ Id. 805.
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On two recent occasions, Congress invalidated Federal banking
pronouncements under the CRA. In late 2017, Congress issued a joint
resolution disapproving the mandatory arbitration rule issued by the
Consumer Financial Protection Bureau (CFPB or the Bureau). \29\ Last
year, Congress invoked the CRA to nullify the CFPB's 2013 bulletin on
indirect auto lending. \30\
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\29\ Pub. L. No. 115-74, 131 Stat. 1243 (2017); see CFPB,
Arbitration Agreements, 82 FR 55,500 (Nov. 22, 2017); CFPB, Arbitration
Agreements, 82 FR 33,210 (July 19, 2017).
\30\ Pub. L. No. 115-172, 132 Stat. 1290 (2018) (disapproving
CFPB, Bulletin re: Indirect Auto Lending and Compliance with the Equal
Credit Opportunity Act (Mar. 21, 2013), https://
files.consumerfinance.gov/f/201303_cfpb_march_-Auto-Finance-
Bulletin.pdf).
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b. The Recent OMB Memorandum Interpreting CRA
Under the CRA, Congress tasked OIRA with determining whether agency
rules are ``major rules'' for purposes of the statute. \31\ The CRA is
silent on the timing of that determination vis-a-vis agency publication
of final rules.
---------------------------------------------------------------------------
\31\ 5 U.S.C. 804(2).
---------------------------------------------------------------------------
On April 19, 2019, the Acting Director of OMB, Russell T. Vought,
issued a memorandum that announced new, stricter procedures for
Congressional Review Act compliance (OMB Memo). \32\ OMB addressed the
memorandum, which it termed a ``guidance'', to all executive
departments and agencies, including all Federal bank regulators and
other independent Federal agencies. According to OMB, the memorandum
takes ``full effect'' on May 11, 2019. \33\
---------------------------------------------------------------------------
\32\ Memorandum from Russell T. Vought titled ``Guidance on
Compliance With the Congressional Review Act'', OMB Memorandum M-19-14
(Apr. 11, 2019), https://www.whitehouse.gov/wp-content/uploads/2019/04/
M-19-14.pdf (OMB Memo).
\33\ Id. at 2.
---------------------------------------------------------------------------
The OMB Memo took an aggressive position on CRA's compliance
requirements in at least three respects. First, in the OMB Memo, Mr.
Vought asserted that agencies ``should not publish a rule--major or not
major--in the Federal Register, on their websites, or in any other
public manner before OIRA has made the final determination and the
agency has complied with the requirements of the CRA.'' \34\ Second,
OMB required all independent Federal agencies, when providing ORA with
their analyses whether a rule is a ``major rule'' under the CRA, to
comply with OMB's cost-benefit analysis methodology and requirements in
OMB Circular A-4 and Part IV of the OMB Memo. \35\ Finally, OMB took
the position that ``guidance documents, general statements of policy,
and interpretive rules'' are subject to CRA review, in addition to
notice-and-comment legislative rules. \36\
---------------------------------------------------------------------------
\34\ Id. at 4; see also id. at 5.
\35\ Id. at 5.
\36\ Id. at 3.
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c. The Congressional Review Act Does Not Apply to Guidances
This last OMB pronouncement followed two separate opinions by the
Government Accountability Office (GAO) in 2017 finding that a guidance
document \37\ and a supervisory bulletin \38\ by Federal bank
regulators were ``rules'' and therefore had to undergo CRA review.
---------------------------------------------------------------------------
\37\ GAO, Office of the Comptroller of the Currency, ``Board of
Governors of the Federal Reserve System, Federal Deposit Insurance
Corporation--Applicability of the Congressional Review Act to
Interagency Guidance on Leveraged Lending'', GAO Opinion No. B-329272
(Oct. 19, 2017), https://www.gao.gov/assets/690/687879.pdf.
\38\ GAO, ``Bureau of Consumer Financial Protection: Applicability
of the Congressional Review Act to Bulletin on Indirect Auto Lending
and Compliance with the Equal Credit Opportunity Act'', GAO Opinion No.
B-329129 (Dec. 5, 2017), https://www.gao.gov/assets/690/688763.pdf.
---------------------------------------------------------------------------
The CRA only applies to ``rules.'' The statute defines the term
``rule'' as having the same meaning as in 5 U.S.C. 551. \39\ In turn,
5 U.S.C. 551(4) of the APA defines a ``rule'' as: ``the whole or a
part of an agency statement of general or particular applicability and
future effect designed to implement, interpret, or prescribe law or
policy or describing the organization, procedure, or practice
requirements of an agency . . . .''
---------------------------------------------------------------------------
\39\ 5 U.S.C. 804(3).
---------------------------------------------------------------------------
Section 551(4) sets forth three requirements to satisfy the
definition of a rule. First, there must be an ``agency statement of
general or particular applicability.'' Second, that statement must have
``future effect.'' Finally, the agency statement must be ``designed to
implement, interpret, or prescribe law or policy . . . .''
That is not the end of the story, however. CRA goes on to expressly
exclude any rule of particular applicability, any rule relating to
agency management or personnel, and any rule of agency organization,
procedure, or practice that does not substantially affect the rights or
obligations of nonagency parties from its definition of a ``rule.''
\40\ Consequently, nonbinding guidances are not rules under the CRA
because they do not substantially affect the rights or obligations of
nonagency parties. \41\
---------------------------------------------------------------------------
\40\ 5 U.S.C. 804(3).
\41\ There is another reason why guidances are not ``rules'' under
the CRA. Because guidances are nonbinding by definition, they do not
``take effect.'' As such, they lack ``future effect'' for purposes of
Section 551(4) of the APA and the CRA. See Adam Levitin,
``Congressional Review Act Confusion: Indirect Auto Lending Guidance
Edition'' (a/k/a ``The Past and the Pointless''), Credit Slips (Apr.
17, 2018), https://www.creditslips.org/creditslips/2018/04/
congressional-review-act-confusion.html. This distinction between
binding rules that ``take effect'' and nonbinding guidances has real
significance when it comes to the CRA. For the CRA states that a rule
cannot ``take effect'' until the agency submits the rule and its
``proposed effective date'' to Congress and to GAO. 5 U.S.C.
801(a)(1)(A). It is impossible, however, for an agency to transmit a
``proposed effective date'' for a guidance that does not take
``effect.'' Strikingly, GAO did not explain how guidances have ``future
effect'' in its 2017 opinions.
---------------------------------------------------------------------------
In an opinion letter last year, GAO affirmed that the Justice
Department's zero-tolerance policy \42\ was not subject to CRA review
based on that exclusion. \43\ According to GAO, ``the rights and
obligations in question [were] prescribed by existing immigration laws
and remain unchanged by the agency's internal enforcement procedures at
issue here.'' \44\ In so concluding, GAO relied on Federal case law
holding that ``rules were `procedural' . . . when the rules did not
have a `substantial impact' on nonagency parties.'' \45\ GAO reasoned:
``Although the memorandum changes previous policy, there is no
underlying change in the legal rights of aliens who cross the border.''
\46\
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\42\ The policy instructed Federal prosecutors to give higher
priority to certain immigration offenses with the goal of deterring
first-time improper entrants along the southwest border. Department of
Justice, Office of the Attorney General, Memorandum to Federal
Prosecutors along the Southwest Border, Zero-Tolerance for Offenses
Under 8 U.S.C. 1325(a) (Apr. 6, 2018).
\43\ GAO, U.S. Department of Justice--Applicability of the
Congressional Review Act to the Attorney General's April 2018
Memorandum, GAO Opinion No. B-330190, at 1 (Dec. 19, 2018), https://
www.gao.gov/assets/700/696164.pdf.
\44\ Id.
\45\ Id. at 4 (citing Brown Express, Inc. v. United States, 607
F.2d 695, 702 (5th Cir. 1979)).
\46\ Id. at 5.
---------------------------------------------------------------------------
If we change the phrase ``aliens who cross the border'' in GAO's
letter to ``regulated financial institutions,'' it is hard to
understand how a nonbinding guidance by Federal bank regulators is a
``rule'' for purposes of the CRA when the Justice Department's zero-
tolerance policy is not. For as the CFPB emphasized under then-Acting
Director Mick Mulvaney last year, ``neither an interpretive rule nor a
general statement of policy can create new rights and obligations for
regulated entities.'' \47\
---------------------------------------------------------------------------
\47\ CFPB Guidance RFI, supra n. 2, at 13960.
---------------------------------------------------------------------------
Other provisions in the CRA highlight why it is advisable to
exclude guidances from the definition of a ``rule'' for purposes of
that statute. Rules that Congress disapproves under the CRA may not be
reissued in substantially the same form unless they are specifically
authorized by a law enacted after the date of the joint resolution. Nor
may an agency issue a new rule that is substantially the same as the
original rule that Congress disapproved unless a later statute
specifically authorizes the new rule. \48\
---------------------------------------------------------------------------
\48\ 5 U.S.C. 801(b)(2).
---------------------------------------------------------------------------
But what does it mean for Congress to disapprove a nonbinding
guidance? The answer is murky, to say the least. Take disapproval of a
policy statement that adopts Federal judicial decisions construing a
statute that the agency is charged with enforcing. Nothing relieves the
agency of its statutory duty to carry out the statute. Similarly,
nothing prevents the agency from observing the case law discussed in
the policy statement when enforcing the statute. This is doubly true
when Congress does not amend the underlying statute or relieve the
agency of its responsibility to enforce it. Under these circumstances,
it is unclear what disapproval of the policy statement actually means.
For these reasons, the text and spirit of the CRA excludes
guidances from the definition of ``rules.'' \49\ However, there is an
even more important reason for not imposing added procedural hurdles
such as CRA, which is the adverse effect that doing so would have on
regulated parties and the larger financial system.
---------------------------------------------------------------------------
\49\ See Levitin, supra n. 41. GAO's and OMB's interpretations to
the contrary are only opinions unless and until they are affirmed by
the courts.
---------------------------------------------------------------------------
IV. Imposing More Procedural Hurdles To Adopting Agency Guidances Is
Unwise
Both of the initiatives to put guidances through notice-and-comment
proceedings and CRA review are overkill because they would result in
serious negative effects on regulated companies and the financial
system. In this section, I discuss why it would be counterproductive to
impose stiffer procedural requirements on guidances.
If nonbinding agency guidances had to undergo the notice-and-
comment procedures in the APA plus CRA review, the negative effect on
regulated persons would be palpable. Normally, a fast-track notice-and-
comment procedure takes at least 2 years and many rulemakings take
longer. Congressional Review Act transmission and review prolongs this
process even further.
At a minimum, the new procedural requirements would result in
protracted uncertainty and loss of transparency during the periods for
notice and comment and CRA review. During the intervening 2-plus years,
the public would be in the dark as to the content of the final guidance
and the agency's current position. The OMB Memo would prolong that
uncertainty and loss of transparency by prohibiting agencies from even
publishing final guidances until receiving a go-ahead from OIRA.
The adverse consequences for industry could be even worse,
depending on how Federal agencies respond. One way agencies might
respond is by elevating nonbinding guidances into binding legislative
rules. This would increase the number of binding rules on financial
providers and with it, their attendant legal risk and regulatory
burden.
Alternatively, agencies might respond by declining to formulate
guidances at all. Agencies would have strong internal pressures to
choose this path, given the daunting staffing and budgetary challenges
of what otherwise would be a vast increase in notice-and-comment
proceedings.
Is this what companies really want? Federal bank regulators have
statutory responsibility to enforce the existing statutory authorities
and binding rules under their jurisdiction. If agencies stopped issuing
guidances, they would still be responsible for enforcing those statutes
and rules. In the meantime, regulated persons would lack any guidance
about agency interpretation of those statutes and rules or about ways
to achieve compliance. This could result in precisely the type of
``gotcha'' enforcement actions that regulated entities complain about
and that guidances are designed to avoid. Moreover, we would lose the
constraints that guidances may practically place on agency enforcement.
Ironically, subjecting guidances to notice-and-comment procedures and
CRA review would result in less transparency, not more. Doing so might
well leave regulated entities to fend for themselves and produce the
``regulation by enforcement'' that they intensely dislike.
Putting guidances through notice-and-comment proceedings and CRA
scrutiny also is a slippery slope. Clearly, statements of policy and
interpretive rules are guidance. Generally, so are official ex ante
agency announcements that are labeled as ``guidance.'' But how about
individually tailored communications by regulators with specific
regulated entities, such as no-action letters, which industry members
find valuable? \50\ Similarly, would concerns about issuing
``guidance'' cause examiners to clam up when companies ask them for
compliance advice? The CFPB, under the leadership of Mr. Mulvaney,
stated in 2018 that it ``uses the term guidance . . . broadly to [also]
refer to compliance guides and other materials and activities that it
does not believe are rules within the meaning of the APA . . . .'' \51\
A sweeping position that all such materials must undergo notice and
comment and CRA review would have a severe chilling effect on those
materials.
---------------------------------------------------------------------------
\50\ Securities and Exchange Commissioner Hester Peirce recently
described S.E.C. no-action letters as guidance. ``SECret Garden:
Remarks at SEC Speaks by Commissioner Hester M. Peirce'' (Apr. 8,
2019), https://www.sec.gov/news/speech/peirce-secret-garden-sec-speaks-
040819.
\51\ CFPB Guidance RFI, supra n. 2, at 13960. These sorts of
``nonrule guidances,'' to use the Bureau's term, include frequently
asked questions, compliance guides, checklists, institutional and
transactional coverage charts, webinars, staff manuals, and oral
informal guidance in response to individual inquiries. Id.
---------------------------------------------------------------------------
Undoubtedly for these reasons, the Mortgage Bankers Association
(MBA) explained last year that ``[t]here are times when the costs of
public participation outweigh its benefits. . . . [T]he extent of
public participation should vary on the nature of the guidance
document.'' \52\ The National Association of Realtors has pointed out
that ``time is of the essence'' in certain regulatory situations and
argued for ``quick responses'' in the form of agency guidances in those
situations. \53\ The MBA similarly called on agencies (and specifically
the CFPB) to ``frequently revise implementation and compliance support
materials to ensure they remain relevant.'' \54\
---------------------------------------------------------------------------
\52\ Letter from the Mortgage Bankers Association to the CFPB on
Docket No. CFPB-2018-0013, at 4 (July 2, 2018) (hereinafter MBA Comment
Letter).
\53\ NAR Comment Letter, supra n. 13, at 1. See also id. at 2
(``compliance bulletins are often useful due to the expedited timeframe
for issuance without formal notice and comment procedures . . . .'').
\54\ MBA Comment Letter, supra n. 52, at 6.
---------------------------------------------------------------------------
Needless to say, companies cannot have it both ways. Imposing
notice-and-comment requirements on agency guidance indiscriminately
would make these types of quick responses and frequent revisions
impossible. \55\
---------------------------------------------------------------------------
\55\ Indeed, the Administrative Conference of the United States
has advised that a ``Government-wide requirement for inviting written
input from the public on policy statements is not recommended, unless
confined to the most extraordinary documents.'' Administrative
Conference, supra n. 6, at 6.
---------------------------------------------------------------------------
Furthermore, erecting stringent procedural barriers to guidance
would pose enormous risks to the financial system and the public writ
large. Regulators issue guidance to increase the level of compliance
with the law. Losing this vital information source for the bulk of
companies that want to comply with banking law would likely increase
the level of unsafe and unsound practices and raise the aggregate risk
in the financial system.
We cannot afford to take that risk, especially after the
devastating losses from the 2008 financial crisis. Currently, leveraged
loans pose one of the biggest threats to U.S. financial stability. \56\
But after GAO classified the leveraged loan guidance as a ``rule''
under the CRA, the Comptroller of the Currency lifted that guidance for
the biggest players in that market, which are national banks. \57\ This
is not good for anyone, be it national banks or the financial system at
large.
---------------------------------------------------------------------------
\56\ See ``Financial Stability Oversight Council, 2018 Annual
Report'' 11-12 (2018), https://home.treasury.gov/system/files/261/
FSOC2018AnnualReport.pdf; ``Office of Financial Research, Annual Report
to Congress'' 18-20 (2018), https://www.financialresearch.gov/annual-
reports/files/office-of-financial-research-annual-report-2018.pdf.
\57\ ``OCC Head Says Banks Need Not Comply With Leveraged Lending
Guidance'', Ropes and Gray (March 1, 2018), https://www.ropesgray.com/
en/newsroom/alerts/2018/03/OCC-Head-Says-Banks-Need-Not-Comply-with-
Leveraged-Lending-Guidance.
---------------------------------------------------------------------------
Part of the controversy about guidances involves Matters Requiring
Attention (MRAs) and Matters Requiring Immediate Attention (MRIAs) that
examiners issue from time to time in individual companies'
examinations. Concerns have been raised that some examiners at the
Federal prudential banking agencies write up violations of guidance as
MRAs and MRIAs.
In addressing this issue, it is important to stress the important
role of MRAs and MRIAs in resolving safety and soundness problems and
violations of statutes and rules short of initiating enforcement.
Without those notices, problems could fester until sanctions were
unavoidable or the institution flat-out failed. Requiring all MRAs and
MRIAs to go through notice and comment--including those that address
unsafe and unsound practices and violations of statutes and rules--
would ban them for all intents and purposes. Instead, a better approach
would be for senior bank regulators to carefully review proposed MRAs
and MRIAs and to train examiners on their appropriate use. Supervised
companies can also appeal MRAs and MRIAs through the supervisory
appeals process. \58\
---------------------------------------------------------------------------
\58\ See, e.g., CFPB Supervisory Appeals, supra n. 16, at 2;
Comptroller of the Currency, OCC Banking Bull. 2013-15 (June 7, 2013),
https://www.occ.treas.gov/news-issuances/bulletins/2013/bulletin-2013-
15.html.
---------------------------------------------------------------------------
In sum, putting nonbinding guidances through notice and comment and
CRA review would result in the worst of both worlds. Either agencies
would issue even more binding legislative rules or they would enforce
their statutes and rules without the benefit of guidance. Given these
undesirable results, this is an area where Congress should tread
carefully.
V. The OMB Memo Improperly Seeks To Curtail Federal Bank Regulators'
Independence
In this final section, I close by discussing other problems with
the OMB Memo and specifically its attempt to infringe on the
independence of Federal bank regulators.
In the OMB Memo, OMB purports to prohibit independent Federal bank
regulators from publishing their final rules on their websites or in
the Federal Register before OIRA has made its major determination under
the CRA. \59\ In addition, the memorandum also seeks to prescribe the
methodology independent agencies are to use when conducting their cost-
benefit (impact) analyses through the back door. \60\
---------------------------------------------------------------------------
\59\ See OMB Memo, supra n. 32, at 4.
\60\ See id. at 5.
---------------------------------------------------------------------------
In adopting this stance, the OMB Memo improperly treads on Federal
bank regulators' independence and violates Executive Order No. 12,866.
Historically, the courts and Federal law have guarded the independence
of Federal bank regulators from the Executive Branch to shield the
financial system from political intervention for short-term gain. \61\
This is why Federal bank regulators are exempt from the requirement
that agencies submit their rules to OIRA for review and cost-benefit
analysis. \62\ This results from the express exemption in Executive
Order 12,866 for agencies designated as ``independent regulatory
agencies'' under the Paperwork Reduction Act. \63\ The Paperwork
Reduction Act's list of independent regulatory agencies includes the
CFPB and all other Federal bank regulators. \64\
---------------------------------------------------------------------------
\61\ See, e.g., Humphrey's Executor v. United States, 295 U.S. 602
(1935).
\62\ Exec. Order No. 12,866, 58 FR 51,735, 51,753 (Oct. 4, 1993).
\63\ Id.
\64\ 44 U.S.C. 3502(5) (2012).
---------------------------------------------------------------------------
Because OMB is an arm of the White House, \65\ Executive Order
12,866 effectively shields Federal bank regulators from White House
review of their rules. The purpose of this carve-out is to ensure the
expert neutrality of bank regulators and to insulate those rules from
political manipulation by the White House and OMB. Instead, Congress,
not the White House, retains ultimate control over Federal bank
regulators' rules.
---------------------------------------------------------------------------
\65\ 31 U.S.C. 501 (2012) (establishing OMB as ``an office in the
Executive Office of the President''). Because OMB resides within the
White House, its website is nested within the White House website. See
``Office Mgmt. and Budget, White House'', https://www.whitehouse.gov/
omb.
---------------------------------------------------------------------------
The OMB Memo seeks to intrude on Federal bank regulators' cost-
benefit analyses by requiring them to submit a major rule analysis that
is consistent with OIRA's cost-benefit analysis methodology. To begin
with, it is not clear how Federal bank regulators can even do a
meaningful cost-benefit analysis of nonbinding guidance. Beyond that,
there are important reasons why Congress exempted cost-benefit analyses
by Federal bank regulators from OIRA and OMB oversight in Executive
Order 12,866. In financial regulation, it is generally harder to
quantify benefits in the form of harms avoided than it is to quantify
costs. Federal bank regulators must make numerous rulemaking decisions
under conditions of incomplete data and uncertainty. Requiring Federal
bank regulators to monetize all harms avoided--which might prove
impossible--would dangerously tilt rulemaking analyses toward inaction
and the status quo.
In short, Executive Order 12,866 means that OIRA's standards for
cost-benefit analyses do not apply to Federal bank regulators' major
rule analyses and may not be wielded as a threat to ``delay OIRA's
determination and an agency's ability to publish a rule and to make the
rule effective.'' OMB's threat to hold up final rules by Federal bank
regulators indefinitely for ``insufficient or inadequate analysis'' in
OIRA's view \66\ poses the added, serious concern that OMB or OIRA
might call a regulator's bluff and press to renegotiate the provisions
of a final rule pending publication of the rule's text, with no
judicial review. Any attempt to do so would be a blatant affront to
Federal bank regulator independence and a rank violation of Executive
Order 12,866. Even more seriously, any such move by OIRA would
represent an attempt under the unitary executive theory to bottle up
rules, detaining them from Congressional review and wresting CRA
oversight from Congress in the process. In that respect, it is well
known that OIRA has mired final rules of executive agencies
indefinitely while conducting its review.
---------------------------------------------------------------------------
\66\ OMB Memo, supra n. 32, at 5.
---------------------------------------------------------------------------
In the OMB Memo, OIRA implicitly commits itself to making a CRA
determination on independent agency rules within 40 days. \67\
Fortunately, if OIRA does not respect the 40-day timeframe, no statute
or rule stops Federal bank regulators from publishing their rules at
that point and transmitting their rules directly to Congress for CRA
review. Any suggestion in the OMB Memo to the contrary has no legal
effect.
---------------------------------------------------------------------------
\67\ Id. The memorandum states that OIRA may inform agencies that
rules are not major within 10 days of notification. Other rules must
undergo the major rule determination, for which OIRA advises
independent agencies to allocate 30 days. Id.
---------------------------------------------------------------------------
To conclude, nonbinding agency guidances bring important
transparency to Federal banking regulation and regulated firms depend
heavily on them. In all likelihood, requiring those guidances to go
through notice and comment and CRA review would backfire by causing
agencies to scrap guidances altogether and increasing the likelihood of
the ``regulation by enforcement'' that industry fears.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
FROM GREG BAER
Q.1. The Financial Services Roundtable and The Clearing House
Association, predecessors of the Bank Policy Institute, have
previously requested written guidance from Federal agencies,
including:
A. a 2013 request for written guidance from CFPB and HUD on
Dodd-Frank mortgage standards;
B. a 2014 request for written guidance from CFPB on the
TILA/RESPA integrated mortgage disclosures rule;
C. a 2015 request for guidance from the Federal banking
agencies, through the FFIEC, on Call Reports; and
D. a 2016 comment letter suggesting guidance from the
Federal Reserve and IRS on the tax consequences of
total loss-absorbing capacity (TLAC) rules.
Please provide to the Committee all instances in which the
Bank Policy Institute or its predecessors have requested or
advocated guidance from the Federal financial institution
regulatory agencies since July 21, 2010.
A.1. We are unable to provide a full accounting of ``all
instances'' in which BPI or any of its predecessors have
requested or advocated guidance. At least in our most recent
iteration, we have consistently expressed concern about the
agencies use of guidance because that guidance has often been
treated as a binding rule through the examination process, even
where no public notice was provided or comment sought. Such
action is inconsistent with the Administrative Procedure Act
and, unless the guidance is submitted to the Congress for
review, with the Congressional Review Act. And it is poor
Government, in the sense that public comment--not just from
banks but other groups or individuals with interest and
expertise in banking policy--tends to make for a better rule.
Postcrisis, the combination of voluminous issuance of guidance
along with agency treatment of that guidance as binding,
effectively created a whole new regulatory regime about which
the public had no input.
Therefore, we strongly support a 2018 interagency statement
that reaffirmed that supervisory guidance ``does not have the
force and effect of law, and the agencies do not take
enforcement actions based on supervisory guidance.'' To the
extent that in recent years the agencies have strayed from that
practice, we are advocating a return to the appropriate role of
guidance: to State the views of the agency, but not create
binding obligations on regulated entities.
None of this is to deny that guidance can sometimes play a
useful role, as it did until relatively recent times. If
treated as nonbinding, guidance can inform regulated entities
of agency priorities, and let them know of best (or worse)
practices that the agency is observing. It is only when it is
treated as binding in practice that we believe it needs to be
issued as a rule under the law.
------
RESPONSES TO WRITTEN QUESTIONS OF
SENATOR CORTEZ MASTO FROM GREG BAER
Q.1. During this hearing, a number of my colleagues floated the
idea of a neutral arbiter or an independent ombudsman to
represent financial institutions who have concerns with Federal
regulators' overreach. Would you support such a proposal? If
so, what should this review process look like? What review
powers do you believe the arbiter should have? If you do not
support the proposal, please explain why.
A.1. We support the idea of a neutral arbiter for financial
institutions concerned with regulatory overreach, but would
caution that its utility can be quite limited. Each of the
banking agencies currently has an intra-agency appeals process
and an ombudsman, but a recent article that analyzed the
process and outcomes of those regimes concluded that they were
a failure. See Hill, Julie Anderson, ``When Bank Examiners Get
It Wrong: Financial Institution Appeals of Material Supervisory
Determinations'', Washington University Law Review (2015).
https://openscholarship.wustl.edu/law_lawreview/vol92/iss5/5/
In sum, banks are loathe to appeal any adverse
determination, for two reasons. First, and most significantly,
they fear retaliation through the examination process.
Moreover, this may seem like overreaction needing to be
addressed by the institutions, but one must keep in mind that
failing to address examiner concerns can result in a downgrade
to the bank's Management rating. As noted in my testimony, such
a downgrade--and until relatively recently--any unremediated
examiner mandate--can act as a prohibition on expansion by the
bank. And that prohibition is nonpublic and therefore
effectively nonappealable. Second, appeals are made to the same
agency that made the initial determination, and thus unlikely
to succeed.
While the second concern could be resolved by allowing
appeal to a third party, the first would remain. Therefore, we
believe that reform in this area should focus more on requiring
the agencies to adhere to statutory standards for deciding
whether a firm can expand, rather than employing a ``penalty
box'' approach, and revisiting the CAMELS rating regime to make
it more objective, as the current approach is to make the most
subjective of its component (Management) the most significant.
------
RESPONSES TO WRITTEN QUESTIONS OF
SENATOR CORTEZ MASTO FROM MARGARET E. TAHYAR
Q.1. During this hearing, a number of my colleagues floated the
idea of a neutral arbiter or an independent ombudsman to
represent financial institutions who have concerns with Federal
regulators' overreach. Would you support such a proposal? If
so, what should this review process look like? What review
powers do you believe the arbiter should have? If you do not
support the proposal, please explain why.
A.1. Stronger ombudsmen and examination appeals processes are
needed to start the cultural change. Recent efforts by the
banking regulators to strengthen the authority of their
internal ombudsmen and their examination review processes are
welcome signs of progress. I do not think that an external
ombudsman outside of the banking agencies is the optimal
structure; instead, more power and authority should be given to
the current ombudsmen. Strong ombudsmen and robust appeals
processes will not, however, be enough because of legitimate
fears of retaliation despite attempts to provide protection
against such retaliation. The root causes also need to be
addressed. These are lack of transparency, limitations on the
practical ability of the agency principals to oversee the
supervisory staff's compliance with applicable legal
restrictions on their discretion, the lack of any clear limits
on the supervisory discretion to classify any shortcoming as a
safety and soundness violation based on an individual
supervisor's policy preferences, and the lack of legal training
for bank supervisors. Congress should also focus on this more
fundamental reform. Increased transparency of the supervisory
process, including appropriate limits on the perimeter of what
can be classified as confidential supervisory information or as
safety and soundness violations, as well as better oversight of
the supervisory staff's compliance with applicable legal
restrictions on their discretion and better training about such
legal restrictions, would increase the odds that supervisory
staff would become more accountable to the public and agency
leadership.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SINEMA
FROM MARGARET E. TAHYAR
Q.1. In your experience, what is the best approach to balance
the competing demands of providing regulatory clarity while
ensuring rigorous supervision that protects the safety and
soundness of the U.S. financial system?
A.1. The best approach is to narrow the realm of confidential
supervisory information to the core minimum necessary to
protect financial stability or individual bank safety and
soundness. As a bank regulatory lawyer, I fully recognize that
some secrecy is needed to ensure candid conversations and
protect the financial system. Yet we need to move away from the
current situation, in which nearly anything a bank gives its
regulator in the course of the supervisory process might be
transformed into confidential supervisory information, with all
the attendant consequences. Part of the solution is for bank
examinations to return to a focus on the quantitative core and
move away from qualitative judgments that reflect examiner
policy preferences on how to run the business--the examiner as
management consultant. Ultimately, however, confidential
supervisory information is a creature of regulation, not etched
in stone, and Congress can exert pressure on the banking
agencies to reform their approach or even take legislative
action to force change if needed.
Regulators should also take efforts to increase
transparency, even within the current bounds of confidential
supervisory information. In particular, the banking agencies
should strive to release more granular data on the state of
banking supervision, aggregated across the industry to
anonymize the information. The Federal Reserve's November 2018
and May 2019 Supervision and Regulation Reports represent
admirable efforts in the right direction. The banking sector is
a critical part of our economy and the banking agencies are a
critical part of our Government, so it is imperative that bank
supervisors are accountable to the public.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN
FROM PATRICIA A. MCCOY
Q.1. Congress designed Federal regulatory agencies to be
independent from the President's continuing influence so that
they could make rules for our economy based on technocratic
analysis and data, rather than political considerations. Can
you describe why independence at regulatory agencies is
critical?
A.1. Congress wisely conferred independence on Federal
regulatory agencies for the long-term welfare of the American
people. Independence promotes the general good in several
important ways. First, it helps ensure that regulators will
make informed decisions on the basis of data, scientific
expertise, and facts. Second, it insulates regulators from
pressure by the President and the Executive Branch to rig
decisions in order to boost the reelection prospects of the
President or the President's political party, to the detriment
of the public generally. Such pressure could occur in at least
two scenarios. Pressure might be exerted to curry favor with
politically powerful industries or groups in tacit exchange for
campaign contributions. Alternatively, the White House could
lean on regulators to stimulate the economy in order to win
election, indifferent to the long-term risks to the economy.
Finally, independence helps shelter Federal regulators from
lobbying by politically powerful and well-oiled industry
interests seeking exceptions from regulatory actions that are
designed to protect the American people. Independence, simply
put, helps ensure that Federal regulators make decisions for
the betterment of ordinary families and not as political
favors.
Q.2. After abusive mortgages crashed the economy in 2008, you
led the team at the Consumer Financial Protection Bureau (CFPB)
that wrote the rules to fix the mortgage market and prevent
another financial crisis. Can you describe, broadly, who wrote
those rules and what evidence they used?
A.2. When Congress charged the CFPB with promulgating the
mortgage rules in the Dodd-Frank Act, ensuring sustainable
mortgages while advancing access to credit and minimizing
industry burden were of uppermost importance to the Bureau. For
this reason, the CFPB's mortgage rules were the product of
extensive factual research, mortgage expertise, and public
consultation. The economists, lawyers, and markets experts in
the Bureau's Research, Markets, and Regulations Division took
the lead in drafting the mortgage rules, following voluminous
written public comment and outreach to all affected parties,
including consumers, financial providers, independent
researchers, community housing organizations, industry
associations, consumer advocacy groups, and sister State and
Federal regulators. In the rulemaking for the integrated
mortgage disclosures, the Bureau even posted each new draft of
the prototype disclosures online and asked the crowd to suggest
needed improvements. Based on the public's suggestions, the
Bureau then improved the draft and posted the next version
online. This crowdsourcing was repeated every month and the
public eventually submitted over 30,000 comments on the
prototype forms. I can say from personal experience that the
final disclosure forms were markedly better due to this public
input.
Meanwhile, the Bureau's economists and researchers drew
heavily on a wide assortment of other empirical data in
designing the mortgage rules. Much of that data came from large
national data sets reporting every residential mortgage
origination in specific channels over a substantial time
period. These data sets contained tens of millions of
observations and allowed the Bureau's researchers to conduct
sophisticated analyses of the projected effect of different
rules on expected default rates, the cost of credit, and access
to credit. In other instances, the Bureau created data sets to
analyze questions such as the size of potential legal liability
to lenders from specific types of mortgage rules. Separately,
the CFPB's markets analysts conducted ongoing, in-depth studies
of the business models and earnings reports of mortgage lenders
to ensure that mortgage lending remained profitable and
sustainable following adoption of the rules. This was augmented
by CFPB analysis of the vast economics literature on the
effects of residential mortgages and specific types of
regulatory intervention on key outcomes such as delinquencies
and cost of credit. In one notable instance--the integrated
mortgage disclosure rule--the CFPB used the most sophisticated
field testing available to ensure that the disclosure rule was
broadly understandable and useful to consumers and industry
participants.
Q.3. When you were writing the rules at CFPB, President Obama
was in the White House and his appointees were leading the
agency. Did you ever submit CFPB rules to the White House for
review? Why or why not?
A.3. Neither I nor the CFPB submitted CFPB rules to the White
House or the Office of Management and Budget (OMB) for review.
This practice conformed to the Dodd-Frank Act, which prohibits
OMB from asserting ``jurisdiction or oversight over the affairs
or operations of the Bureau.'' 12 U.S.C. 5497(a)(4)(E).
Furthermore, this practice comported with Executive Order No.
12,866, 58 FR 51,735, 51,753 (Oct. 4, 1993), which exempts all
Federal bank regulators, including the CFPB, from the
requirement that agencies submit their rules to OMB for review
and cost-benefit analysis. This express exemption applies to
agencies designated as ``independent regulatory agencies'' in
the Paperwork Reduction Act. The Paperwork Reduction Act's list
of independent regulatory agencies includes the CFPB and all
other Federal bank regulators. 44 U.S.C. 3502(5) (2012).
This exemption from OMB review of rules is a crucial
mainstay of Federal bank regulators' independence. Because OMB
is located within the White House and is subject to White House
control, any provision requiring the CFPB and/or other Federal
bank regulators to submit their rules to OMB would open up
their rulemaking processes to White House pressure for short-
term political benefit. Effectively, Executive Order No. 12,866
shields the CFPB and other Federal bank regulators from White
House review of their rules. The purpose of this carve-out is
to ensure the expert neutrality of CFPB rules and to insulate
those rules from political manipulation by OMB and the White
House. Instead, Congress, not the White House, retains ultimate
control over CFPB rules.
Q.4. On April 11, 2019, Acting OMB Director Russel Vought sent
a memo to all heads of executive departments and agencies,
including independent agencies, creating a ``systematic process
to determine whether rules that would not be submitted to OIRA
. . . are major,'' \1\ a determination that should be made by
looking at whether a rule will cost $100 million or more
annually, will cause a major increase in costs or prices, or
will have a significant adverse effect on players in the
market. Are you concerned that the review of the cost-benefit
analysis by OIRA of rules promulgated by independent agencies
could substantively affect the rules?
---------------------------------------------------------------------------
\1\ Office of Management and Budget, ``Guidance on Compliance With
the Congressional Review Act'', Russell T. Vought, April 11, 2019,
https://www.whitehouse.gov/wp-content/uploads/2019/04/M-19-14.pdf.
A.4. I am deeply concerned that the OMB's back-door attempt to
subject rules promulgated by independent agencies to cost-
benefit analysis by OIRA could distort the content of those
rules, to the detriment of the American public.
The April 11, 2019, OMB Memo \2\ seeks to intrude on
independent agencies' rulemaking autonomy by requiring them to
submit major rule analyses under the Congressional Review Act
(CRA) that are consistent with OIRA's cost-benefit analysis
methodology. However, there are important reasons why Congress
exempted cost-benefit analyses by independent agencies from
OIRA and OMB oversight in Executive Order No. 12,866. One
reason, discussed above, is to protect independent agencies
from White House pressure for purposes of political gain.
Another reason, discussed in my response to Senator Cortez
Masto's Question 1, involves the precautionary nature of many
rules by independent agencies. Precautionary rules are ones
that seek to avoid harm. These types of rules pose challenges
in cost-benefit analyses, because quantifying harms avoided is
generally more difficult than quantifying costs. Because OIRA's
cost-benefit methodology gives no or little weight to benefits
that cannot be quantified, OIRA's methodology overweights costs
and thus biases rulemaking decisions in favor of agency
inertia. As such, OIRA's approach is poorly suited to a
precautionary approach to harm.
---------------------------------------------------------------------------
\2\ Memorandum from Russell T. Vought titled ``Guidance on
Compliance With the Congressional Review Act'', OMB Memorandum M-19-14
(Apr. 11, 2019), https://www.whitehouse.gov/wp-content/uploads/2019/04/
M-19-14.pdf (OMB Memo).
---------------------------------------------------------------------------
Here, it bears emphasizing that the OMB Memo lacks legal
validity as applied to independent agencies. Executive Order
No. 12,866 means that OIRA's standards for cost-benefit
analyses do not apply to independent agencies' major rule
analyses and may not be wielded as a threat to ``delay OIRA's
determination and an agency's ability to publish a rule and to
make the rule effective.'' OMB's threat to hold up final rules
by independent agencies indefinitely for ``insufficient or
inadequate analysis'' in OIRA's view (see OMB Memo at 5) poses
the added, serious concern that OMB or OIRA might call a
regulator's bluff and press it to renegotiate the provisions of
a final rule pending publication of the rule's text, with no
judicial review. Any attempt to do so would be a blatant
affront to agency independence and a rank violation of
Executive Order No. 12,866. Even more seriously, any such move
by OIRA would represent an attempt to bottle up rules, detain
them from Congressional review, and wrest CRA oversight from
Congress in the process. OIRA has mired final rules of
executive agencies indefinitely while conducting its review in
the past and there is reason to think the same would occur if
independent agencies had to submit the cost-benefit analyses of
their rules to OIRA.
Q.5. This review ``applies to more than just notice-and-comment
rules; it also encompasses a wide range of other regulatory
actions, including, inter alia, guidance documents, general
statements of policy, and interpretive rules.'' \3\ How will
the mandatory submission of guidance documents for review
affect the ability of agencies to do their jobs?
---------------------------------------------------------------------------
\3\ Id.
A.5. Please see my response to Question 3 from Senator Cortez
---------------------------------------------------------------------------
Masto.
Q.6. If Donald Trump was president when you were writing the
mortgage rules in 2011 and his OMB demanded the opportunity to
review cost benefit analysis as it just did, what do you
believe could have happened to those rules?
A.6. Please see my response to Question 4 above. The CFPB used
rigorous cost-benefit analyses in the mortgage rules. Despite
the strong foundation supporting those rules, the OMB Memo, had
it been in effect at the time, would have raised concerns that
OMB might have withheld the major rule determination required
by the Congressional Review Act on grounds that the CFPB's
regulatory impact analyses did not adhere to OIRA's cost-
benefit analysis methodology.
------
RESPONSES TO WRITTEN QUESTIONS OF
SENATOR CORTEZ MASTO FROM PATRICIA A. MCCOY
Q.1. In our discussion, you raised concerns with the OMB memo
specifying the methodology for cost-benefit analysis. Do you
believe there is a better process by which to determine cost-
benefit or a rulemaking or guidance?
A.1. To answer this question, it is necessary to distinguish
between regulations and guidances. In the case of regulations,
the most important consideration is preserving the discretion
of the independent Federal bank regulators to determine the
appropriate methodology for their regulatory impact or cost-
benefit analyses. Federal bank regulators take regulatory
impact analyses extremely seriously. Since the enactment of the
Dodd-Frank Act, they have strengthened and refined their
regulatory impact and cost-benefit analyses, particularly given
the heightened judicial scrutiny that those analyses now
receive after the D.C. Circuit's decision in Business
Roundtable v. Sec. and Exch. Comm'n, 647 F.3d 1144, 1148 (D.C.
Cir. 2011). \1\
---------------------------------------------------------------------------
\1\ See, e.g., Board of Governors of the Federal Reserve System,
Response to a Congressional Request Regarding the Economic Analysis
Associated with Specified Rulemakings 9, 20 (June 2011), http://
oig.federalreserve.gov/reports/Congressional-Response-economic-
analysis-2011web.pdf (stating that the Federal Reserve ``conducts its
rulemaking activities in a manner that is generally consistent with the
philosophy and principles outlined in the Executive orders'' and
suggesting that the Federal Reserve acts consistently with at least
some aspects of the guidance in OMB Circular A-4); GAO Report GAO-12-
151, Dodd-Frank Act Regulations: Implementation Could Benefit From
Additional Analyses and Coordination 12 (Nov. 2011), http://
www.gao.gov/new.items/d12151.pdf (reporting statements by the Federal
Reserve Board, FDIC, NCUA, and OCC that their agencies follow OMB's
guidance in spirit or principle. CFPB officials also stated that the
Bureau expects to follow the spirit of OMB's guidance, ``in a manner
consistent with the Dodd-Frank Act, which speaks directly to the
consideration of benefits, costs, and impacts'').
---------------------------------------------------------------------------
An overly rigid cost-benefit methodology that required
quantification of all costs and benefits could jeopardize
financial institutions' solvency, consumer welfare, or
financial stability. That is because in financial regulation,
it is generally harder to quantify benefits in the form of
harms avoided than to quantify costs. Federal bank regulators
must make numerous rulemaking decisions under conditions of
incomplete data and uncertainty. Requiring Federal bank
regulators to monetize all harms avoided--which might prove
impossible--would dangerously tilt rulemaking analyses toward
inaction and the status quo.
In the case of guidances, it is difficult or impossible to
conduct regulatory impact or cost-benefit analyses because
guidances are not binding on private third parties and
therefore do not impose defined costs.
Q.2. In your testimony, you raise concerns regarding political
influence on our Nation's economy and financial system. Can you
elaborate on the potential harms political influence on our
financial system may have?
A.2. Insulating bank regulation from political influence is
vital to the long-term economic welfare of our Nation and the
American public. A couple of examples illustrate why this is
the case. If Federal bank regulators lacked independence, a
President could pressure those agencies to deregulate the
banking industry to an excessive degree in order to increase
bank lending, goose the economy, and boost the President's
reelection prospects. If the ensuing deregulation resulted in
unwise lending and an eventual spike in loan delinquencies, the
economy might experience a short-term bump but long-term
losses. In a similar way, White House pressure on the Federal
Reserve Board to lower interest rates could stimulate the
economy in the short term, to the President's political
benefit, but inflict harm on the economy in the long term by
stoking inflation and reducing the buying power of ordinary
Americans.
Q.3. Could you discuss the potential impact that a drawn out
OIRA review or Congressional Review Act process on guidance
could have on the markets, or the economy as a whole?
A.3. As I noted in my written testimony (p. 9 [p. 54 herein]),
notice-and-comment proceedings for major rules take at least 2
years and normally longer. Congressional Review Act
transmission and review prolong this process even further.
Imposing those same procedures on guidance would have
unintentional effects redounding to the detriment of markets or
the economy as a whole. For instance, agencies might respond by
issuing pronouncements that otherwise would be nonbinding
guidances as binding legislative rules. This would put a drag
on financial firms by unnecessarily increasing the number of
binding rules they had to observe and raising their legal
exposure for violation of those new rules. If the financial
sector became less efficient and increasingly cautious in
lending and investment as a result, the larger economy could
suffer adverse knock-on effects in the form of reduced access
to capital and credit.
Alternatively, agencies might respond to more onerous
guidance procedures by issuing fewer compliance guidances or
none at all. This would hurt honest companies' efforts to
comply with regulations, because many guidances are designed to
aid industry with compliance. As a result, firms would face
increased legal exposure for violations of rules, with a
potential negative impact on earnings and their willingness to
take reasonable business risks. Any such excessive business
caution could dampen the financial sector and reduce credit and
investment to the economy as a whole.
Q.4. Some of your fellow witnesses raised concerns regarding
the opacity of the Matters Requiring Attention (MRA) and the
Matters Requiring Immediate Attention (MRIA) process, and have
suggested giving financial institutions a process by which to
arbitrate or contest these actions. Would you support such a
process and if so, why? If not, please explain why.
A.4. Depository institutions and their holding companies
already have several avenues of recourse to challenge MRAs and
MRIAs with which they disagree (see pp. 4-5 [50-51 herein] of
my written testimony). First, they can meet privately with
examiners and their supervisors to propose changes to or
contest those actions. Second, all Federal bank regulators
maintain ombudsmen whom financial institutions can enlist to
help resolve any problems from MRAs and MRIAs. Third, Federal
bank regulators all have procedures for formal agency reviews
of examination results, including MRAs and MRIAs. And fourth,
the banking industry can informally petition Federal bank
regulators to reduce the burden of MRAs and MRIAs through
across-the-board reforms. Indeed, in response to banking
industry calls, the Board of Governors of the Federal Reserve
System proposed a guidance in 2017 that would reduce the burden
on financial institutions' boards of directors to respond to
MRAs and MRIAs. See Federal Reserve System, ``Proposed guidance
on Supervisory Expectation for Boards of Director'', 82 FR
37219 (Aug. 9, 2017).
In view of these multiple avenues of relief from MRAs and
MRIAs, there is no justification for tying Federal bank
supervisors in knots by conferring depository institutions with
a right to arbitrate MRAs and MRIAs. Such a cumbersome
procedure would intensify the problem experienced during the
lead-up to the 2008 financial crisis, when Federal bank
examiners routinely failed to insist that institutions address
and resolve outstanding MRAs and MRIAs from their prior
examinations and regularly failed to take enforcement for
persistent unsafe and unsound practices. IndyMac Bank, F.S.B.,
was an especially egregious example, but it was not alone. See
Office of Inspector General, Department of the Treasury, Safety
and Soundness: Material Loss Review of IndyMac Bank, FSB 17-19,
24-26, 33-34, 63-70 (OIG-09-032, Feb. 26, 2009). This
widespread regulatory inaction contributed to the 2008
financial crisis and its fallout. If anything, the regulatory
inaction that culminated in the crisis of 2008 underscores the
importance of preserving today's stronger MRA and MRIA process,
not weakening it through rigid arbitration procedures. Adopting
such arbitration procedures would embolden unsafe institutions
to discourage Federal examiners from writing up needed MRAs and
MRIAs, thereby endangering the Deposit Insurance Fund,
uninsured depositors, and the banking system as a whole.
Q.5. During this hearing, a number of my colleagues floated the
idea of a neutral arbiter or an independent ombudsman to
represent financial institutions who have concerns with Federal
regulators' overreach. Would you support such a proposal? If
so, what review powers do you believe the arbiter should have?
If you do not support the proposal, please explain why.
A.5. Federal statutes already provide financial institutions
that are aggrieved by Federal regulators' actions with a
neutral, independent arbiter in the form of Article III courts.
Under the Administrative Procedure Act (APA), aggrieved
institutions can seek federal judicial review of a broad array
of final agency actions, including rules and agency
enforcement. 5 U.S.C. 701-706. This right to Article III
judicial review is on top of the multiple avenues of internal
agency relief to which financial institutions are entitled (see
pp. 4-5 [50-51 herein] of my written testimony).
Superimposing the right to another neutral arbiter or
independent arbiter would be unwise and potentially disastrous.
First, it would undermine the carefully drafted procedures in
the APA for independent, neutral judicial review and the
judiciary's constitutional responsibility for conducting that
review. Second, it would supplant the judgment of Federal bank
regulators with decisions by outside arbiters who lack
responsibility for the safety of the larger financial system.
Especially in this era of heightened systemic risk, that would
be a dangerous path to tread. Finally, it would hamper the
nimbleness of Federal bank regulators to respond to emerging
threats by bogging them down in unnecessary and time-consuming
procedures.
Q.6. In your conversation, you discussed improvements to the
MRA and the MRIA process. What are the problems with the
current process? What reforms do you believe need to be made to
the process? Do you believe there should be a threshold of some
sort for what MRAs and MRIAs go through the process?
A.6. It would be a mistake to hamstring Federal bank
regulators' ability to cite depository institutions for unsafe
and unsound practices and seek remediation of those practices
by legislating artificial limits on the MRA and MRIA process.
Regulators need full latitude to address practices that
threaten the safety and soundness of depository institutions
and MRAs and MRIAs are important to that flexibility and
discretion. To the extent that the MRA and MRIA process could
benefit from streamlining, that should be resolved through
transparent engagement with the public by Federal bank
regulators. The banking industry is fully capable of exploring
any needed reforms with regulators and, indeed, those
discussions have already set in motion a pending guidance by
the Federal Reserve Board to reduce the demands imposed by MRAs
and MRIAs. See Federal Reserve System, ``Proposed Guidance on
Supervisory Expectation for Boards of Director'', 82 FR 37219
(Aug. 9, 2017).
Additional Material Supplied for the Record
LETTER SUBMITTED BY CBA
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
LETTER SUBMITTED BY CUNA
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]