Sunday, May 11, 2014

Time for Bank Charter Reform?

Credit: "Plato's Cave" Kombo Chapfika, 2008

This week's superb article in the New York Times, Loans That Avoid Banks? Maybe Not  is notable not only for its content and analysis, but also for signaling modern implications for the basic existential question in our industry, "What is a bank?"

The triptych above entitled "Plato's Cave" gives a surrealistic interpretation to Plato's famous Allegory of the Cave (summary here).  The allegory's general concepts can be applied to the question: "What is a bank?" in the sense that we see the world  through a personal frame of reference and a collective frame of reference.  We also see that world through lenses that could be characterized as plain sight, microscopic (seeing things close up), telescopic (seeing things from a distance), and panoramic (the shape and spirit of the times we live in).  Because we perceive the world we live in through these various frames of reference and lenses, we are always challenged by the difficulty of distinguishing between what is apparent and what is real.

For example, the usual and customary way of sizing and ranking banks in the U.S. is by total balance sheet assets or total deposits.  That traditional way of sizing banks stems from our legal and accounting frame of reference about the form of a bank - cash, investments, loans, premises, deposits, borrowings, shareholder capital at risk, and a charter granted by a government authority.

A banker friend of mine in Miami, the Americas director for a large European bank, has for years sized and ranked his "bank" in the Florida marketplace as the sum total of the balance sheet assets of the subsidiary U.S. commercial bank, the parent's foreign branch in Miami, and the assets under management (AUM) of both entities.  In other words, in his formulation of bank size, the bank is the sum total of all of its customer-facing touch points... its spheres of financial marketplace influence.

My friend's sizing of his bank's presence in the Florida marketplace expands upon the formal and traditional definition of a bank by changing the frame of reference for his banking operation to be more aligned with the functions of a banking intermediary.  In a broad sense, a bank applies expertise (knowledge capital), technology, and, when necessary, their proprietary financial capital in a manner which meets the financial services needs of providers and users of funds in the marketplace.

The functions of banking can be exercised in several ways; first, by traditionally-defined bank financial intermediation where deposits are taken and bank credit is extended using the proprietary capital of the bank to absorb all risks; second, it can also be exercised via advisory or fiduciary services where the application of expertise is fee-compensated but non-operational risks are borne by the funds provider, or lastly, it could exercised through fee-compensated, customer-directed transaction services such as payments processing.

By changing the frame of reference about what is a bank, you, in essence, change how you view, plan, respond to marketplace developments like web-based crowdfunders, such as Prosper or Lending Club, or payments innovators, like PayPal, Bluebird, or virtual currency creators.

Certain observers of the peer-to-peer lending landscape, for example, have characterized the activity as a major threat to the banking industry - Too Big to Disintermediate? Peer-to-Peer Lending Takes on Traditional Consumer Lending   And as long as bankers consider this activity as separate from their existing preconceptions about the form of a bank, peer-to-peer lending could indeed be considered a growing threat.

But if bankers consider the activity consistent with the function of banking and treat it as a logical, technology-driven evolutionary development in the growth of banking itself, significant opportunities abound.  The opportunity to embrace it, subsume it, and add it to your menu of banking services is there.  

Some banks, like Titan Bank of Wells, Texas, BBVA Compass, and Congressional Bank of Bethesda, Maryland are dipping their toes in the water and are taking what are being characterized as small, calculated risks through partnerships with existing peer-to-peer lenders.

In an ideal government setting, however, the legal form of the banking charter granted by that government would slowly follow the evolving functions of banking in the financial services marketplace, so that proper and consistent prudential and consumer protection regulation can be applied to all providers of the same financial services.

In the United States, the powers granted by a bank charter are explicitly grounded in the Federal enabling legislation for federally-chartered banks.  Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), state-chartered banks are limited to the powers granted to federally-chartered banks, unless the FDIC approves exceptions on a case-by-case basis.

The time may be ripe for some bank charter reform.  While the political will is lacking, the mechanics of legislative bank charter reform could be as uncomplicated as changing the word "and" to "or" in a few places, and revisiting the corporate powers of national banks in 12 USC 24, including the incidental powers provision.

This would provide bank regulators a green light to cast the net wider and say to certain players in the shadow banking community, your activities are identical to, or closely resemble, what we have now legally defined as "banking".  You must now obtain a state or federal bank charter to conduct your business.  The result being, taking some of the "shadow" out of the new technology-driven shadow banking models.

There are some who have mused that shedding the traditional "strict constructionist" mindset of the existing national bank charter definitions and showing an innovative, well-reasoned and plucky application of administrative discretion, Tom Curry, the present Comptroller of the Currency and the chartering authority of federally-chartered banks, could obtain a roughly similar result.

Though he approached a similar issue from a completely opposite direction (deregulatory), does anyone still remember the feisty Comptroller C. Todd Conover and the "non-bank bank" controversy of the 1980's?

None of these new Web 2.X entrants into the shadow banking arena, at this point, present the kinds of macro-level financial stability concerns that would snare them into the orbit of the Financial Stability Oversight Council (FSOC) and thereby subject them to prudential supervision by the Board of Governors of the Federal Reserve System.

But their presence does undermine the concept of "competitive equality" in the marketplace for financial services.   Ideally, all providers of similar financial services should compete on as level a playing field as possible.  That includes all bearing the weight of their regulatory obligations equally.

The growing divergence between banking's legal form and de facto function, if left unchecked, will leave today's banking charter a slowly atrophying and increasingly irrelevant animal; condemned to living out its days in its own sad, dilapidated version of Jurassic Park.  Quaint specimens existing to help inform the world-view of historically-inquisitive visitors.

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