Thursday, August 7, 2014

Putting the Duel Back Into the
 Dual Banking System

In January, the Office of the Comptroller of the Currency (OCC) released a Notice of Proposed Rulemaking (NPR) to amend the existing 12 CFR 30 - Safety and Soundness Standards by establishing a set of formal safety and soundness standards specifically for national banks with total assets greater than $50 billion.  These proposed safety and soundness standards (called Appendix D) are based on the OCC's heightened expectations program.  The NPR also establishes explicit and enforceable standards for oversight by the boards of directors of these banks.  The public comment period is over and the OCC is digesting the responses received from the banking industry and the public.

The heightened expectations program was established to strengthen the governance and risk management practices in the OCC's largest national banks.  The gist of the heightened expectations program is that corporate governance and risk management practices in our nation's largest national banks need to be "strong", not merely "satisfactory".

Since the Federal Reserve and FDIC, federal regulators of state-chartered member and non-member banks respectively, have not followed the OCC's approach, it's probably safe to infer that they have staked their institutional expectations for bank corporate governance and risk management somewhere along the continuum between "satisfactory" and "strong", either in a blanket sense or on a bank-by-bank basis.  The potential liability to the boards of directors of these state-chartered banks are those already outlined in existing law, regulation, guidelines, and common law precedent.

With his effort to codify these safety and soundness standards in federal law, the Comptroller of the Currency has thrown down the gauntlet; metaphorically giving a glove slap to the faces of  regulators of the largest state-chartered banks, by implicitly fingering them as the bank supervisory custodians of lower (or at least unexpressed) expectations.  In more chivalrous days, such a derision of someone else's bureaucratic character would set the stage for an old-fashioned duel.

Except in this case, the Comptroller of the Currency will be holding a pistol with its barrel bent downward at a 90-degree angle, so that in whichever direction he points that pistol, he is likely to shoot himself in the foot.

Don't get me wrong, I am a big supporter of the OCC's effort to codify enforceable best-practice standards and install real accountability in our largest banks through the mechanism of heightened expectations.  See my previous blog posting - Strong Coffee and Weak Tea   But upon reflection, I now also strongly believe that doing so outside the forum of interagency cooperation, without an accompanying policy statement signifying interagency consensus, is the grandest of follies.  It could foreshadow a seismic change in the distribution of federal- vs. state-chartered banks among the population of banks with assets greater than $50 billion... a group small in number, but immense in banking marketplace presence.

At the present time, about two-thirds of the group have federally-chartered lead banks with the remainder having state-chartered lead banks.  Under the Comptroller's current informal version of his heightened expectations program those national banks are already being held to those higher expectations through the moral suasion exerted through the ongoing bank supervision process.  

The remaining banks in the group, the state-chartered banks, are not under the jurisdiction of the OCC and are therefore not subject to the heightened expectations program.  These state-chartered banks operate under governance standards presently outlined in law, regulation, and individual state or Federal Reserve or FDIC examination handbook guidelines.

The recent talk of Washington, among the Illuminati inside-the-beltway, has been the popularity of what have been called "tax inversions".  Where U.S. corporations are changing their tax domicile through mergers with other corporations in overseas jurisdictions with lower income tax rates; arbitraging their taxing authorities and thereby lessening their income tax burdens.  Something similar, onshore regulatory arbitrage, could happen if the Comptroller's heightened expectations guidelines are adopted in the Code of Federal Regulations without an explicit interagency policy backstop.

First, simply switching from a federal to a state bank charter in your home state makes the Comptroller's heightened expectations program go away - poof!  Second, as the "tax inversion" proponents have demonstrated, you do not have to move your operations to move your official corporate domicile.  In fact, there are many banks today where their official headquarters are in one city or state, while their corporate officers live and work elsewhere.  So the potential exists not only to convert to a state bank charter, but also to select any state bank regulator willing to roll out the Welcome Wagon in the states where the bank already has an established branch presence.

The latter option might even be attractive to those national banks with corporate domiciles in New York State.  In the State of New York, given the recent banker-bashing pyrotechnics by state officials, the state-level regulatory arbitrage calculus is more complicated... on one hand, there is the fire, and on the other hand, the frying pan.  By moving a corporate domicile to a different state and changing the home-state/host-state equation, the 1997 Nationwide Cooperative Agreement (signed by all state bank regulators) kicks in and at least the prospect exists for the state-level regulatory dynamics to change significantly.

The bane of bold leadership is that the Comptroller of the Currency becomes, by definition, a pioneer.  Pioneers were an important part of what made this country great.  But every pioneer weighed the implications of go-it-alone leadership against the benefits of collective action.

As hard and frustrating as the interagency agreement process can be, the OCC needs to push harder for an interagency policy statement on this topic because the ramifications of going-it-alone could radically change the present stasis in the balance of the dual banking system and put OCC on a slippery slope of becoming less relevant.  As the old saying points out, sometimes the lone pioneer is the guy lying face down in the mud with an arrow in his back.