Handicapping Congress and worrying about issues like “Will there ever be a Biden Comptroller of the Currency who isn’t an ‘acting’ one?” can simply spin your wheels. Nonetheless, many real-world initiatives affecting financial services may come together in 2024 in Washington.
Here are five to watch as the year begins, based on interviews with experienced Washington hands and additional research. This is a companion article to “2024 Trends: Prepare for Disruptive Activism from a Politicized CFPB.”
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1. M&A Policies May Ease, as 2024 Progresses, Out of Necessity
During the banking crisis in the first quarter of 2023, all the rules seemed to be paused for a time and damage control was the goal. In time, the hubbub over the crisis seemed to die down, the hearings were over, the agency reports were issued.
The crisis, after all, didn’t set the tone for the entire year.
“Memories are short and when there weren’t continuing big failures, the conclusion in the media and among a lot of folks in Congress was, well, crisis over,” says Konrad Alt, partner and co-founder at Klaros Group.
Alt, who paid his Washington dues on Capital Hill and in high-ranking posts at the Office of the Comptroller of the Currency, says it’s important to look beneath the surface.
“I don’t think people who look hard at the numbers think the crisis is really over. We still see a tremendous amount of bank assets that are underwater relative to market value. FDIC has published a number of things that if read at face value are pretty concerning. There’s a lot of capital pressure out there and I think there continue to be many banks at risk of failure.”
— Konrad Alt, Klaros Group
“The bank regulatory agencies are super-focused on credit quality right now,” says Keith Noreika, EVP and chairman of the banking supervision and regulation group at Patomak Global Partners. Noreika, a former acting Comptroller of the Currency, says the prudential regulatory agencies are deep into their analysis to identify the banking system’s stress points, and judge how far the cracks could go if those stress points go bad.
For some of the weakened institutions, avoiding failure will hang on either finding capital or selling assets or finding M&A partners.
The math could be better. “There aren’t a ton of deals being announced right now,” says Noreika. “One of the inhibitors is market-to-market accounting. You just can’t mark these books to market. The price would have to be astronomical to get a deal done.”
Nonetheless, Noreika says, “Regulators should be championing consolidation in the marketplace, to make the banking industry stronger, to weather the storms.”
When push came to shove, in the case of JPMorgan Chase swallowing First Republic, the government was able to swallow a mega institution getting larger still. But for the most part the Biden administration has been anti-merger, fearing loss of competition.
Ultimately, Noreika thinks the Biden administration has painted itself into a corner by perpetuating a general attitude in Washington to not encourage the chartering of many new institutions — but also opposed mergers because of the assumed impact on competition. “It’s just crazy,” says Noreika.
Will the anti-M&A attitude change? Some think that is already beginning to happen, quietly.
“There needs to be more consolidation in the industry,” says Noreika. “The regulators, from my cursory canvassing, understand that — when the lights and cameras are off and there are no reporters in the room. There’s just an acceptance of reality. They can do it in their own time. Immediately post-election there will be an opening.”
Konrad Alt thinks that troubles in commercial real estate portfolios have potential sellers warming up for selling and potential buyers ready to buy. He doesn’t think the administration or its regulators will be very happy about opening the M&A gate, but they may have to take their medicine.
“You’ve got to solve these problems somehow,” says Alt. “Nobody is forecasting that interest rates are going to get back down to the point where conditions pre-2019 are going to obtain once again.”
The capital issues developing in banking are real, Alt insists, and M&A is one of the few paths to solve the challenge.
“They will continue to have issues about consolidation among the very largest banks,” says Alt. “But when you get below that level, they will have to allow a lot of M&A activity. They just don’t have a lot of other tools at their disposal.”
Read more about the aftermath of a cancelled merger: First Horizon’s CMO Powers Through Merger Misfire with Growth Strategy
Resistance to capital proposals is tip of an iceberg of pushback
Regulators’ efforts to impose stringent new capital requirements on larger institutions aren’t going over well. This was abundantly evident during the early December Senate Banking Committee hearing, where the heads of major U.S. banks opposed the capital push.
This was a public manifestation of a movement that began beneath the surface but is increasingly is popping up now, according to observers. Banks want to fight back on things they object to, whether through jawboning or lawsuits. Ads opposing the Basel III capital demands have been appearing during NFL games, a move by the Bank Policy Institute that has attracted much attention in Washington.
“You don’t want to ever piss off regulators that you’re trying to get something from, nor do you want to piss off a regulator that might take action against you in some way,” says Michele Alt, partner at Klaros Group and longtime senior attorney at the Comptroller’s Office. Typically, she says, pushback has been quiet and behind the scenes. But now more is coming out in the open.
Bryan Hubbard, a senior consultant at Patomak Global and former deputy comptroller for public affairs at the Comptroller’s Office, anticipates that thousands of comment letters will be generated on the capital requirements proposal. He says the sheer burden of getting through all of that makes the goal of publishing a final rule by June seem unrealistic. Meanwhile, smaller banks will be worried about trickle-down effects.
2. Financial Services Just Isn’t Only About Banking Anymore
Commentators interviewed by The Financial Brand reflect a growing consensus that Washington remains locked into old thinking about what financial services is all about and who provides the services. Yet more and more happens that is outside of their bailiwicks. Jamie Dimon, chairman and CEO at JPMorgan Chase, has been emphasizing this issue in his long-form shareholder letters over the last few years.
“The regulators draw a little circle. They’re only responsible for this little circle. They don’t want anything bad to happen in the little circle, or they get blamed for it. And they don’t realize that all this other stuff going on outside of the circle is impacting what goes on inside the circle. That is unfortunate.”
— Keith Noreika, Patomak Global Partners
This way of looking at the financial services business has ramifications for many aspects of banking.
Case in point: the Community Reinvestment Act.
From one administration to another, the regulatory administration of the CRA has been recast multiple times. For all the fresh thinking, the impact of each iteration has to be challenged, says Thomas Vartanian, a veteran regulator and banking attorney and author of “200 Years of American Financial Panics.” Why? Banks control less and less of the consumer lending and mortgage lending activity in the U.S.
“Washington is fiddling around with about a quarter of the market,” says Vartanian. “Where’s the rest of the market? Who’s worrying about bias or fairness in the rest of the market like they are in banks?”
Vartanian has a point. Fair-lending law has been around for decades and the Consumer Financial Protection Bureau for over a decade. Yet a joint fair-lending settlement of $22 million reached in 2022 between the Justice Department, the CFPB and Trident Mortgage Co. was the first redlining agreement that Justice has ever made with a nonbank mortgage lender. Today the nation’s largest mortgage lender is Rocket Mortgage, not a bank.
The challenge goes beyond compliance. Noreika points out that the volume of assets under management in the private equity industry is greater than the amount in the banking industry. That separate industry, he says, hasn’t been tested in a major rout like the financial crisis of the 2000s.
Says Bryan Hubbard, formerly of OCC: “Regulators have run a lot of risky activity out of the banking system, but that doesn’t mean that it’s been run out of the economic system.”
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3. Fintech Needs a New Label and a New Mindset in Washington
At the same time, Michele Alt says that there has been one flip flop in Washington: Fintech companies have ceased to be the “cool kids,” she says, and need to start thinking about a rebranding of sorts.
“They need to talk less about building better mousetraps and being better than banks,” says Alt. “They have to start emphasizing what their technology actually does, the problems it solves, and how it builds on well-established bank powers and how that could reduce risk in the banking system.”
She explains that as increased focus on the risks of banking-as-a-service or “partner banking” deals gets more sway in Washington, the more important this will be for the continuing relationship between banks and fintechs. She says banks have become much more selective about their relationships with fintechs overall, and that some have begun offloading some connections.
“The cost of managing risk successfully in the fintech-bank partnership is going to go up,” says Alt. “Ultimately, I think the fintechs will end up having to bear a lot of that cost. And that’s going to make it very expensive for startups to create risk management infrastructure of a quality that will allow them to get bank partners.”
Not so long ago, fintechs and challenger banks were seen as potential buyers for financial institutions — SoFi can be considered something of a success story, in this regard. Alt says she knows of fintechs that would like to enter banking on their own, handling the compliance and other challenges directly, perhaps as de novo entrants.
“They’d like a direct relationship with a federal regulator,” says Alt, “because it’s hard when you’re dependent on a small bank that may not be that sophisticated. That makes it hard to be confident that you’ve got a clear understanding of what the regulatory requirements are.”
Konrad Alt says the 2023 banking crisis home to many fintechs the desirability, even the necessity, of being master of your own destiny. However, the two consultants don’t see the possibility of a softening attitude toward M&A nor the need for capital in the industry opening any doors to fintech de novos anytime soon.
“I don’t know if people understand how hostile the environment has been towards innovation and the impact that will have on the vibrancy of the banking industry,” says Hubbard.
Indeed, Vartanian says he’s been flummoxed that while Washington is so aware of artificial intelligence that much paranoia surrounds it, AI tools seem to be playing no part in helping regulators monitor risk in the financial system.
“Everything is based off what happened, as opposed to what’s likely to happen,” says Vartanian. “So, it’s not surprising that we’ve never ever anticipated nor stopped a financial crisis from occurring. That’s because we always react to it after it occurs. We have never had the kinds of data before the regulators where they can say, ‘Gee, this may result in a financial crisis.'”
As a result, he concludes, “we’re micromanaging institutions and missing the big picture.”
4. Fair-Lending Scrutiny Will Continue into 2024
The December filing of a class-action lawsuit against Navy Federal Credit Union over allegations of fair-lending violations serves as a reminder for banks and credit unions. Redlining, a key issue in fair-lending examination and enforcement, has been a major focus for the Biden Department of Justice since October 2021.
Last November Kristen Clarke, assistant attorney general, gave a two-year update on the anti-redlining push. Since the launch of the effort — fulfilling a Biden campaign pledge — the DOJ has reached settlements with 10 banks and a nonbank mortgage lender.
In her speech, Clarke said commitments to over $107 million in relief had been obtained for communities of color, in such forms as loan subsidy funds, outreach to minority prospects, opening branches or loan production offices in minority areas, providing funds to support community partnerships to improve access to credit, hiring lenders dedicated to credit for minorities. Often cases include allegations of failing to market to minority prospects and in minority neighborhoods.
The institutions involved in these cases have ranged from community banks up to City National Bank of Los Angeles, with assets of $96.8 billion, which made a settlement for over $31 million in early 2023. DOJ says the latter is the largest settlement that it has ever made in a redlining case.
Clarke said that Attorney General Merrick Garland has told staff that it should “continue our work at full speed” in the redlining area. Both Rohit Chopra, director at the Consumer Financial Protection Bureau, and Acting Comptroller of the Currency Michael Hsu were in on the launch of the redlining campaign with Clarke and Garland.
Clarke also said that results of consumer compliance exams should be a clue to a brewing fair-lending problem. (Cases can arise when bank examiners report findings or suspicions to Justice or when lenders self-report, the latter of which can sometimes lead to some leniency.)
“One hallmark of so many of our redlining investigations — whether agency-referred or self-initiated — is that the lender failed to implement recommendations issued by its regulator,” Clarke said.
Clarke said that some institutions failed to look beyond their traditional lending tracts: “In our redlining resolutions, we have regularly highlighted that some lenders could have proactively identified risk if they had stepped back to determine whether there were communities of color adjacent to their lending areas that they could have reasonably served.” Others could have taken a more nuanced look at minority communities in their current markets, she added.
Clarke also highlighted two efforts lenders must also take into consideration:
• An ongoing issue in this context are appraisals. A federal interagency task force has been working in the area of appraisal practices that discriminate against minority borrowers. “PAVE” — Interagency Task Force on Property Appraisal and Valuation Equity — is a Biden administration initiative that began in mid-2021.
• Another element in consumer lending in general is the use of algorithms for evaluating credit. Justice, CFPB, the Equal Employment Opportunity Commission and the Federal Trade Commission issued a joint statement in 2023 committing to monitor bias and discrimination issues in artificial intelligence.
“Lenders should proactively and consistently review and test their underwriting process — including their automated steps — to ensure that credit decisions do not turbocharge discrimination by disproportionately rejecting loans to applicants of color for reasons unrelated to creditworthiness,” said Clarke.
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5. A Sleeper Issue for 2024: Potential Changes to National Bank Preemption
Michele Alt suggests that a “sleeper” threat faces national banks in 2024, depending on how the Comptroller’s Office reacts to a letter from Sen. Elizabeth Warren (D.-Mass.) and Sen. Jack Reed (D.-R.I.), both members of the Senate Banking Committee, and other senators, concerning the agency’s power to preempt state laws in favor of federal law for national banks. The letter writers believe that the regulator has gone too far in overriding state level consumer protections under power granted by the Dodd-Frank Act. The arguments grow quite complex.
Alt says the risk here is that, if the Comptroller’s Office gives in to this pressure, a key advantage of a national charter could be reduced. The ability to do business under a single license nationwide has been a major benefit for national banks that has set them apart from, for example, fintechs that have needed to obtain state licenses for various banking and payment services.
“People are not paying attention to this,” says Alt. “They should be waking up and saying, ‘Whoa, this could make our lives a lot harder.'”
Read more about the Washington outlook: Trends 2024: Prepare for Disruptive Activism from a Politicized CFPB