The Winds Of Banking Regulation Change Blow From The Right In DC For Now

This month, we visited our nation’s capital with the Mississippi Bankers Association for its annual “fly-in,” which is a week when Mississippi bankers hear from federal regulators as to their enforcement priorities and speak with their congressional delegation as to their bank policy priorities. It is always an informative and enlightening week, but what stuck with us this time was how much the tone of the meetings had evolved over the past few years, with discussions feeling particularly congenial and collaborative. Below are a few of our main takeaways.

1. Digital assets were (and will continue to be) front and center.
   On Tuesday of that week, the Senate held a cloture vote on the amended CLARITY Act to determine whether the legislation would move forward for consideration in the Senate. The draft considered by the Senate failed to include language that bankers felt was necessary to prevent bank deposits from being lured by digital assets through cryptocurrency yield or rewards programs, and therefore the bankers opposed passage of the bill by the Senate without an amendment to address that deficiency. Ultimately, the cloture vote failed in the Senate, partly because of bankers’ concerns but mostly due to ethical language Democrats felt was missing. As a result, CLARITY is unlikely to move forward until the lame duck session, if at all, this Congress. That could mean that the bill in its current form may never move forward, especially if Democrats take control of one or two houses this fall. However, there is no doubt that digital assets remain a major focus in Washington. The concept of tokenized deposits came up in more than one conversation with regulators, and many people feel that bank tokenized deposits are ultimately needed to compete for the payments business related to Wall Street’s rapidly growing market for tokenized treasuries, stocks, and money markets. Currently, stablecoins are mostly used for these transactions. Wall Street is also starting to use stablecoins for wholesale payments related to treasury management, trade finance, and syndicated lending, which disintermediates banks from even more transactions. While Chair Travis Hill believes that the use cases for tokenized deposits are mostly cross-border payments and large institutional customers that are unlikely to involve rural community banks, most bankers seem to think that Congress needs to provide community banks some way to compete in this space to ensure viability in the future. Even if community banks consider the CLARITY Act’s demise a win, their future engagement in tokenized assets may be an existential necessity nonetheless.
   
   
2. Prudential regulators rule again with a much lighter touch.
   Two or three years ago, most conversations with regulators on a Washington fly-in centered on consumer protection regulations and the ever-growing government expectations for banks with regard to them. This year, we’re not sure we heard consumer protection addressed once. All regulatory expectations were communicated on the basis of safety and soundness, and for the most part, bankers liked what they heard. All federal regulators seem to be aligned on the ideas that risk management should focus only on material financial risks and that a bank’s management rating should not be impacted by other technical violations, nor should it be the ultimate factor in deciding a bank’s composite rating. All federal regulators are at different stages of implementing this new world, but all agree that bankers should start seeing concrete differences in their examination processes soon as a result. For the most part, the bankers present who had recent exams agreed that the process is much more reasonable, and they welcomed the lighter touch.
   
   
3. Everyone wants Bank Secrecy Act reform, but few have a map to get there.
   Everyone, and I mean everyone, that we heard from agreed that the Bank Secrecy Act (BSA) needs to be modernized. Transaction thresholds for Currency Transaction Reports (CTRs) and Suspicious Activity Reports (SARs) are entirely too low, and everyone acknowledges it. However, no one has a clear idea of how it will actually happen. Federal Deposit Insurance Company (FDIC), Office of the Comptroller of the Currency (OCC), and Federal Reserve representatives all agreed that these rules needed to change, but the FDIC and Federal Reserve blamed the Treasury, and the OCC blamed Congress. The Treasury, for its part, claims to have had BSA on its agenda for a while, but it stopped short of saying how it plans to address the issue. All seem to agree that law enforcement is a pretty large constituency standing in the way, but Independent Community Bankers of America reported that a recent US Government Accountability Office report found that law enforcement accessed only 5.4% of CTRs filed. Nevertheless, inertia rules.
   
   
4. Regulatory consensus is getting harder to find.
   It has not been unusual in years past for federal and state regulators to disagree, but at least in our part of the world, it is unusual for the state banking department to be concerned about the lack of regulatory oversight from the federal government. According to Commissioner Rhoshunda Kelly, Commissioner of the Mississippi Department of Banking and Consumer Finance and Chairperson of the Conference of State Bank Supervisors (CSBS), state regulators are somewhat concerned that the federal pendulum has swung too far. Commissioner Kelly stated that CSBS simply wants a stable and durable network of bank regulation, and while they don’t want the “M” (management) in the CAMELS rating overemphasized, they do want it considered as an important part of the composite rating in a consistent way. Commissioner Kelly said that she appreciates the emphasis on material financial risks by federal regulators but that state regulators still want to make sure compliance with the law is considered during an examination. She believes that banking regulation should consider not only material financial risks existing at the time but also elements that may create such risks in the future. There are even points of disagreement among federal regulators. Chairman Hill and the OCC expressed interest in a process for certifying third-party bank vendors, but the Federal Reserve representative stated that vendors can be monitored without a process for regulators recommending them. The FDIC and OCC are planning to establish an independent appeals process for examinations, but the Federal Reserve is more skeptical of the utility of such a program. While there have often been differences between bank regulators and charters, it does seem that each is asserting its independence in different ways.

Even though these clear themes permeated the week, it was also evident that everything could change rather significantly once again in a couple of months. If one or two houses of Congress turn blue following the midterms, we expect next year’s meetings to provide even more surprises. The winds of change never stop blowing in Washington and can shift from right to left on a dime these days.