- Key insight: Senate Democrats led by Elizabeth Warren are urging bank regulators to withdraw an October proposal that would narrow the definition of “unsafe or unsound” banking practices to only those “likely” to cause material harm to a bank’s financial condition or the Deposit Insurance Fund.
- What’s at stake: The lawmakers argue this standard would prevent regulators from addressing risky behaviors early and force them to ignore low-probability catastrophic risks, requiring examiners to wait until harm becomes evident when it may be too late to intervene.
- Forward look: The proposal won’t be withdrawn, but it’s a signal as to the direction of what oversight could look like in Congress post-midterms.
WASHINGTON —
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The lawmakers, led by Senate Banking Committee ranking member Elizabeth Warren, D-Mass., asked the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency to withdraw the rule, proposed in October, that defines “unsafe” or “unsound” practices.
The proposal would curb bank supervisors’ ability to initiate enforcement actions against banks who are engaging in risky activity, the lawmakers said. Specifically, the rule would limit unsafe or unsound practices to those that are “likely” to materially harm a bank’s financial condition or the Deposit Insurance Fund.
“At best, this standard would seem to prohibit examiners from addressing risky behaviors that could very plausibly cause damage,” the lawmakers said. “It could also result in examiners ignoring tail risks, which have a low likelihood of occurring but would cause catastrophic harm. Examiners would have to wait until harm becomes evident, at which point it would likely be too late to prevent the bad outcome.”
The letter is also signed by Sens. Jack Reed of Rhode Island, Chris Van Hollen of Maryland, Richard Blumenthal of Connecticut and Sheldon Whitehouse of Rhode Island.
At worst, the lawmakers said, the standard would set an impossible threshold for bank supervisors.
“There is often no way to precisely quantify the likelihood that an imprudent act or practice will directly lead to some quantifiable harm,” they said.
The proposal allows bank regulators to act only if the risk of harm the bank would cause is “material,” and the rule doesn’t set standards for that materiality, the lawmakers said.
“Given the sheer size of a Wall Street bank, waiting for the likelihood of a ‘material’ harm to develop could be catastrophic and put the entire economy at risk,” they said. “In addition, the materiality standard is primarily framed in terms of direct impact on the bank itself, not the broader financial system. If a bank was manufacturing and distributing toxic financial products (e.g., subprime mortgage backed securities) to other financial institutions, but didn’t have ‘material’ exposure to those risks itself, examiners would be unable to turn off the spigot of risk at its source.”
While the FDIC and OCC aren’t likely to withdraw the rule just on the ask of a group of Democratic lawmakers, the letter underlines continued focus on systemic risk and financial stability among Northeast, finance corridor Democrats ahead of a midterm election season that’s expected to swing heavily in the direction of the Democratic party.
It also highlights potential spots of growing risk in the system that potential regulators could pick up on.