Kristin Johnson on Bank Regulation
Basel Endgame, bank charters, true lenders and other commentary
On Thursday evening Bloomberg reported that current CFTC Commissioner Kristin Johnson1 “has emerged as a top candidate to lead” the FDIC. Law360 on Friday had a similar report, as did Reuters, which noted that President Biden may make a final decision as soon as next week.
There is no guarantee that Commissioner Johnson will in fact be chosen as the nominee, but because she has a more extensive record of public remarks on bank regulation relative to some of the other nominees that are reportedly under consideration for the job,2 this post uses the above reporting as an occasion to take a brief look at some of her most notable prior comments in this area.
Just to avoid hiding the ball or giving the wrong impression: there is no big reveal coming in this post. Commissioner Johnson’s prior public comments are pretty squarely in line with — and sometimes quote at length from — those of other banking regulators nominated by President Biden.
What’s more, even if Commissioner Johnson does happen to hold views on certain issues that are either more hawkish or more dovish on bank regulation than those of other banking regulators, there is no guarantee that those views would necessarily flow through to policymaking. For one thing, some of the most prominent rules on the FDIC’s agenda will require reaching consensus with multiple regulators, such that even a strong-willed FDIC would be limited in its ability to force through changes opposed by other regulators. For another thing, and to state the obvious, much of Commissioner Johnson’s time and energy at the FDIC would, rightfully, likely be devoted to addressing issues identified in Cleary Gottlieb’s report (and possibly in reports by the FDIC IG that are currently in progress).
With all those caveats out of the way, this post looks at prior comments from Commissioner Johnson on ten current issues relevant to bank regulation.
Basel Endgame
On multiple recent occasions, Commissioner Johnson has commented on the U.S. Basel Endgame proposal released by the federal banking regulators last year.
In remarks in January 2024, citing approvingly to Federal Reserve Board Vice Chair for Supervision Michael Barr’s report on Silicon Valley Bank, Commissioner Johnson described the failures of SVB and Signature Bank as “timely reminders of the importance of bank capital.”
Commissioner Johnson acknowledged that “banks argue that any increase in capital requirements will reduce their capacity to provide lending services, including residential mortgage and small business lending.”
Commissioner Johnson then continued, however:
Public interest advocates point to data that they believe refutes the banks' claims that requiring more capital will reduce a banks’ ability to lend by suggesting that as capital at banks has increased materially since 2008, bank lending to the nonfinancial sector has also increased. Further, they argue, community banks provide majority of lending to small businesses and low and medium-income households and smaller, less complex, banking organizations are unlikely to be subject to the $100 billion asset threshold that triggers the new requirements. Additionally, while there is an increased cost in executing derivatives transactions, the limited increase is justified because of the likelihood that imposed reforms may remarkably contribute to and enhance risk management, potentially mitigating losses associated with unrealized risks.
Last month, Commissioner Johnson again commented on bank capital rules, stating that the events of Spring 2023 “underscore the necessity of ensuring the adequacy of capital requirements.”
In July 2023, U.S. bank prudential regulators requested comments on proposed rules to strengthen capital requirements for large banks. Disruption in the banking sector in the first quarter of 2023 underscore the necessity of ensuring the adequacy of capital requirements. . . .
Capital requirements are critical to ensuring the safety and soundness of financial markets. Financial market regulators must address the moral hazard of excessive risk-taking and “ensure the resilience and stability of our financial system.”
Smaller, Regional Banks
In September 2023, Commissioner Johnson in a statement on recordkeeping fines assessed against certain GSIBs argued that “smaller, regional banks” may also be a source of systemic risk. In a section of her remarks captioned “Diversity of Sources of Systemic Risk: Smaller, Regional Banks and Non-bank Financial Institutions,” and after quoting extensively from prior remarks by Vice Chair for Supervision Barr and FDIC Chair Gruenberg, Commissioner Johnson observed:
Banking regulators in the United States and global financial market regulators are increasingly focusing on the impact of liquidity concerns that may arise due to activities or decisions of smaller, regional banks, and non-bank financial institutions.
Bank Charters
In 2021, a subcommittee of the House Financial Services Committee held a hearing entitled “Banking Innovation or Regulatory Evasion? Exploring Trends in Financial Institution Charters.”
In written testimony prepared for the hearing, Professor Johnson criticized the OCC’s decision to explore a special purpose national bank charter, saying that doing so would “create gaps in the supervision of fintech firms” and encourage regulatory arbitrage. Professor Johnson also noted she had signed on to an amicus brief in the NYDFS v. OCC litigation that argued the OCC would be acting outside of its statutory authority were it to grant such a charter. (“While banks are permitted to conduct a wide range of financial activities, the OCC does not have the power to charter entities that are not in the deposit—that is, money creation—business.”)
Special purpose charters have also been a notable development at the state level, and during the question and answer portion of the hearing Professor Johnson fielded a question about Wyoming’s efforts in this area:
Chairman Perlmutter: Thank you. Professor Johnson, I would like to ask you a question. In 2019, the State of Wyoming enacted a series of laws related to cryptocurrency, including one authorizing the chartering of special purpose depository institutions (SPDIs). Last year, Wyoming approved the first SPDI charters for Kraken Bank and Ivani Bank, two cryptocurrency custodial firms planning to offer services. It seems many cryptocurrency companies are eager for a legal framework in which to operate. Do you believe bank charters are the appropriate framework for these firms?
Ms. Johnson: Thanks so much for the question, Mr. Chairman. I would echo Professor Gerding’s comments and amplify them. During the financial crisis of 2008, we not only saw these challenges that were endogenous with respect to regulated firms, but exogenous challenges as well that triggered systemic risks that created losses across financial markets. I would encourage a very careful evaluation of any extension of charters to cryptocurrency-based firms because of the endogenous and exogenous shocks that could create systemic risks and destabilize financial markets.
Industrial Banks
In a separate section of the same written testimony quoted above, Professor Johnson criticized “the ILC loophole” that she believes “threatens the separation of banking and commerce that is a general feature of the US banking system.” Professor Johnson also characterized the FDIC’s approach to ILCs as reflecting inappropriate “permissiveness.”
In oral remarks at the beginning of the hearing, Professor Johnson stated that she “encourage[s] the committee to support the limitation on banking charters and ILC licenses.”
True Lender
Again in the same written testimony, Professor Johnson described the OCC’s 2020 true lender rule (since repealed through a Congressional Review Act resolution) as one of several actions by regulators that “serve to undermine state usury laws.” Professor Johnson argued that the OCC’s true lender rule, despite its protestations to the contrary, “effectively legitimize[d]” rent-a-charter arrangements.
Enforcement Actions, Deterrence and Admissions
In August 2023 remarks, Commissioner Johnson noted her concern that “all too often the Commission finds that a few central market participants (firms that strongly influence industry best practices) repeatedly violate well-established legal requirements.” Commissioner Johnson argued that the CFTC’s civil money penalties ought to be calibrated to deter such repeated compliance violations.
Along similar lines, just a few days ago Commissioner Johnson argued that when regulators bring enforcement actions it is important to secure admissions of wrongdoing, because admissions “promote accountability, transparency in the relationship between regulated market participants and regulators, and justice” and “may foster deterrence.” She continued:
All too often, and in far too many instances, enforcement matters are resolved without an acknowledgment of the mistakes, misconduct, or compliance failures at the center of the enforcement action.
Artificial Intelligence
While in academia, Professor Johnson wrote several articles on AI, both in financial services and in society more generally.3 She also testified on the subject at a 2019 Congressional hearing.
In February of this year, Commissioner Johnson delivered a speech laying out “three policy interventions that [she] strongly urge[d]” the CFTC to consider adopting. These included “1) a survey of market participants’ use of AI; 2) the introduction of heightened civil monetary penalties by actors who abuse AI technologies to engage in fraud, market manipulation, or otherwise disrupt the integrity of our markets; and 3) a collaborative inter-agency initiative intended to harmonize AI regulation across financial markets.”
On that third point, Commissioner Johnson elaborated:
I would like to propose the creation of an inter-agency task force composed of financial regulators including the CFTC, SEC, Federal Reserve System, OCC, CFPB, FDIC, FHFA, and NCUA.
The task force would support the AI Safety Institute in developing guidelines, tools, benchmarks, and best practices for the use and regulation of AI in the financial services industry. The task force should have a mandate to provide recommendations to the AI Safety Institute as well as evaluate proposals coming out of the Institute.
Addressing the perils of AI, while harnessing its promise, is a challenge that will require a whole-of-government approach, with regulators working together across diverse agencies. Through the task force I believe that financial regulators will aid the Institute in its critical mission: providing their essential experience and expertise to help guide the development of AI standards for the financial industry.
Dodd-Frank Section 342(b)(2)(C) and Diversity
In a 2016 law review article, Professor Johnson along with two co-authors argued that “regulators should use their traditional authority to stem unsafe and unsound banking practices (and similar prudential regulations) to encourage more diversity in the financial sector.” The authors concluded:
[W]e suggest that the financial regulators modify the basic approach of the Joint Guidelines[4] and fully integrate them into all aspects of their examination and supervisory processes. Further, firms should face legal obligations with respect to diversity to the extent that mismanagement of diversity contributes to unsafe and unsound practices or creates an environment and culture of unlawful conduct. The regulators should also proactively require stronger diversity measures for firms sanctioned for unlawful behavior or risk mismanagement as part of negotiated enforcement outcomes.
Macroprudential Regulation
In a 2013 law review article, Professor Johnson “reject[ed] the notion that conventional composition and structural corporate governance mechanisms, such as requiring boards to create specific risk-management committees or appoint independent directors to these committees, determinatively address systemic risk concerns.” Instead, Professor Johnson argued that regulators should place “greater emphasis on macroprudential regulation.”
Quoting a Group of Thirty report, Professor Johnson noted that under a macroprudential approach:
Capital requirements could be increased in boom times through techniques such as dynamic provisioning, and capital buffers could be funded in boom times to moderate procyclical activities or create a fund to serve during economic downturns
Boards of Directors
In a 2011 law review article, Professor Johnson analyzed provisions of the Dodd-Frank Act that imposed new risk management requirements for boards of directors. She concluded that the reforms “laudably reflect an appreciation for the conflicts of interest and self-serving incentives that color directors' evaluation of risk-taking activities.” Even so, Professor Johnson believed that because of the “limited reach” of the reforms, “undesirable or excessive risk taking will persist and directors will not be subject to more rigorous accountability standards.”
Commissioner Johnson was confirmed by the Senate by voice vote in March 2022. Her full CV is available on Emory’s website.
Others mentioned this week as potential contenders for the role include (in no particular order): CFTC Commissioner Christy Goldsmith Romero, FHFA Director Sandra Thompson, NCUA board member Tanya Otsuka, former SEC Commissioner Kara Stein, New York Superintendent of Financial Services Adrienne Harris, former Treasury Department official Graham Steele, current Treasury Department official Nellie Liang, and former deputy director of the NEC Bharat Ramamurti.
The above names are drawn from reporting from (again in no particular order): The American Prospect, Capitol Account, CNN, American Banker, Morning Money and Reuters.
Some individuals listed above have already ruled themselves out.
See the CV linked in footnote 1 above.
This is a reference to the 2015 Board, FDIC, OCC, NCUA, CFPB and SEC Interagency Policy Statement Establishing Joint Standards for Assessing the Diversity Policies and Practices of Entities Regulated by the Agencies.