Something or Nothing? The OCC Updates Its Bank Enforcement Actions Manual
Also, the OCC's updated liquidity booklet and a look at some Democratic proposals from this week's HFSC markup
Too big to manage
In January Acting Comptroller of the Currency Hsu delivered a speech about “Detecting, Preventing, and Addressing Too Big To Manage” and suggested in remarks after the speech that some banks were “in the penumbra” of that classification. Yesterday as the apparent next step in the OCC’s efforts to address this concern, the OCC issued an update to its Policies and Procedures Manual on enforcement actions to add a new Appendix C, intended to lay out the OCC’s approach to “banks with persistent weaknesses.”
The January Framework
Briefly by way of recap, the January speech laid out a four-step framework the OCC would use to address supervisory concerns at large banks.
Banks are put on notice of weaknesses or deficiencies, generally through MRAs
If the issues identified in the MRA are not appropriately addressed, the OCC will escalate to a consent order, perhaps accompanied by a civil money penalty.
If even after this formal enforcement action the issues still persist, “a restriction on growth, business activities, capital actions, or some combination may be warranted.”
Finally, if all the above has proven ineffective, the OCC will consider “simplification via divestiture.”
The May PPM
The new Appendix C to the PPM “generally applies” to banks subject to 12 CFR Part 30, Appendix D - that is, national banks and federal savings associations with $50 billion or more in total assets.1 The OCC reserves the right to apply the framework of Appendix C to any bank, however, including (unspecified) other banks “with operations that are highly complex or otherwise present a heightened risk.”
Appendix C assumes that the OCC has already identified weaknesses at a bank, and so starts with something that seems to mostly correspond to step 2 in the January framework.
The following table shows the details or tweaks added by the OCC in the PPM compared to Acting Comptroller Hsu’s January speech (right click to make bigger).
Quick Thoughts
I suppose the first question is how big a deal this is or how seriously to take it. On one level, a reasonable answer could be “not very.” The PPM, of course, explicitly is framed as non-binding internal OCC guidance, and even in an alternative world where Appendix C were binding, the OCC is careful not to use the appendix to rule out, or in, any actions, saying instead that these are just some things it will “consider” or that an enforcement action “may” or “could” include.
I think that is probably the right take, but if you wanted to take the other side you could point to Acting Comptroller Hsu’s more definitive statement in the OCC’s press release that “a bank’s inability to correct persistent weaknesses will result in proportionate, fair, and appropriate consequences, including growth restrictions and divestitures when warranted.” (Acting Comptroller Hsu also made a Gary Gensler-style Twitter video about the revised PPM, so you know it’s serious.)
Perhaps also arguing in favor of taking this seriously is the overlap some of this has with other recent recommendations from the federal banking regulators. Compare, for instance:
Federal Reserve Board Vice Chair for Supervision Barr’s cover letter accompanying the SVB report:“[T]he Federal Reserve generally does not require additional capital or liquidity beyond regulatory requirements for a firm with inadequate capital planning, liquidity risk management, or governance and controls. We need to change that in appropriate cases.”
OCC PPM: “A resulting enforcement action may include requirements or restrictions such as one or more of the following . . . requirements for the bank to take affirmative actions, including making or increasing investments targeted to aspects of its operations or acquiring or holding additional capital or liquidity.”
To the above point, see also this statement from Acting Comptroller Hsu’s January speech: “I see significant value in working collaboratively with the other federal banking agencies as we refine our thinking.” It is not clear if this PPM represents an example of that, or if this engagement is still to come.
In the January speech, Acting Comptroller Hsu also said that the OCC was “considering steps to provide greater transparency and predictability into the escalation framework.” I guess this new PPM sort of counts, but it would be disappointing if the OCC stops here in terms of transparency.
For instance, I am not sure how in most cases the public is meant to judge how closely (if at all) the OCC is following Step 2 in its escalation framework, given that many of the triggers laid out in the PPM are currently treated by the OCC as confidential supervisory information.
Also, as remarked on in an earlier post on this blog and in others’ reactions to the Acting Comptroller’s speech, there is the question of where specifically the OCC believes a few large banks that have been in high-profile trouble over the past few years currently are in the escalation framework.
The OCC, as you would expect, has declined to comment on this, but Acting Comptroller Hsu said in post-speech remarks in January that for “banks that are in the penumbra of being too big to manage … this escalation framework has a lot of salience - where are they in terms of that escalation process and articulating where we are in how we are thinking about it and what we are willing and going to do.”
Presumably this is a message that has been conveyed to the banks in private with less ambiguity.
Finally, a few cynics back in January wondered if it was a coincidence that Acting Comptroller Hsu’s speech was nicely timed to coincide with the OCC’s approval of a large bank M&A deal which was unlikely to be well received by some progressives. Those cynics might again wonder whether there is a temporal link between the sharp (and I think unfair) criticism of Acting Comptroller Hsu’s role in approving the JPM-First Republic deal and the release of this PPM which brings the OCC’s actions against the too big to manage problem — real or perceived — back to the fore.
OCC Updates Its Liquidity Booklet
With less fanfare yesterday the OCC also released a new version of its Comptroller’s Handbook booklet on liquidity. I’ll highlight two additions here that a found interesting, although there might be others.2
Surge Deposits
In a new paragraph on what it calls “surge deposits,” the OCC says that examiners need to be watchful for whether banks are appropriately managing and monitoring deposits that tend to flow in during declines in economic and lending activity.
During a decline in economic and lending activity, deposit balances tend to surge above historical levels. These large inflows of deposits occurred after the 2008 financial crisis and again during the pandemic in 2020. The behavior of these surge deposits is difficult to predict and may not be consistent with deposits gathered under normal conditions. Surge deposits may exhibit less stability and have different characteristics than a bank’s typical deposits. Surge deposit flows can reverse rapidly as economic and market conditions change. Similar to brokered deposits, surge deposits are more sensitive to rates and market conditions, so examiners should determine whether the bank appropriately monitors and manages the volume of surge deposits.
The Discount Window
Also newly added is a paragraph on the discount window. Query whether the addition of this new paragraph, including the bolded, on the whole helps, hurts or is neutral to the effort to reduce discount window stigma.
The Federal Reserve discount window can help banks control liquidity risk. Examiners should apply additional scrutiny in assessing funding strategies in banks that place significant reliance on the discount window to meet recurring liquidity needs or liquidity needs over a prolonged period. Discount window borrowings have tight restrictions, especially for banks that are adversely rated or less than adequately capitalized under prompt corrective action (PCA). During times of unusual market stress, such as the COVID-19 pandemic, discount window access can be useful for short-term or unanticipated needs. The discount window is available to relieve liquidity strains for individual banks as well as the banking system, but the Federal Reserve Banks are not required to lend through the discount window and may turn banks away.
For what it’s worth this sentence also appears in the OCC’s September 2021 booklet on Problem Bank Supervision.
The Rejected Amendments to the Increasing Financial Regulatory Accountability and Transparency Act
Earlier in the week I wrote about the Increasing Financial Regulatory Accountability and Transparency Act, noting that even though the bill in its current form probably won’t become law, it could still represent an interesting statement as to the priorities or frustrations of the House Financial Services Committee majority.
Along similar lines, I thought today I would look at a selection of the amendments HFSC Democrats offered to the bill at the markup this week,3 again not necessarily because they have much chance of becoming law (indeed all were rejected on party line or voice votes) but because they may say something interesting about priorities and frustrations.
Preventing Future Deals Like JPM-First Republic. Representative Lynch offered an amendment to change the nationwide deposit concentration limit (as well as the BHC Act consolidated liabilities concentration limit) so that an agency’s ability to waive the concentration limit for an acquisition of a bank in default or in danger of default would only be available if the responsible agency has not received an application from a different acquirer that would not require a waiver.
I get the intention, but I am not sure this would actually work given that based on the text it would apply only to situations where an agency receives applications from multiple banking organizations seeking to acquire the same bank.
If you are concerned about JPM-First Republic type deals, the bigger thing you would want to solve, and what this bill leaves unaddressed, is the least cost test that the FDIC is required to follow, which resulted in the FDIC staff feeling that under the law the FDIC was required to accept JPM’s bid. Only at that point did it become up to the OCC whether to approve JPM’s application.
AOCI Filter. Representative Sherman offered an amendment that would require all firms with $100 billion or more in total assets, as well as any other firms that the banking regulators believe appropriate, to include all AOCI components in regulatory capital, other than accumulated net gains and losses on cash flow hedges related to items that are not recognized at fair value.
This is
directionally similar toconsistent with a recommendation made by the Barr report and is not something that regulators need a statutory change to be able to adopt.To be clear, though, this would go much further than what the Barr report recommended. There, the suggestion was that the Board “should require a broader set of firms to take into account unrealized gains or losses on available-for-sale securities.” This amendment, in contrast, would have required firms to recognize unrealized gains or losses on both AFSandHTM securities.[Update 5/27: A reader emailed to point out that I made a pretty embarrassing error here - under current accounting standards Rep. Sherman’s bill would generally result in the new inclusion in regulatory capital only of unrealized gains and losses on AFS securities, but would not change the treatment of HTM securities. Apologies for the error.]
Chief Risk Officer Requirement. An amendment from Representative Casten would have expanded the range of firms which must by statute have a board-level risk committee (currently a firm has to be above a certain size threshold and be publicly traded) and would also by statute require such firms to have a Chief Risk Officer. This in itself would not be too much of a change from what is already required by regulation, but other language in the amendment would try to get at the SVB risk officer issue by putting in place more prescriptive requirements for regulatory and, later, public disclosure when the CRO role becomes or remains vacant. If the role remained vacant for 60 days or more, growth restrictions would apply until the role was filled.
More Stress Test Scenarios. The Dodd-Frank Act used to require that the Federal Reserve Board’s supervisory stress test include “at least 3” scenarios. The EGRRCPA amended this to say “at least 2.” An amendment offered by Representative Sherman would take a page from Gillette’s playbook and revise this to say “at least 5,” to consist of baseline, adverse, severely adverse, upward rate shock and downward rate shock scenarios.
Even without this amendment, Vice Chair for Supervision Barr has signaled an intent to move toward the use of multiple scenarios in stress testing, and this year’s stress test includes an “exploratory market shock” scenario for certain firms.
MRIAs = No Bonuses. An amendment from Representative Pettersen would say that any firm with more than $50 billion in total assets that receives an MRIA or other similar supervisory notice could not make discretionary bonus payments to any senior executive officers until the MRIA is resolved.
EPS for Banks With No Holding Companies. An amendment from Representative Waters would have applied Section 165 of the Dodd-Frank Act to banks that do not have a holding company to the same extent that Section 165 applies to holding companies of the same size as the bank without a holding company.
This is designed to get at the fact that banks like First Republic Bank and Signature Bank operated without holding companies and so would not have been subject to all of the enhanced prudential standards to which holding companies of equivalent size are subject.
Clawbacks, Prohibitions and Other Consequences. Finally, a different amendment from Representative Waters would have made several changes relating to clawbacks and other consequences for executives of failed banks.4 Under the Waters amendment, among other things:
If the “negligence” of any current or former executive or director of a failed bank has “caused substantial losses” to the bank the FDIC would be permitted to recover from that executive or director any compensation received during the 2-year period prior to the bank’s failure.
Section 8 of the FDI Act would be amended to allow the federal banking regulators to permanently bar from the banking industry any institution-affiliated party that “negligently caused financial loss to any insured depository institution that has failed.”
The provisions of Section 8(i)(2) of the FDI Act relating to fines would be amended to provide special fines for executive officers or directors of failed banks. Specifically:
any executive officer or director who has “negligently caused financial loss to any insured depository institution that has failed” would be subject to a fine of not more than $25,000 for each day on which the conduct occurred;
any executive officer or director who has “knowingly or recklessly caused financial loss to any insured depository institution that has failed” would be subject to fine of not more than $1 million for each day on which the conduct occurred.5
After rejecting all these amendments, the bill was agreed to by a party line vote of 26-22.
Thanks for reading! Thoughts, challenges or criticisms are always welcome at bankregblog@gmail.com.
Technically insured Federal branches above this asset size threshold are subject to the OCC’s Heightened Standards under Subpart D as well, but insured Federal branches are rare, and the latest data says there is currently only one with assets above the relevant threshold.
I noted some other vaguely interesting additions (social media risk!; GAAP tangible capital considerations!; reciprocal deposits!) in a thread on Twitter.
Not discussed in the text but also offering amendments were Representatives Green (two amendments) and Tlaib.
Clawbacks have been floated as an area of possible bipartisan compromise, although the CW is that prospects for that are waning and in any case the legislation would probably not go as far as the Waters amendment. For other examples of bills that have been introduced, see for instance the Senate bill introduced by Senators Warren, Hawley and others.
I think I am reading this right. The amendment would say that an executive or director in this category would be subject to “a civil penalty in an amount not to exceed the applicable maximum amount determined under subparagraph (E) for each day during which such conduct occurred.” And subparagraph (E), which is just existing subparagraph (D) but redesignated, says: “The maximum daily amount of any civil penalty which may be assessed …(i) in the case of any person other than an insured depository institution, an amount to not exceed $1,000,000.”