The Trump Administration is trying to push through a rule that would neuter banks’ ability to consider ethics and reputation issues when offering services — a kiss to the oil & gas industry, and one that would undermine banks’ ability to consider social and ethical factors when evaluating business relationships.
The Office of the Comptroller of the Currency released the notice of proposed rulemaking last Friday evening. It would require large banks to consider only credit and operational risks when deciding whether to do business with a client. That’s a clever way of saying banks can’t consider other factors, such as whether the prospective client works in an unsavory business that might call the bank’s ethical principles into question.
What does the oil & gas industry have to do with this rule? Well, they were the ones that put this idea into motion. Last winter, numerous Wall Street banks started to announce that they would no longer finance oil exploration and development in the Arctic, given those projects’ environmental damage and contribution to climate change. Among the banks were Goldman Sachs, JP Morgan, Citigroup, and Wells Fargo.
This did not sit well with Republican lawmakers, who have been up to their ears in donations from the oil and gas industry for decades. Republican lawmakers in Alaska complained to OCC earlier this year in a letter, saying the banks’ decision not to do business with oil exploration companies amounted to unfair discrimination in lending.
This rulemaking notice from OCC, which specifically cites the letter from Alaska lawmakers in the text, is the result.
“The terminated services were not limited to lending, where risk factors might justify not serving a particular client (e.g., when a bank lacked the expertise to evaluate the collateral value of mineral rights in a particular region or because of a bank’s concern about commodity price volatility),” the OCC notice said. “Instead, certain banks indicated that they were also terminating advisory and other services that are unconnected to credit or operational risk.”
OCC says that the proposed rule would apply only to banks with more than $100 billion in assets. Specifically, banks could not “deny any person a financial service the bank offers, except to the extent justified by such person’s quantified and documented failure to meet quantitative, risk-based standards established in advance by the covered bank.”
Banks would be expected to have written policies and procedures to support this supposed obligation to provide equal access to financial services, which OCC would review as part of its regulatory examinations. Violations could lead to enforcement actions.
The Ethics of ‘De-Risking’
This isn’t the first time banking regulators have denounced the practice of “de-risking,” where banks decide to avoid whole classes of customers because those customers pose more risk management trouble than they’re worth.
In 2014, OCC took banks to task for de-risking away from money service businesses along the U.S. southern border, since MSBs were a much higher risk for drug cartel money laundering. The regulator sent a similar warning in 2016 about managing the risks of foreign correspondent banking. In both cases, OCC said banks need to evaluate each customer based on its individual risks.
In this latest rule proposal, acting Acting Comptroller of the Currency Brian Brooks tries to make the same argument: that banks can’t take the easy route of de-risking away from whole categories of industry, because that violates fair lending rules under the Community Reinvestment Act. Each customer relationship should be evaluated based on a “quantitative, impartial risk-based standard” established by the bank well in advance of any specific customer walking through the door.
Tread carefully, compliance officers. Brooks is conflating several distinct issues to advance his true objective, which is to please the oil & gas industry. His effort comes at your expense.
First, he equates de-risking from the oil & gas industry to de-risking from other industries, such as money service businesses. That’s not quite right. When you de-risk from money service businesses, coin dealers, strip clubs, weed dealers, and so forth, they all bring money-laundering risks that a bank might decide are simply not worth the hassle.
That was the issue in 2014, when OCC warned banks about money service businesses along the border. Too bad, OCC said: you still need to evaluate the risks of each MSB customer and act accordingly. Which banks can do, even if that process is an expensive pain in the neck. Money laundering risk can be managed.
In contrast, oil & gas businesses bring reputation risk: by working with them, a bank is making a statement about its ethical and social priorities. To mitigate the damage that statement makes, a bank could either impose conditions on the client — “no loan for you, unless your project also meets certain carbon emissions standards” — or not engage in the business relationship at all. But the situation is not like OCC’s warnings about money service businesses, because the risks involved are categorically different.
Second, Brooks said banks are supposed to use a “quantitative, impartial risk-based standard” to provide banking services.
Except, reputation and ethical risks are inherently qualitative in nature. They often manifest in ways that businesses don’t anticipate or that don’t neatly fit into your risk assessment framework. In that case, senior bank executives need to consider how doing business with Unsavory Customer X fits with the bank’s ethical principles and core values — if you actually take those principles seriously, at least.
Brooks wants to divorce the provision of banking services from that ethical context. His proposal would force banks to make decisions based solely on credit and operational risks, nary a peep about ethics anywhere in that analysis.
A Risky Situation
Several questions come to mind here. First, how would Brooks’ directive for banks to ignore questions about climate change square with the New York Department of Financial Services’ directive that banks disclose more about their risks from climate change?
For example, oil & gas businesses might use banks to fund long-term projects, but those assets then decline in value as the world moves away from fossil fuels. So what’s the disclosure the banks should make? “We underwrite large projects that could become worthless stranded assets by 2040, and federal regulators disallow us from moving away from this sector” — something like that?
Clearly New York banking regulators want banks to support the move to a greener economy. OCC wants to undercut banks’ ability to do that. They are working at cross-purposes.
Second, will this rule proposal actually come into force? The public is allowed to submit comments until Jan. 4, which gives Brooks only 16 days until the Biden Administration arrives and presumably puts the kibosh on this idea. Brooks is also only acting director; President Trump nominated Brooks last week to fill a complete, five-year term as OCC director — yet another attempt by Trump to undermine President-elect Biden.
It’s unclear whether Senate Republicans will be able to confirm Brooks before Jan. 20, but they’ll try. If they run out of time, Brooks probably gets fired immediately, and this proposal goes into the deep freeze.
So yet again, compliance officers will need to wait and see what happens here.