"Banks are going to have to ... get ready for the new era."

Recently, Rob Blackwell, IntraFi’s Chief Content Officer and host of the Banking with Interest podcast, interviewed noted banking attorney and Senior Chair for Sullivan & Cromwell, H. Rodgin Cohen. Cohen proved to be such a provocative guest, we wanted to share portions of his interview here. If you like the interview, we invite you to listen to the entire podcast now. 

Are some banks really too big to manage, never mind too big to fail?

There are real advantages to large banks: They bring credit, the breadth of financial services, and the convenience a modern economy needs. I don’t mean to excuse obvious violations or failures of controls, but before one reaches the conclusion that banks are too big to manage, they should strongly consider these benefits.

Regulators have taken a tougher stance on M&A. What does that mean for the industry? 

There’s a cost to time. In 2021, the two largest bank transactions were approved in about five months. Today, applications from large banks are taking a year or more to approve. When you increase the amount of time, you lose customers and employees. There's the additional loss of business opportunities as revenue and expense synergies get further delayed. There’s the cost of keeping banks separate. There’s the cost of business as usual, and beyond.  

Something I want to point out is the Fed’s data on processing time, which shows a clear dichotomy between the time it takes to approve a protested application versus a non-protested application. Agencies should reconsider what constitutes a substantive, credible protest, because the differential between protested and non-protested seems to occur irrespective of the protester’s credibility. 

Is there a way for banks to satisfy regulatory concerns over M&A  - or do they just need to understand approval may take a year?

I think your premise is correct; it’s a question of time rather than substance. If you look at the approval letters from the Fed and OCC on the U.S. Bank/MUFG Union Bank transaction, the largest approval in some time, it’s not merely that it was approved, it’s that the analysis the agencies used was comparable to analyses used in the past. Which should be the case, because the statute is the same. 

Is there an asset threshold where bank regulators won't approve a deal? 

I don't know if regulators will say there is one, and they should be cautious, because Congress has acted twice on this issue—first in the mid-1990s, then with Dodd-Frank. In the first case, the tests were not in terms of absolute dollars, but in percentage of nationwide deposits, and nationwide liabilities, in the second. I think a percentage test makes more sense. 

Regulators have signaled more scrutiny of bank-fintech relationships. What are they looking for? 

It depends on the fintech. A couple banks have suffered significant losses from crypto activities. When you look at the most recent release from the agencies, their attitude seems to be “unsafe at any speed.” So with regard to crypto fintechs, the message is clear: It’s a red light.

With the more traditional fintechs, it’s a cautionary yellow light. The concern is that some are engaging in improper or illegal practices, particularly in the context of consumer protections. Some worry banks are a transmission vehicle for fintechs to get into questionable consumer- and small-business products and services. Regulators are telling banks they’re going to hold them responsible under their vendor-management obligations if those products and services violate laws and regulations. 

“Anything with the breadth and depth of the CRA proposal is going to have issues and, in all probability, errors.”  

Most analysts believe Fed Vice Chair Michael Barr is going to raise capital requirements. How do you see this playing out?

I do think he’s going to raise the requirements. This Fed has made it clear it doesn’t consider capital neutrality a goal, and that suggests it won't be met. This isn’t because capital requirements are going down, it’s because they're going up. 

There are many levers to pull, and many will be pulled. For instance, at many large banks, the stress-test process is the most capital-constraining, and it doesn't take much to change it. You can change the economic assumptions to assume more of a market correction, higher unemployment, or any number of economic factors. Most important are the assumptions on whole categories of loan losses. Take a category of loans that represent, say, 20% of a bank's loan portfolio, increase the percentage losses by 25% over a time horizon, and capital requirements will increase proportionately. 

The banking industry has threatened to sue regulators if the latest CRA reform proposal is approved. Is that going to happen? 

Anything with the breadth and depth of the Community Reinvestment Act proposal is going to have issues and, in all probability, errors. I think regulators will be responsive to industry concerns, but I don't know how much change will occur.

It’s a high-priority item for the agencies, and although a number of people believe they should re-propose it, I’m not sure that will happen. A re-proposal would mean pushing it to 2024, and that's a long time. There is widespread agreement that current regulations are outmoded and need to be changed, but it’s hard to get the agencies to agree; then there's the whole process of proposing rules. 

Ultimately, I think regulators will make some changes and go straight to a final rule sometime in the first half of 2023. We will have to find out how significant those changes are, but some areas could be prone to litigation if they don’t change enough. One issue that will be critical is the period to implement. Whatever the final form, banks are going to have to do a lot to get ready for the new era.

How much time would be sufficient for CRA reform? A year? 

That would be the dead minimum.

You’ve called for cryptocurrency regulation and suggested regulators could use the Dodd-Frank provision to regulate financial utilities. Is that better than legislation? 

Legislation is better because cryptocurrency and other crypto assets don’t readily fit into any existing legal scheme. But legislation is extremely difficult to accomplish. Although this should be a bipartisan issue, few issues today are, plus this is a fiendishly difficult area to legislate. Having said that, it’s an abdication of responsibility by the executive and the legislative branch of government to not regulate. 

Frankly, the Financial Stability Oversight Council (FSOC) should do it. It has the authority, and that authority is broadly written. It doesn't have to be an issue of systemic importance; all it needs is to likely be of systemic importance, and that fits cryptocurrency. FSOC should move forward on an ambitious time schedule if Congress fails to act in the next few months.

If a stablecoin bill were to pass, do you think people will use them more? 

Just as money market mutual funds had a disintermediation effect on banks, so could stablecoins. And yes, if the market were regulated, it would draw more deposits, because people would be more comfortable using stablecoins. But central bank digital currency would have an enormous disintermediating effect and is a far bigger concern.

Do you think a CBDC is inevitable? The Fed sort of keeps moving it along, even though they claim they haven't decided anything yet.

Yes, but in my view, the Fed does not have the legal authority to establish a Central Bank Digital Currency (CBDC). It would require congressional action, and for some of the reasons we talked about, it’s difficult to get legislation through. If we do get a CBDC, it won’t be for many years.

It would seem a CBDC is a much greater threat to community banks than to large banks. 

I agree.