Richard Cordray, former head of the U.S. Consumer Financial Protection Bureau, recently came to California to advise the state on how it should regulate banking and other financial services.
The current regime places in one entity — the Department of Business Oversight — responsibility for both monitoring the safety and soundness of state-chartered banks and credit unions, and protecting consumers of financial services, including those provided by nonbanks.
At a March 26 hearing of the Assembly Banking and Finance Committee, Cordray called that model “obsolete.” He said “a built-in conflict of interest” exists when one regulator possesses the dual duty to both ensure the safety and soundness of financial institutions and protect consumers. “That is not the right answer for a state as important as California,” he told the committee.
Cordray and other proponents argued for a so-called “twin peaks” regulatory structure under which the safety and soundness and consumer protection functions are housed in separate entities. Example: the federal government. One set of entities — including the Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation and Federal Reserve — focus mainly on safety and soundness. The CFPB focuses solely on consumer protection.
With that in mind, Cordray and others suggested California establish its own version of the CFPB.
The idea’s proponents, however, seemed off key. Most notable was their focus on banking oversight when talking about regulatory conflict of interest. California may have the fifth-largest economy in the world, but it is still a state. As such, it has no power to regulate federally chartered banks, whether it’s for safety and soundness or consumer protection.
The DBO regulates state-chartered banks. They pose far less consumer protection problems than their federally chartered counterparts — the folks who drove the country into an economic abyss in 2008 while inflicting massive financial damage on millions of Americans.
Additionally, DBO does not monitor nonbank financial service providers — payday lenders, consumer installment lenders, mortgage lenders and the like — for safety and soundness. The agency’s primary regulatory focus with respect to nonbank entities is consumer protection.
One note sounded by Cordray on the conflict of interest issue rang true. He noted in his testimony banking regulators’ funding comes from fees paid by licensees. That’s true for DBO, both for the banks and nonbanks it regulates.
Such fees may be an appropriate source to cover licensing costs. But the resources regulators possess to ensure licensees comply with consumer protection and other laws should not depend on fee revenue provided by those regulated entities. On that score, financial services regulators should be funded by, and thus fully accountable to, taxpayers.
Californians do deserve a new vision for financial services regulation. That begins not with creating a new bureaucracy, but with reimagining, strengthening and rebranding DBO.
Start with the name. It’s bad. Department of Business Oversight tells people nothing about what the office does. Call it something like Department of Financial Services Regulation.
Second, restructure the agency. It’s now divided into the Division of Financial Institutions (banks, credit unions and money transmitters) and the Division of Corporations (nonbanks, including lenders, loan brokers, securities broker-dealers, investment advisers, franchises and escrow agents).
In their place, establish one division responsible for licensing both banks and nonbanks, and monitoring of banks’ and credit unions’ safety and soundness. This division would be funded by licensee fees. Establish a second division called something like Consumer and Investor Financial Protection. This division would be responsible for monitoring and enforcing compliance with consumer protection and other laws for both nonbanks and banks. It would be funded by taxpayers through the State General Fund.
Then, create a division responsible for market monitoring and consumer education, also funded by taxpayers. This division would handle consumer complaints, process and analyze annual reports submitted by licensees, house a financial innovation office, conduct market research and manage consumer education programs. Such a unit is critical if California wants to provide the public a gold-standard regulatory agency.
Regarding funding, much more would be needed to provide Californians the kind of entity espoused by Cordray and others. The DBO is populated by outstanding, dedicated public servants. But they can only do so much with what they have. And what they have falls short.
Measured by bank and credit union assets and consumer dollars loaned or managed by nonbanks, DBO’s jurisdiction at the end of 2017 covered $1.12 trillion. That’s more than the total GDP of 47 states. The agency regulated 382,738 individuals and companies.
To perform its gargantuan responsibilities, the State’s FY 2017-18 budget allocated DBO $93.2 million and 580 personnel positions. Compare that to the Department of Insurance, a regulator responsible for protecting far less consumer money. The FY 2017-18 budget allocated DOI $270.2 million and 1,218 positions.
The DBO needs more lawyers to prosecute enforcement cases. It also has a great need for more examiners to audit licensees, especially on the nonbank side. Such audits constitute the cornerstone of the compliance program. Additionally, DBO has no resources to perform a viable market monitoring function.
Providing premier consumer protection requires more than money and people. California needs much tougher laws to protect consumers of nonbank financial services. Statutes need to be updated to provide oversight of out-of-state banks that operate online and affect the financial lives of increasing numbers of Californians. The DBO, and its mission, need stronger backing from the governor’s office than received in the past.
Within the agency, banking oversight needs more focus on compliance and increased transparency in enforcement actions. On the nonbank side, DBO should end its enforcement practice of entering informal settlements that are never disclosed to the public. The practice is anathema to government transparency and deterrence of misconduct.
Providing world-class financial services regulation for a world-class economy won’t be easy. But Californians deserve nothing less.
