Regulatory changes are brewing in Washington. Between the final implementation of the Basel III international framework, supervisory reforms in response to recent bank failures and the modernization of the Community Reinvestment Act, some banks could face a new set of regulatory obligations in the months and years ahead. Acting Comptroller of the Currency Michael Hsu will sit down with American Banker to discuss these and other policy considerations, including how to best address merger and acquisitions at time of continued instability in the banking sector.
Transcription:
Kyle Campbell:
Hello and welcome to this session of Leaders. My name's Kyle Campbell, I'm a reporter with American Banker. And before we jump into things, just a few programming notes. As you can see, we are streaming live from the Arizent Studio here in Lower Manhattan. And unfortunately we will not be able to take audience questions today. So if you have any comments or questions feel, please feel free to engage with us on social media. You can find us on Twitter at @AmerBanker or you can find me @byKyleCampbell, and we'll be sure to get back to you just as promptly as we can.
And with that said, I'd like to welcome our very special guest this morning, acting Comptroller of the Currency, Michael Hsu. And for those who are not familiar with Mr. Hsu, he is, he's been the acting comptroller of the currency since May 2021. Previously, he has worked at the Federal Reserve, the IMF, Treasury and the SEC. And along with his position as the head of one of the top regulatory agencies in the country, he also is a member of the Financial Stability Oversight Council as well as the Federal Financial Institutions Examination Council.
Michael, thank you for joining us. Appreciate it.
Michael Hsu:
Thanks for having me. Really appreciate it.
Kyle Campbell:
Great. So just to start things off, we're going to kind of work through a few topics this morning, but I think we should start with the news of the day, which is just about an hour ago, Michael Barr, the vice chair for supervision at the Federal Reserve, talked through his findings from his holistic capital review, which has been a sort of much anticipated report on capital in the banking system. No real surprises from folks who've been really following this issue, but essentially he called for the implementation of the Basel III endgame, which comes with some risk-capital adjustments.
I guess the one bit of news there is that it's going to be applied to banks that have $100 billion of assets or more rather than $700 billion. Again, something that was sort of expected but maybe not stated explicitly. And then, I mean, some other tweaks to, potentially, the stress test and the GSIB surcharge, sort of smaller things.
But let's start with this topic of capital. What is your view on the capitalization of the banking system now and why do you think strengthening it is appropriate given what we've seen? Obviously, three banks failed earlier this year. Many have said these failures were not related to capital expressly, and we've seen a sort of strong bank system since then. But what are your thoughts?
Michael Hsu:
Sure. Well, maybe there's two things I think are worth, worth emphasizing. The first is that there's pretty strong alignment between the OCC, the Federal Reserve and the FDIC on kind the direction of travel on Basel, the endgame, capital requirements, et cetera, and so I think that's important to kind of highlight. The second is, one, it's helpful to think, I think about capital requirements, they're almost like building codes. And I think if you think about building codes, what do you want out of your building codes? Well, you want them to be tailored. You want the building codes for your single family home to be tailored for that versus like a skyscraper. And then for those large buildings that do a lot of things, skyscrapers, airport terminals, et cetera, you want 'em to be strong so that people don't have to worry when there's different stresses. For instance, here in New York, I know there was recent flooding, historic flooding. I grew up in Ohio, you had lots of tornadoes, in the south you have hurricanes, you want your buildings to be able to withstand those things so folks don't have to worry. And things change over time. And you want to make sure those codes are updated to be able to deal with that. And I think that's the right framework, it's kind of the right mindset to think about as we embark, embark on finalizing these requirements. So, having strong capital requirements is important. It can help promote the economy, ensure a safe and sound banking system, and that is in the interest of everyone. Like building codes, you don't want to be pennywise pound foolish with those requirements.
Kyle Campbell:
That makes sense. And it seems like these changes, well at least based on what Vice Chair Barr said, will be somewhat, I wouldn't say minimal, but they're not going to be, there was a report about 20% increase in capital, whereas he said that it's going to be about 2% on average across mostly the larger banks. Obviously this is going to need to be rolled out and spelled out specifically. But how do you see the burden of the changes being considered impacting certain types of banks? Obviously, you have the very largest GSIBs, you've got, in this $100 billion-plus category, a lot of banks that are sort of mid-size or super regional. Where do you see the burden sort of falling and how do you expect that to be absorbed and internalized?
Michael Hsu:
So, I don't want to get ahead of where the proposal's going to be, and clearly we're going to have a common process to get a lot of feedback as to whether we calibrated that in the right way. I think the important thing is that we get the requirements right and so that's really where the focus is. Are we getting those requirements? And then let's, obviously, we have to take into account, well, what is the burden going to be either on specific institutions on particular markets? And that's all part of the analytical process, which is fed into how we're approaching this. And, of course, the comment period will provide us with even more information as to where we should go in terms of finalizing things.
Kyle Campbell:
Got it. Got it. With the Basel III endgame, there's going to be a focus on risk-capital and risks around credit, trading and those sort of components of a bank's balance sheet. What have the last few months told you about the buildup of risk in the banking system? Are there areas that have stood out to you and what do you think needs to be addressed?
Michael Hsu:
Sure. So I would separate these a little bit. So, because the requirements that we're seeking to put into place are through the cycle, over the long term and there'll be a transition period. I think it's important to remember once these gets proposed, then it takes time to get them finalized. Once they're finalized, then there's even more time before they're, they come into full force. So, with those requirements, we're playing the long game. At the same time, we have a current situation which is informed by a lot of different things. So we have to do both. And so, I wouldn't necessarily link where those requirements are going to land with the current situation. But, obviously, with the current situation, we're coming out of a pandemic, we just had some stress in the banking system not too long ago, so all of these are top of mind. I have emphasized from day one coming in about guarding against complacency. And I think this is a really important thing that as bankers, risk managers, boards of directors, supervisors, examiners, we don't get complacent about where things are, because we had gone through, after the 08 financial crisis, a pretty long period of zero interest rates and relatively benign markets. And then with the pandemic, I think there were really a lot of fears that this was really going to crush the economy and the government and the private sector stepped up to keep the economy moving, which is fantastic. It does create space for some complacency. And I think even after this recent bank turmoil, there's a sense, 'oh, things have stabilized somewhat.' And our message to both examiners and to banks is use this time wisely. Be on the balls of your feet in terms of risk management, risk management, risk management, make sure where your risks are, make sure you don't have concentrations. This is the time to do that. Hope for the best, prepare for the worst. And that's kind of the approach we're taking.
Kyle Campbell:
So the calm after one storm is the calm before another storm.
Michael Hsu:
Yeah, yeah, exactly. And look, can things improve and stay buoyant? Sure they can. They can also turn, and I think there are some signs in certain markets that there could be stresses in the future and we want to make sure that banks are ready for that.
Kyle Campbell:
Right. And you have direct experience in the bank supervision space and something that has come up, I guess, in the past four months since those failures is just the culture of supervision, and I think there's been a focus on how can we improve that. Based on your personal, direct experience, how does a culture of supervision evolve? And is it something, how do you steer it? Is it something that can't turn on a dime, obviously, but how do you go about adjusting culture?
Michael Hsu:
So that's a great question. And so the first thing I would say is the DNA of a supervisor, of a bank supervisor or examiner is to be paranoid about risk because it's all about risk management and it's to say where are the risks? Are we identifying them? Are we monitoring them? Are they being managed? And that's a good thing. I think that's what everyone wants. That's what you want in an examiner. And, so culturally, that part has been there from the get go and across all the different bank regulatory agencies. I think what came out in this latest set of events is that reliance on supervisory discretion, the pendulum tends to swing a bit back and forth on whether supervisory discretion is a good or bad thing. And I think what this latest set of events has shown is that it's a necessary thing. We need our supervisors to exercise discretion and empower them to act.
I think the reports from the Fed and the FDIC and from the other agencies showed that examiners were not blind to the risks. The risks, they had identified the risks, they saw something, they had even engaged with the banks on, hey, there's some risks here. It's that last part on acting on it where there's been a greater focus on and that, there's a cultural element to that and not just culture, it's a tone from the top issue. And then I think this is something that I feel very strongly about. In the OCC, if you see something, you have to say something, you have to act on it. And that's something that is, that I think leaders of agencies and even public leaders and others, I think you're seeing a lot of attention on how come the questions about why the supervisors didn't act. And I think that's something that we want to empower and support in good times and in bad.
Kyle Campbell:
Right, right. How do you, sort of, and, obviously, culture is going to exist on multiple levels in an agency, maybe in a region, specific office and team. How do you bridge the gap between agencies when you know, and the Fed and FDIC all have, and even and state regulators as well, all have the same objectives, but you know, go about different, you attack different parts of the puzzle. How do you get on the same page and make sure that that culture is not only improving but moving in unison at least in some degree?
Michael Hsu:
So I'm a very strong believer in collaboration. I think of supervision, bank supervision, as a team sport. And yes, there are some intramural rivalries, if you will, between agencies, but at the end of the day we're doing the same thing, which is to keep the banking system safe and sound and fair. And in order to do that maximally effectively, we have to work together. And that's something, it doesn't always come easily, but a lot of that has to come. It comes down to information sharing, keeping each other apprised, making sure are we on the same page when talking to another agency, when dealing with a particular institution or a set of risks. So we've lots of forums, both kind of bilaterally where examiners are working together. I talk to my counterparts pretty frequently at the other agencies. We've got things like Financial Stability Oversight Council, FFIEC, lots of forums where we can get together and we're not always going to agree and see eye to eye on things. The important part is that we engage, that there's constant engagement, that there's constant, 'Hey, where are you on something? Where are we on something?' And I think you saw with the most recent turmoil, like good coordination across different agencies to get to the right outcome, which is financial stability, making sure the system is safe and sound, making sure depositors are protected, those priorities. To pull that off requires a pretty significant amount of coordination and working together.
Kyle Campbell:
Right. What is your view on the state of the banking system right now? Obviously, resilient is a term we hear a lot. We certainly made it through this period well, all things considered, but we're still seeing deposits sort of trend down. I mean maybe that's sort of moderated a bit, but still general downward trajectory, which is increasing the cost of capital for banks and eating away at that net interest margin. So, where do things stand and what are you concerned about right now most?
Michael Hsu:
Teah, so I think that overall the system is sound and it's resilient and that's due to a number of things. I think the post-crisis reforms really did, the post-2008 financial crisis reforms, Dodd-Frank, et cetera, really did provide just a much stronger base for capital and liquidity. Capital and liquidity buffers, they work, they're our friend, they're the banks' friends, those are significantly higher and stronger than they were prior. Risk management has improved, et cetera. But there are certain fragilities and vulnerabilities which remain, which we have to be really attentive to. And the thing I worry about the most is complacency. I worry that periods of quiet are mistaken for strengths that may or may not be there. And that, again, concentrations as we've seen, concentrations can kill. Those can come in different forms. And so we're constantly on the lookout for, 'OK, where are those potential concentrations? What are banks doing to prepare themselves just in case?' And that's really, really important.
Kyle Campbell:
With some of those tensions that we talked about in terms of cost of capital and sort of profitability, there's a view that from some, that there needs to be some consolidation or there may might a healthier level of M&A than what we've seen. And obviously you've spoken about this topic quite a bit in the past, but has your thinking about this evolved at all under the current circumstances or where are you seeing, what's your outlook on M&A right now?
Michael Hsu:
Sure. So, I think the most important thing to, the north star, the compass that we need to have when having this discussion: we need to have a diverse banking system. That's really, really, and when I say diverse banking system, we need large banks, we need mid-size banks, we need community banks. It's really critical because I think it often we skip over, why is that important? Well, it's important because we have a diverse economy. The U.S. economy is the strongest in the world because it is diverse and you really, I've come to appreciate the diversity. I travel quite a bit to visit field offices, talk to bankers, community bankers, mid-sized bankers all over the country. And you really do, when you do that, you get this strong feel like, yeah, we're a big country, we've got lots and lots of communities with lots of different needs. The banking system needs to be able to match that diversity, to support it, to enable it to grow. I think it's a critical starting point. So, that's the starting point. Then the second is a safe and sound banking system can then enable and support that growth. So you need diversity and you need a safe and sound banking system.
Healthy mergers can support both of those. Unhealthy mergers can hurt that. So really in my mind, there's a clear distinction between healthy mergers and unhealthy mergers. And we want, we need to allow healthy mergers and we need to discourage and prohibit unhealthy mergers. Now that begs the question, what is a healthy merger? It's pro-competitive, it's pro-community, it's pro-safety and soundness, and it's pro-financial stability and it complies with BSA/AML. So these are statutory factors in the Bank Merger Act. We've got frameworks to assess all of those. Those frameworks are pretty dated right now. Those were developed, many of them, back in the mid-90s. The banking system has changed. And so, I think we want to make sure that we have healthy mergers because that can help, again, support a diverse banking system because it's pro-community, pro-competitive, pro-financial stability. We need to make some updates and adjustments to how we analyze those. And that's what we're in the process of and doing it inter-agency. We're working with the other agencies and the DOJ to make sure we kind of get that balance right.
Kyle Campbell:
A specific merger that has been talked about a lot recently: First Republic, JPMorgan. Obviously that's not a typical situation, but, you know, you have gotten some criticism because it was the largest bank in the country getting larger. As you've, I mean, have you looked back at that at all and thought about it differently in the context that has emerged since then? Or are you still feeling pretty confident that that was the right move for the time?
Michael Hsu:
So, for financial stability, that was absolutely the right move at the time. There, we do have an issue of excessive concentration in the banking system. That, we, that's not good for the system, it's not good for the banking industry, it's not good for politics. That's something that needs to be addressed. Financial stability in situations where you've got large banks failing and financial stability is at risk. Financial stability has to come number one, number two and number three. And so I've said it publicly, I've said it in other settings, when faced with those decisions, ensuring there's coordinated and timely government action to ensure financial stability is always going to be my top priority. That being said, I think anything we can do to minimize excessive concentration of banking power amongst the largest banks, we should pursue those. That should be something that we do. And it's one of the reasons why I think it's important that there is a path for there to be competition amongst large, I've spoken about this, there should be competition amongst large banks and simply prohibiting all mergers of large banks really locks in the concentration amongst the existing mega banks. And I don't think that's the right answer. But we have to do that in a way that doesn't create a too big to manage problem, that doesn't create a too big to fail problem. And so I've talked about what do we need to do to ensure that, and that path is narrow, but it's there and I think that's important that we pursue that.
Kyle Campbell:
You talked about the diversity of the banking system and right now obviously there's a lot of focus on that middle portion, the sort of mid-size, regional bank, however you want to term it. And it seems like there's some pretty clear roles that the largest banks play in the economy in terms of making markets and providing the types of finance that you can only do at that size. And then the community banks, they have a clear role in supporting their local economies. What do you see as the role of that middle portion of the banking system going forward?
Michael Hsu:
It's a very diverse portfolio. So, if you were to, we talk about these as big blocks, as if all the GSIBs are similar, they're not. They're actually quite different individually, and then the community banks are very, very different. When you go to different communities, you realize that what each bank does and how it goes about doing, and that's the beauty of it, that's why it works so well. The same thing goes for the mid-sized regional banks, each one of them. There's not a generic archetype for a regional and mid-sized bank. It depends. It depends on which one you're talking about and which communities it serves. But again, I think this reinforces the need that we're both cognizant of, that what that diversity provides to the economy and that we support that.
Kyle Campbell:
Got it, got it. So letting it, it's not going to be one thing. It has to prove itself out to be what it needs to be. That makes sense. So when we are looking at another sort of regulatory consideration coming up, the Community Reinvestment Act, something that needs to be, again it's sort of outdated, it needs to be modernized. What are your sort of pillars in that process? What's sort of the guiding light?
Michael Hsu:
So I think it's important to go back to the historical roots of the Community Reinvestment Act. So the CRA was passed in the 70s as part of civil rights legislation to deal with redlining. And that really was the problem at that time was that banks were providing credit to certain communities and not to other communities. And that's not fair. And not only is that not fair, it's not good for the economy, it's not good for the banking system. So the CRA was passed to ensure that banks provide, meet the credit needs of everyone, of all the communities they serve, including and especially low and moderate income communities. So that's important to just restate because that's the core spirit and the law of the CRA. As you noted, we have to modernize it, right? It's, the CRA was last, the implementing regs were last updated in '95. And so the banking system has changed a lot since then. So we want to modern, we need to modernize it for today's banking system and we need to strengthen it. And by strengthening it, I always talk about it in terms of there needs to be more CRA activity in general because the indicators on inequality, they're pretty persistent. So kind of more needs to be done. I think most people would acknowledge that. It needs to be better, so better targeted. It's not just about sheer dollars. Sometimes communities need something more than just more loans. They need branch access, they need other kinds of things. So we want to make sure it's responsive to the needs of communities. And it needs to be faster. And I think this is something where both banks and advocates see alignment is that the process of what qualifies for CRA having a long drawn out process doesn't help anybody. So kind of more, better, faster. Those are the guiding principles that I've kind of told my staff to use that as we engage. The good news is, again, across the three agencies, OCC, Fed, FDIC, strong alignment on where we need to go and how to get there. I'll preempt your question about when and just say it's coming.
Kyle Campbell:
Okay, fair enough.
Michael Hsu:
I can't give an exact date, but it's coming.
Kyle Campbell:
Fair enough. And so a main goal of that is to incorporate mobile banking and digital...
Michael Hsu:
That's right.
Kyle Campbell:
And online banking. And how do you weigh the dynamic of, you know, want to encourage larger sort of more tech savvy banks to reach communities that are underserved versus potentially stressing or providing excessive competition to the smaller institutions that are already in those areas that maybe aren't quite as savvy. Is there, is that something that you sort of think about in this dynamic that you've sort of thought through?
Michael Hsu:
So I, maybe I'll approach this from a slightly different angle than CRA. So, banking services, the provision of banking services has been changing and maybe just stepping back in the old days, I'll say with in air quotes, banking and banks were co-terminus. Only banks provided banking services. Increasingly, this is now being kind of split up where banking, taking deposits, facilitating payments, making loans is being done by a variety of actors. Sometimes it's banks, sometimes it's nonbanks. And so I think we want to be cognizant of those changes. And part of this has to do with digitalization, e-commerce, et cetera, mobile, everyone doing things mobilely. From my perspective, what's most important, it's safe, it's sound, and it's fair. If it's banking, it needs to be safe, sound, and fair. How do we achieve that? It really depends on the means by which this is being delivered. And this gets to, there's a lot of bank FinTech partnerships out there. They're proliferating, there's more and more of them. How do we make sure that those are done in a way where the consumer that's getting a banking service is getting something that's safe, sound and fair. It's complicated. And we just recently put out some interagency guidance on third party risk management. That's a step at the OCC. We've had similar guidance around for some time, but that's a step towards getting us into a better place for those relationships. And we obviously have to refine that as we move forward and that's one of our priorities.
Kyle Campbell:
Yeah, I've heard of some banks actually going towards fourth party management and making sure their vendors, vendors are
Michael Hsu:
Yes. Yeah, no, that, that's really critical. Well, this gets to, I've talked a little bit about this idea that there's now a supply chain for banking.
So in the pandemic, we all learned what a supply chain was because there were these disruptions and it doesn't take much for one part of that chain to have stress and then suddenly some, you're not getting your package overnight. So in banking, as we move more into these partnerships, there's going to be a similar phenomenon taking place. And again, as a bank regulator, my job is to make sure that where those things are critical, that there's a lot of awareness around that and we, we've got safe sound and fair outcomes.
Kyle Campbell:
Right. On a similar note, I mean from your position on financial stability oversight counsel, do you think there's an appetite for maybe declaring some types of businesses to be systemically important, or is that something that you'd like to explore more in the years ahead?
Michael Hsu:
Yeah, so the FSOC, we are very actively discussing the systemic designation process and how to both modernize it and make it effective because it exists on paper, but we want to make sure that it's effective and we want to make sure that it's also fair and that it serves its purpose. And I think that that requires a lot of interaction and dialogue and discussion between the different FSOC members. But I think that there is, there's broad agreement amongst the council that this is something that needs to have some teeth, and so we're kind of working towards that end.
Kyle Campbell:
Right. Any thoughts on why that hasn't crystallized sooner? I mean, obviously there's a lot of focus on things like fairness and equality in the financial sector broadly, but we're now a few years into the current administration that has focused on that without seeing any, I guess, tangible progress on that front. Do you have a sense for why that is?
Michael Hsu:
Well, I think the devil's in the details, and so sometimes to get things right, it does take a little bit of extra time, especially when there's multiple stakeholders. There's a saying, my staff is sick of me saying this, but faster alone, farther together. So it's possible to just make moves as either as a single agency in a particular way, but it's more durable if you can get all the stakeholders to agree on a particular direction and framework, and that takes a little bit of time and we want to make sure we get that right so that it is durable and it has that kind of lasting impact and effectiveness.
Kyle Campbell:
Got it. I know we are running out time here. So one thing I did want to bring up was tokenization, Bitcoin. I know you spoke about this recently. It seems to have kind of faded into the background a little bit versus last year, but is this still a live topic for banks? Is it something they're interested in? And do you have any sort of particular concerns, especially around stable coins and their impact on maybe financial stability?
Michael Hsu:
I think in general terms, banks' interest in crypto has died down, and I think that has as much to do with issues in the crypto space and the immaturity of the crypto technology and some of the firms in that space as much as us as regulators, just highlighting there's a lot of risk. Where there is risk, you have to have appropriate risk management. So we put out some interagency guidance on that across the agencies, just reminding banks about that. So from that perspective, I agree with your opening statement there. Where there's been more, what I think interesting activity has been around trying to utilize some of this to solve actual problems. So one of the problems in the financial system is that settlement of various sorts has a lot of frictions associated with it, and those frictions cost money and they take time. And if there are ways to reduce or minimize some of those frictions, that's worth pursuing.
And I think there's some interesting, mostly bank specific efforts. Some of them are consortiums to try to address some of those frictions, and some of it takes the form of tokenization utilizing either blockchains or DLTs or something along those lines. Those are interesting from a supervisory perspective, we just want to make sure that the appropriate risk management controls are developed alongside those. And for the most part, in general, what we're saying that is the case. And so there's some promise there. It's something to keep an eye on. But again, I think it's important to focus on what is the problem that we're trying to solve. And I think that's where the crypto industry sometimes gets kind of turned around a little bit and can be a bit circular
Kyle Campbell:
Solution seeking a problem
Michael Hsu:
That that's how some people have described it, which I think is not inaccurate.
Kyle Campbell:
Right. Well, to close things off, you've talked about, I'm going to go back to the sort of banking crisis, and you've talked about wanting to learn the right lessons. What are the lessons you've learned and what if there is just one or two things that you think the whole industry, both banks and those who regulate them, need to take away from this? What should it be?
Michael Hsu:
So I think there's four main lessons, and the first one is risk management matters. And this gets back to my opening priority on guarding against complacency, risk management, risk management, risk management, identify the risk, monitor it, manage it, make sure you don't have concentrations, just kind of reinforces that. Second, capital and liquidity. They work, they're your friend like that, those buffers are important to ensuring both safety and soundness and financial stability. Third, supervisory discretion is important. We want to empower our supervisors to utilize that discretion. Then fourth, we probably need to rethink deposit insurance. And I think the FDIC had put out a really good report on the history of deposit insurance and some options going forward. And I think that requires a lot of public discussion debate. We want to make sure we get it right. And so I think that those are kind of the four main, for me, those are the four main lessons coming out of the recent banking turmoil.
Kyle Campbell:
Got it. Well, acting comptroller Hsu, thank you so much for joining us here today, and thank you everyone who tuned in and watched this live. Again, please find us on social media if you have any questions, and tune in next time.
