Fed's conundrum: Whether to remove Wells Fargo's asset cap

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Dennis Kelleher has spent the last decade building a reputation as one of Washington’s toughest critics of big banks. As the president and CEO of Better Markets, which he co-founded in the wake of the 2008 financial crisis, Kelleher has championed strong rules for megabanks and criticized regulators when they have bowed to industry demands.

So it is a measure of how much the world has changed over the last month that Kelleher is now arguing that the Federal Reserve Board should lift its asset cap on Wells Fargo.

Wells Fargo has been barred from growing its assets above $1.95 trillion for more than two years, but now representatives are asking the Fed to suspend the cap, at least on a temporary basis, to give it more flexibility to lend during the coronavirus crisis.

Kelleher agrees, saying in an interview this week that that lifting the cap temporarily would spur much-needed lending. The Federal Reserve “ought to leverage the knowledge and capacity of those who know the small-business community best,” said Kelleher, who spelled out certain conditions that he wants to see the Fed put in place.

The question of whether to lift Wells Fargo's asset cap in the midst of a crisis is a complicated one for Fed Chairman Jerome Powell, left. As recently as March 10, Wells Fargo CEO Charlie Scharf said that he believes the $1.95 trillion cap is appropriate.
The question of whether to lift Wells Fargo's asset cap in the midst of a of a crisis is a complicated one for Fed Chairman Jerome Powell, left. As recently as March 10, Wells Fargo CEO Charlie Scharf said that the $1.95 trillion cap was appropriate.

The Fed imposed the asset cap on Wells Fargo following a raft of scandals, including revelations that employees had opened millions of customer accounts without authorization.

The question of whether to lift the asset cap during the throes of a crisis — and if so, under what parameters? — may pose a conundrum for the Fed. The central bank would have to decide at what point the imperatives of an economic emergency outweigh the requisites of its most severe enforcement action in recent memory.

A Fed spokesman declined to comment for this article. Wells Fargo said in a statement that the bank is focused on satisfying the Fed’s requirements. “During these challenging times, we are very focused on doing all we can for our clients while operating under the constraints of the asset cap,” the bank’s statement read.

Before the current crisis, Fed Chairman Jerome Powell made certain promises about what would have to happen before the asset cap gets lifted. Those remarks could constrain the central bank’s ability to improvise.

Powell pledged, for instance, that the Board of Governors would hold a vote on whether to lift the asset cap. He also stated that the board does not intend to remove the cap until Wells Fargo implements sufficient remedies. The Fed’s 2018 order identified problems in both the bank’s risk management program and in its board of directors’ oversight of the firm.

Earlier this week, Bloomberg reported that Wells has confidentially warned the Fed that it will miss an April deadline to submit a plan for improvements. And just last month, CEO Charlie Scharf said in congressional testimony that he believed the asset cap was appropriate. “I am focused on getting the work done that is required by the Federal Reserve,” he said in March 10 testimony.

For now, the Fed does not appear to be moving quickly to lift the asset cap, even temporarily.

“The problem is that you have the CEO just in front of Congress saying that they need to do more,” said Brian Kleinhanzl, an analyst at Keefe, Bruyette & Woods. “So it puts the Fed kind of in an awkward situation.”

But Kleinhanzl predicted that the Fed will become more inclined to lift the cap on a temporary basis if conditions in the financial markets continue to worsen.

It is unclear just how much Wells Fargo’s ability to lend is currently being constrained by the two-year-old asset cap. Over the last eight quarters, the San Francisco bank’s quarterly assets have stayed within $70 billion of the $1.95 trillion cap. Compliance with the cap is measured on a two-quarter daily average basis in order to allow for management of temporary fluctuations, the bank has stated.

Analysts said this week that there are certain moves Wells Fargo can make to free up lending capacity, including the sale of assets. They also noted that while industrywide loan demand in certain categories has been surging, some of that increase may be offset by reduced demand in other asset classes.

“We don’t know exactly what the level of loan demand is at this point,” said Allen Tischler, an analyst at Moody’s Investors Service.

One area where banks have been facing unusually strong demand is in business lending, as many companies draw on their existing credit lines, either as a precaution or because their revenues took a big hit last month. During the week that ended March 18, commercial and industrial loans outstanding across the banking industry rose by a whopping $176 billion from the week before, according to Fed data. Total bank credit rose by $267 billion from the week ending on March 11.

For its part, Wells Fargo reported $347 billion in unfunded credit commitments for commercial and industrial loans at the end of last year. Unfunded commitments do not get counted on the bank’s balance sheet, but once they are funded, they do get counted as assets.

As U.S. consumers and businesses prepare for rainy days ahead, the asset cap could hinder Wells Fargo’s ability to meet loan demand, said Bain Rumohr, an analyst at Fitch Ratings. “There in theory could be a point at which they may not be able to participate in that buildup,” he said.

The Fed, which has taken a series of dramatic steps in recent weeks to keep credit flowing, is facing heavy political scrutiny regarding its handling of Wells Fargo. Rep. Maxine Waters, D-Calif., sent a letter to Powell last week asking for a briefing on Fed deliberations regarding any potential removal of the asset cap.

Waters chairs the House Financial Services Committee, and last month the panel’s Democratic staff released a detailed report that was critical of Wells Fargo’s previous leadership for its focus on lifting the Fed’s asset cap, rather than addressing the bank’s risk management weaknesses.

Kelleher of Better Markets said that the COVID-19 crisis offers Wells Fargo an opportunity to show that it has changed during Scharf’s nearly six-month tenure as CEO. “This is kind of an acid test for the new leadership,” he said.

He proposed that the Fed temporarily lift the asset cap while requiring Wells Fargo to ring-fence loans that it makes under the $2.3 trillion emergency relief legislation signed by President Trump last week.

Kelleher also suggested that Wells Fargo should voluntarily offer to provide credit to small businesses on an at-cost or no-cost basis, in order to help its customers during a crisis.

“My view is: If they did that, it would demonstrate to the Fed and everybody else that it is a new bank,” he said. “And that should be taken into account when they evaluate permanently lifting the cap.”

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Law and regulation Coronavirus Federal Reserve Wells Fargo Charles Scharf Jerome Powell