There are cases where financial institutions set out to violate applicable laws or regulations. We can all think of examples: Bank of Credit and Commerce International, Enron and others come to mind. But the institutions named in recent enforcement actions by regulators do not belong on such a list. In most of these cases there were, at worst, failures of controls designed to prevent illegal or other inappropriate activity by employees who did not appreciate the significance or consequences of what they were doing.
Increasingly, these enforcement actions reflect differing judgments between supervisors and supervised institutions about how to address technical violations of incredibly complex regulations or the appropriateness of practices that comply with regulatory requirements and are embraced by consumers.
Some will applaud the increase in enforcement actions as evidence of more vigorous enforcement, or even call for more stringent penalties, but it should be viewed as a breakdown in the supervisory process.
Governments charter banks because they like them. They want them to perform financial intermediation between those with funds to spare and those who need funds, to take deposits and to lend money and to perform payment and other financial services for consumers and businesses. They recognize that these functions are critical to a market economy.
The bank supervisory process was developed over two centuries of trial-and-error to shape the role of banks in our economy. Supervision of banking institutions is based on a combination of express statutory and regulatory requirements that provide transparency for banking institutions and their customers. To help banking institutions meet these requirements and to address more judgmental issues of risk, there is a sophisticated process of bank examinations and supervisory evaluations of a growing list of characteristics of the institutions' condition and operations.
The examination process gives supervisors access to virtually all aspects of the institutions' activities on a regular basis. This access is not theoretical, hypothetical or even sporadic or occasional. It is regular and repetitive. While the examination process cannot detect or prevent all problems, it can provide peer comparisons that help grade safe, sound and appropriate banking practices.
What does this have to do with enforcement actions? The examination process is coupled with broad discretion to order correction of legal violations and unsafe or unsound practices. The ability to issue cease-and-desist orders, to order restitution and to impose civil money penalties at levels that far exceed any benefit to be achieved by illegal action gives supervisors the undivided attention of banking institutions. Further, the very existence of banking institutions depends on their ability to maintain public confidence. Even a hint of supervisory problems can make it more difficult or expensive to raise capital and to borrow in the financial markets.
In this context, the resort to a formal enforcement action means that the regulators' supervisory process has broken down at some point along the way. Regulatory examiners have failed to identify a gap in controls; have ignored a material departure from industry practice; have failed to clearly articulate their concerns and observations to the supervised institution; or the institution has chosen to ignore identified problems.
Some argue that historical failure of supervisors to identify and react to problems warrants aggressive enforcement to correct past failures. If this is the case, we should scrap the historical process in favor of an aggressive enforcement model. But the constant pillorying of banking institutions can hardly inspire public confidence in them and without public confidence we cannot expect consumers or businesses to trust them with their funds, to borrow from them or obtain other financial services.
In the longer run, a focus on enforcement, in lieu of peer comparisons and the encouragement of effective policies and procedures, will promote a climate of fear that will stifle innovation and make it more difficult for banking institutions to properly implement the services that they muster the courage to offer.
Finally, banklike supervisory powers have been extended to the Consumer Financial Protection Bureau. The CFPB has not been immune from the trend toward increased reliance on enforcement actions. For the CFPB, the development of an educated and robust supervisory program that will lead to better consumer financial products and services will take both time and effort, but in the long run consumers will be better served by such a program than by a focus on more highly visible, but less effective, enforcement actions.
Oliver Ireland is a co-head of the financial services practice at Morrison & Foerster and a former associate general counsel at the Board of Governors of the Federal Reserve System.