JPMorgan, Condoms and the Problem of Reputational Risk
If government bureaucrats, acting without statutory authority, can coerce banks into denying services to firms engaged in lawful behavior that the government does not like, where does it stop?
State and federal regulators appear to be orchestrating a series of actions to force financial institutions and third-party payment processors to stop doing business with certain online consumer installment lenders.
A recent move by JPMorgan Chase highlights how bank regulators growing concern with reputational risk could easily spiral out of control.
According to Tiffany Gaines, president of Lovability, the bank refused to process payments for her startup, which markets and sells condoms to women, after JPMorgan's risk management department decided the business fell into its "prohibited adult category" and was considered a "reputational risk."
Chase would not say whether or why reputational risk played a part in its decision not to do business with the condom company. (A spokesman did feel inclined to point out "we process payments for a wide variety of merchants.") But, outside of the fact that condoms should be, ahem, the least of JPMs reputational worries, the citation wouldnt be all that surprising.
As Peter Weinstock of Hunton & Williams LLP pointed out in a BankThink post back in July, regulators have become increasingly preoccupied with who banks are doing business with. Take, for instance, this letter from the Federal Deposit Insurance Corp, issued back in 2011, urging financial institution to do a better job managing the risk associated with their third-party processor relationships. That sounds fine, except some of the merchant categories listed as "high risk" are obvious choices. "Debt consolidation scams" and "Ponzi schemes," for instance, should be unbankable, while others seem to be there simply because they're icky (tobacco sales?).
Also worth considering is the Department of Justices ongoing "Operation Choke Point," which aims to prevent payday lenders and other fraudsters from accessing consumer bank accounts by going after the banks that service them. Again, a laudable goal, but critics may have a point when they say it raises concerns about the government using the banking system, rather than the legislative branch, to outlaw certain activities.
This type of scrutiny should have everyone banks, businesses and consumers concerned. Its one thing to ask banks not to do business with Iranian terrorists. Its even conceivable why a bank would want to avoid doing business with porn sites, given they are a high-chargeback business that large swaths of the public frown upon. And, yes, payday lenders arent exactly going to win any popularity contests. But cutting off a company that makes contraceptive or prophylactic products puts us in murkier waters.
As Bill Isaac, former FDIC chairman, wrote in a recent BankThink, which addresses the DOJs "Operation Choke Point" specifically:
"If government bureaucrats, acting without statutory authority, can coerce banks into denying services to firms engaged in lawful behavior that the government does not like, where does it stop? The same slippery slope that the DOJ uses today to choke off payday lenders from banking services could tomorrow be used on convenience stores selling large sugary sodas, restaurants offering foods with high trans-fat content or family planning clinics performing abortions."
Gaines says a Chase representative told her other big banks might be equally reluctant to do business with her. She has, however, been approached by other financial firms "mostly small banks Ive never heard of" who have offered to process her payments since her story broke on HuffPo.
Lets hope JPMorgan is the outlier here or, even, that its decision sends a message to the government. Because when regulators expect banks to "manage" the risk that someone, somewhere might disapprove of a customer, it's hard to predict which ones will become pariahs.
Jeanine Skowronski is the deputy editor of BankThink. Marc Hochstein is the executive editor of American Banker. The views expressed here are their own.