Federal Reserve Rolls Back Reputational Risk Assessments Linked to Debanking   

The Federal Reserve recently announced on June 23^rd that it would no longer consider reputational risk for bank supervision exams. The Fed’s move mirrors similar developments at the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC).  

The move is welcome news for banks, who no longer have to tip-toe around avoiding arbitrary penalties for managing a subjective and nebulous risk criterion.  

Federal regulators follow an assessment system known as CAMELS, an acronym that represents different components of risk management ranging from capital adequacy to liquidity risk. Although reputational risk appears nowhere in statute, it has not prevented regulators from overstepping their statutory authority to enforce it by slipping it into CAMELS. Reputational risk falls under the management category (M) and has been abused in the past as seen with Operation Choke Point beginning in 2013. The FDIC pressured banks to sever ties with businesses in certain industries such as firearms and payday lending solely over reputational risk concerns. This led to the arbitrary termination of accounts for some customers despite being in good standing with their banks.  

Under the Biden administration, Operation Choke Point 2.0 pursued banks conducting business within the digital asset space, targeting cryptocurrency firms. The issue of debanking emerged primarily from banks being coerced by regulators to avoid arbitrary penalties and compliance fines by cutting ties altogether with politically disfavored industries.  

A 2014 report on Operation Choke Point by the House Oversight Committee found that guidance issued to depository institutions under the FDIC’s jurisdiction contained language that implied potential consequences for working with industries deemed “high-risk. No financial or material justification was given for designating these entities as high-risk.  

Existing laws contributed to debanking as well. The Bank Secrecy Act and Anti Money Laundering Act mandate customer account surveillance to report suspected criminal activity. These laws require banks to file Suspicious Activity Reports (SARs) and Currency Transaction Reports (CTRs) to pass on to law enforcement. However, these reports often yield little value as 0.3% of the 4.6 million SARs filed in 2023 resulted in an active FBI or IRS investigation.  

Yet despite this regime, banks face penalties for failing to act even when SARs are filed. As a result, regulators incentivized banks to debank customers to avoid incurring unwanted fines and investigations. The basis for reputational risk is not rooted in any tangible financial concern. It merely served the objectives of agenda driven bureaucrats who sought to clamp down on politically disfavored industries. 

Rising awareness around debanking brought attention to the role federal agencies played in creating this issue.  

The issue of debanking gained attention when President Trump raised the issue during the World Economic Forum meeting in Davos earlier this year. Louisiana adopted a resolution on debanking commending the Trump Administration and calling on Congress to act. Texas introduced a similar resolution expressing disapproval of debanking and calling on lawmakers in Washington to rein in overzealous regulators.  

Both states highlighted federal efforts to combat debanking such as the introduction of Sen. Tim Scott’s (R-Sc.) FIRM Act. The bill would prohibit reputational risk in bank assessments altogether to prevent bank supervisors from misusing their power and repeating Operation Choke Point. Codifying these changes into law would help prevent debanking from resurfacing if a future administration attempts to revive Obama and Biden era tactics.  

The Federal Reserve’s move is a step in the right direction. Government agencies should play no role in deciding which industries have access to financial services provided they abide by the law. 

Financial regulators should solely focus on core risk-management principles in their supervision instead of inserting their own politics to punish conservative-leaning industries.  

The Fed’s cessation of reputational risk oversight in its supervision work will ultimately help refocus the agency to better adhere to its statutory obligations, reducing its politicization.