What’s next in banking regulation?

Join us for a conversation with preeminent banking regulation attorney H. Rodgin Cohen of Sullivan & Cromwell and American Banker Editor-in-Chief Chana Schoenberger to discuss how financial institutions can navigate these challenges.

Transcript:

Josh Rucci:

Welcome, everybody, to snowy Arizent Studios. We are honored to have you here for a very informative and quite timely discussion about what is next in banking regulation. My name is Josh Rucci. I’m the chief commercial officer of Arizent, the parent company of American Banker. And we’re delighted to have in our audience here, our enterprise subscriber subscription clients.

So give yourselves a warm round of applause. We’re delighted to have you down here at Arizent Studios, where we host unique events for our subscribers. And we think that, again, this is one of the more informative discussions we’re going to have based on the news of the last couple of days. Our mission at Arizent is to advance professional communities through meaningful content and powerful connections.

We hope that we can achieve both of those today with a wonderful program discussion with our editor-in-chief, Rodgin Cohen, and also with you all being together with one another. You will see cameras around here as well. This session will also be recorded and it will be available on our Leaders channel. Our Leaders channel is for our editors to interview thought leaders and experts in the industry, and that is available on Americanbanker.com/leaders.

And you can see more of that in our whole archive behind our subscription wall. And you’re all subscribers, so you all have full access. So now onto programming. We’re delighted here to have Chana Schoenberger, who’s our editor-in-chief of American Banker. Round of applause, please. And of course, Rodgin Cohen, senior chair at Sulliivan & Cromwell.

Well, I think Rodgin’s reputation speaks for itself, but I will read his illustrious bio as well. Somewhat. The abridged version, Rodgin, because we’d be here all day otherwise. A prominent thought leader in banking, regulation, enforcement, and compliance. Having worked closely with the FDIC, U.S. Treasury, National Security Agency, and several state commissions since joining Sullivan & Cromwell in 1970.

Rodgin you’ve seen a lot over the past 50, 50 plus years and leading the firm as chairman from 2000 to 2009, Mr. Cohen has received lifetime achievement awards from several entities, including the New York Law Journal, the Who’s Who in Legal Chambers, Legal 500 and the M&A bar and the M&A advisor, we’re getting there. Rodgin, and we’re delighted to have you here, sir, and thank you so much for coming.

And with that, I’ll turn it over to Chana.

Chana Schoenberger:

Thank you.

So yeah, I promise that this was not put together in the last five minutes since all of the events of the last week. We actually have been planning this for a long time and we were just very lucky on the timing. So everybody’s very excited about that. Well, let’s get right started. So you’re pretty much the preeminent bank regulatory attorney really anywhere in the country. What is the biggest bank regulation issue going on right now?

Rodgin Cohen:

Right now it is how is Congress going to legislate and how are the regulators going to regulate to try and prevent a recurrence of what we’ve been experiencing for the last, it seems like months, but it’s really just days and hours. But I think if you look over time as to certainly Congressional action, it usually follows. So a major problem and that seems to be one area where bipartisanship can actually exist, which is regulating banks.

Chana Schoenberger:

Well you see that with the California delegation. They don’t agree on much, right? But they did all come out and say that they want to do something together or at least not fight each other as much as normal. So how do you do that? How do you actually prevent this sort of thing from happening again?

Rodgin Cohen:

I think actually there is probably less a need for legislation, which tends to be blunderbuss in approach and more for targeted regulation. It, it’s interesting, the stress tests, of course, you always focus on the last problem and the stress tests were credit oriented because the problem in 2008 was predominantly credit. There have not been real stress tests for liquidity, and these are stress tests which are more sophisticated than the liquidity ratio requirements, which are now applicable to the GSIBs. I think now on you’re not only going to have to have enough liquid assets to cover deposits, but a much more modeled approach to runability of those deposits and the interest rate sensitivity of the HQLA which covers it a Silicon Valley, but nobody has criticized the credit quality of those securities. They were pristine, but to sell took, as was demonstrated, a substantial loss simply because of the interest rate mark. So there’s going to need to be, again, I think a much more sophisticated approach and regulation to deal with liquidity risk.

Chana Schoenberger:

It’s crazy because to think that this could all happen again, that it’s only been 15 years since the global financial crisis and we all thought we had seen the last of the bank runs because there were all these laws passed and then there was the whole thing about the stress test and there are people whose whole job it is just to deal with living wills for banks. And now I guess it’s a really good time to be a compliance lawyer because you can have a job.

Rodgin Cohen:

That is for sure. I think compliance lawyers have been in substantial demand generally, and there will be even more so now. And I think actually the individuals who deal with modeling are going to be a lot more in demand beyond just compliance. Just the skillset to model for interest rate variations is going to be fundamental.

Chana Schoenberger:

Full employment act for modelers.

Rodgin Cohen:

Yes,

Chana Schoenberger:

That’s a little bit scary to think that this is going to be another compliance regime again.

Rodgin Cohen:

I think it is. And there is a question ultimately as to cost, but I don’t think the regulators are or Congress will shrink from imposing those costs to make the system safer.

Chana Schoenberger:

Do you think that Americans are scared about their deposits in banks overall?

Rodgin Cohen:

I don’t think the consumer is. I think the FDIC has done a generally good job. As confusing as the whole insured deposit system is to make people comfortable. You don’t see, for the most part, individuals in lines outside of banks. There was the one line on I guess Saturday in on the West coast, but you haven’t seen that. I think that the large depositors, which are not necessarily large corporations, these can be small corporations that just have an operating account of more than $250,000. It can be a large nonprofit, take a major hospital for example. It’s got to have an operating account of far more than 250,000. I think there will be a review at that level as to whether they can continue to keep deposits of that amount and hopefully if you now have a regulatory system which is more geared to this issue and I think the decisive action by the government over this weekend, it will instill a high level, much higher level of confidence from everything I know and I’m not in there. So this is not a careful study. The deposit outflows really stopped in the last 24 hours, which is a hopeful sign. Very hopeful.

Chana Schoenberger:

So one of the interesting things about this particular bank run is that we had a story today where we talked to a number of startups and they all told basically the same story, which is that they had an account at Silicon Valley Bank and that either because they had the account or because they had venture debt held by the bank, issued by the bank, they were required to keep all of their cash at the bank and have all their credit cards through there. Is that something that regulators are going to allow after this situation?

Rodgin Cohen:

I don’t think they would allow that. There’s actually a very interesting question. There’s a fairly obscure provision of the bank holding company act amendments, which prohibits tying of one service for another service, but there is an exception. I’m glad you raised this because it really is interesting. There’s an exception for bank services performed in the ordinary course. I not sure that what every individual bank’s policy is, but there’s also a convenience for any small business or any middle sized or larger business to have a smaller number of operating accounts. I think most corporations try and minimize the number of banks at which they bank because it’s just more cumbersome. So it’s convenience versus safety I guess to an extent.

Chana Schoenberger:

I wonder if that equation is going to shift now.

Rodgin Cohen:

I think it may. Yes.

Chana Schoenberger:

Many CFOs will have that conversation with their boards. What can bankers learn from this crisis?

Rodgin Cohen:

I think it goes back to this fundamental issue again, that you can have securities which are 100% money good, the very highest rating, but unless you have the capacity to hold them until maturity, they’re not money good anymore.

Chana Schoenberger:

Great. That’s a little scary. And now we’re back to modeling.

Rodgin Cohen:

We are back, all roads lead to, instead of Rome, to modeling, but it’s, it’s really about interest rate sensitivity and that the linkage between sensitivity and liquidity, I think those two are inextricably tied and I’m not sure everyone realized that though.

Chana Schoenberger:

Yeah, probably not. It is interesting also because before last week regulators, if regulators were concerned, they didn’t say anything and none of the securities analysts thought that anything was wrong. Do regulators need to be more transparent with the public or does that just cause bank runs?

Rodgin Cohen:

I think there’s probably a legitimate degree of transparency and not disclosing too much about banks. I think in fairness to the regulators, they were sounding some cautionary notes about the embedded losses in these portfolios. I think FDIC chair Gruenberg gave remarks on this. I think it must have been covered in the American Banker, which is my principal source. So for these of course, and so I think the warnings were there and as far as the analysts were concerned, this is not exactly a mystery. You have in the quarterly and annual reports, you have the marked market valuations, not as a balance sheet matter in at least in terms of health maturity securities, but in the footnotes, the differential between the face value and the then current market value. So it was not a deep dark secret that there was this substantial differential which was in turn solely a function of the very rapid rate increase.

Chana Schoenberger:

So is it then just a public relations problem?

Rodgin Cohen:

I think again, it is more I, I’m not sure that there was a full recognition of the risk. No, no one expected with due respect. I don’t think anybody expected that at any bank of certainly of any size that the depositors would start to flee and banks didn’t plan for that. We really haven’t seen that. Again, it’s always been about credit. If you go back all the way to really, I guess even the 1840s when you began to have real bank crises, it was always about credit and usually the credit has related to real estate lending of in one form or another. This was the first time that there have been bank runs without credit issues. And so this is unique and again, it’s very easy to cast blame that the regulator should have seen it, Congress should have seen it. Most importantly, the banker should have seen it. But I think everyone needs to step back, draw a deep breath and recognize that this was a unique event in all, at least American banking history, the first banking crisis without credit problems,

Chana Schoenberger:

The Twitter crisis.

Rodgin Cohen:

And social media clearly fuels this.

Chana Schoenberger:

I wonder if that’s something the regulators will turn their attention to.

Rodgin Cohen:

I think that’s actually a great point. I don’t know how much they do monitor social media, but I think if they haven’t awakened to that, maybe they should. Obviously it can be almost addictive, but somebody’s got to do it.

Chana Schoenberger:

And suddenly every regulator will have TikTok on their phone.

Rodgin Cohen:

Well, no, no, can’t not the federal because Congress won’t allow it.

Chana Schoenberger:

Yeah, yeah, no, I mean it’s definitely a scary scenario. And the interesting thing is we also had a story today talking about commercial real estate because several of the analysts have flagged that that might be the next big risk for banks, which of course is exactly what you’re saying.

Rodgin Cohen:

Yeah, I do think here the regulators and the banks have been quite conservative. It’s not hard and fast, but there has been this informal 300% CRE to capital ratio, which the regulators look at very carefully. And although the stress test we talked about earlier are credit related, if you look at the assumed stress test losses on CRE they are enormous. They are sort of end of the world scenarios. So look, CRE can always be a problem. I just think the banks have lent into it far more conservatively than in the past. So I just don’t see that as being a serious problem for the industry.

Chana Schoenberger:

That’s good.

Rodgin Cohen:

Nice to have

Chana Schoenberger:

A bright spot.

Rodgin Cohen:

Right.

Chana Schoenberger:

Okay. So one other thing that you talk about a lot is crypto.

Rodgin Cohen:

Yes.

Chana Schoenberger:

So of course Silvergate Bank, that was an interesting thing. I don’t think anybody thought that they were going to go under and then certainly no one thought that we’d have two more banks fail within a week. The administration has made pretty clear that it wants to regulate crypto, but it hasn’t said how it will do so or what the bank’s responsibilities will be. What do you think banks should do?

Rodgin Cohen:

Okay, well it’s pretty easy to answer the last part of that, which is what should banks do? They should be doing nothing because the regulators have made it extremely clear that they do not want the banks at this point to touch the crypto space full stop. We had a so-called sprint to wind up with crypto regulation, and that hasn’t turned into a crawl. It’s turned into a backward march. I mean, literally the regulators have been saying, we do not want you engaged, you, the insured banks, in any crypto activities. And I think after FTX and Silvergate, they have been making clear as well, maybe even going back to the crypto winter last year, that they don’t want banks even interacting with crypto firms performing normal services, deposits, loans and so forth.

Chana Schoenberger:

So does that mean that all of that will just be pushed onto non-banks?

Rodgin Cohen:

And that’s really the issue. And now that comes back, I think to the first part of your question, everybody says we want to regulate, it’s like the weather, but nobody does anything about it. And I’ve said it before, I don’t mind saying it again. The government writ large is abdicating its responsibility on crypto. I think there are responsible crypto companies and they would welcome really well thought through regulation, which doesn’t mean like touch, it means good regulation, but the regulators are looking to Congress. Congress is looking to the regulators. Somehow we’ve got to get to a regulatory system which works

Chana Schoenberger:

Well. First the regulators have to agree on which agency gets to do it.

Rodgin Cohen:

A great point, and that is why if Congress could act, it would be preferable for Congress because I don’t think the crypto regulation, because of the novel status of crypto, really falls clearly within any agency’s statutory authority or expertise. And ideally, this would either be a new agency or explicitly assigned to one of the existing agencies, but that agency will have to step up to deal with it.

Chana Schoenberger:

It’s like a loophole that became an industry.

Rodgin Cohen:

It’s well said. Yes.

Chana Schoenberger:

That’s going to be pretty interesting because after, it’s funny, I haven’t thought about FTX all week, which is the first time that’s happened in a while. I’ve just been thinking about bank failure, right?

Rodgin Cohen (17:59):

Yeah. It might have been for the banks if FTX were occurring last week or the Murdock murders, something to take off something more lurid.

Chana Schoenberger (18:12):

Right? Yeah. It’ll be interesting to see what happens with crypto because whatever happens with the retail side of crypto, certainly blockchain is not going anywhere.

Rodgin Cohen:

No. And I think we should be embracing technology. Just because it can be abused doesn’t mean it shouldn’t be embraced. It should just be regulated.

Chana Schoenberger:

It’s a tool. So another big issue that banks are facing from regulators is the administration’s junk fees campaign, right? A junk fee being anything that Rohit Chopra says is a junk fee. What’s your perspective on how banks should handle this? Is every fee a junk fee? What’s a junk fee?

Rodgin Cohen:

So that is a term which I think in view of the CFPB is it is effective to be ambiguous because as you point out what is one bank’s or one customer’s legitimate fee to somebody else can be a junk fee. I think in fairness, I do think there is, again, I’ve used this word a couple times fundamental, but we’re dealing with some fundamental issues. Banks have a very substantial revenue stream from fees which they charge to their customers. Banks are going to have to make money. If you want to have a banking system, which is a utility, which is basically nonprofit, you’re, I think are posing a very serious question as to whether the banking system can really promote the American economy. So let’s take as a given, although certain people would not agree that banks have to earn a legitimate return on capital.

So if you do away with fees, what this means, I think has to be more net interest spread, which means lower interest on deposits or higher interest on loans or both. And where, and I’ll now come around to this where I think Mr. Chopra has a legitimate concern is looking at who pays the fees. And some of these studies suggest that 90%, 80% of the fee income is being paid by 10 or 15% of the customers. And that does tend to break down on socioeconomic lines. And so again, use, this is why it’s fundamental, is this from a societal perspective that those below that, whatever that socioeconomic line is, should bear by far the lion share of the fees. And would it be better that the banking system relied more on net interest income and less on deposit fees?

Chana Schoenberger:

Yeah, I mean that’s the question. And the whole issue of whether, well, this was actually my next question, which is sort of related to that, which is banks are trying very hard to make money from higher end customers because that’s where the money is. It’s the people who could pay it. Sure. And yet they have both a legal and a regulatory and sort of a moral obligation to serve the whole public, including people who are not very profitable. And how do they balance those two goals?

Rodgin Cohen:

I think already you’ve used the right word balance. It’s got to be a balance because you can see where the two goals are antithetical with one another. But I think there fortunately is enough room that you can serve those who are not the highest earners, the wealthiest, and still preserve a franchise which will earn a necessary return on capital. I think this all has to be thought through very carefully. And also just going back to this fee question, you know, can’t ask banks to go cold turkey on this, so let’s take the proposal on credit card late fees. Now you can argue that it’s should be the current 35. You can argue the proposal at eight, or I guess it’s 31 and eight, but you just can’t, it’s not like you can turn a light switch on or off and go from 31 to eight in months. Even. It’s, so there has to be, if the CFPB or other agencies really want to change these fees, there’s got to be at least a transition period to enable banks to deal with the very significant revenue loss.

Chana Schoenberger:

What happens if the CFPB is declared unconstitutional ?

Rodgin Cohen:

That starts to have repercussions well beyond the CFPB. I’ll go way out on a limb. I think that is unlikely just because again, of the impact that Fifth Circuit in that case went way out of its way. They knew what they were doing here to try and say the CFPB is different from the FDIC and the Fed, but both are done, are funded without an annual congressional appropriations. And both would then be susceptible to a challenge. Now they’d both be on sound of grounds, but if the CFPB were, I think they’re really, to answer the question there would be chaos. Nobody would know what the CFPB rules meant anymore or any of them enforceable. And some of these, I think the banking industry such as the qualified mortgages would embrace. So that would be an extraordinary action by a court just to declare an entire government agency unconstitutional. I don’t know how they’ll come out. I’m not sure at this point any justice knows, but I think such a radical step is unlikely.

Chana Schoenberger:

So then what happens if you’re wrong? Does that mean that people just have to give back all of the penalties that the CFPB required?

Rodgin Cohen:

Well, is a, we’ve looked at this. I think there is an interesting question as to whether a bank which had paid a fee for a rule which was unconstitutional, or a proceeding which by an unconstitutional agency it, let’s say here you said it would be full employment for earlier for compliance people. This truly would be full employment for lawyers,

Chana Schoenberger:

Right? You just call them and you say, well, we’d like it back. Yes.

Rodgin Cohen:

I don’t think the government would be quick to say, oh, here’s your check.

Chana Schoenberger:

Probably not. No, that would be funny though. It’d be interesting though if they had annual appropriations because then it becomes a partisan fight.

Rodgin Cohen:

It does a bit, but there are all sorts of possibilities in between what exists now and annual appropriations. But Congress is supposed to be a co-equal branch of government and some level of control over an administrative agency. Makes sense. I mean, after all the SEC exists with annual appropriations, many agencies do.

Chana Schoenberger:

Right. And the SEC isn’t even one of those that Congress is always trying to defund.

Rodgin Cohen:

Correct. Some people were, but yeah,

Chana Schoenberger:

Or the Department of Education. Right. Don’t need one of those. Definitely not.

Rodgin Cohen:

No.

Chana Schoenberger:

My last question and then I’m going to open it to the audience. You rarely talk about yourself in public. Can you tell us who’s been a mentor or a role model for you in your career?

Rodgin Cohen:

I was very fortunate. I came up with, and maybe you look at the past through a golden haze, but there were a series of senior banking partners at the major firms in New York. There was a gentleman by the name of Bruce Nichols, Davis Polk; Roy Haberkern at Milbank Tweed; Dick Simmons at Cravath; at my own firm, a gentleman by the name of Dick Powell. And these were, for me, just role models and lions of the legal profession. They always thought about their clients, but they also thought about their responsibility as legal professionals. And I would say as lawyers, those were definitely the people that I tried to emulate.

Chana Schoenberger:

Is there one thing you learned from them that you can share?

Rodgin Cohen:

Yes. And that is you don’t listen very well if your mouth is open.

Chana Schoenberger:

This is actually a book that we’re reviewing in an issue to come later this year. It has an unprintable name, but it basically means stop talking. Yes. Okay. We are going to open this up to questions from the audience. So I think there’s, Kevin has a microphone that he’s walking around with. If you have a question for our eminent guest, otherwise I just get to fire more questions at him. All right,

Audience member:

Rodge, there’s been reports of deposits flowing uphill to the larger institutions as this has been going on, and so consolidation in the industry is pretty quickly happening organically. The administration obviously has been focused on consolidation, not just for banks, but in American industry, but banks in particular. Do you have a view on what comes out of that and does, do the events of the last week influence thoughts around them?

Rodgin Cohen:

That is really a great question, and I actually believe that these events should encourage, rather than discourage consolidation, we need strong regional and community banks which are diversified and which is going to usually mean consolidation. The banking industry in the US is very different than the banking industry anywhere else in the world. You’ve got thousands and thousands of banks. And I do think that some of the analyses that have been done on consolidation really are not as informed as they could be. And I’m just going to give one example. The statistic, which is almost always used to demonstrate the evils of consolidation, is the sharp decline in the number of banks. Now, you couldn’t, again, argue is the right number of the current 5,000, 3000, 7500. But I think what is missed in all of this is the decline. This is a net number and the decline is a function of the absence of new banks being formed since 2007.

I mean the number, it varied over the years before that, but it’s almost been flatlined since then at zero. And this relates to chartering policies and maybe they are the right policies as a safety and soundness matter. But if you go from averaging 800 new banks a year to eight, by definition, over time, the number of banks will decline. So I think there are real benefits from consolidation. If you don’t want a system and you made the key point, the deposits flowing into the very largest banks where there are 4, 5, 6 banks, which are so far apart from everything else, then consolidation is a key part of that answer.

Chana Schoenberger:

So what happens when the administration doesn’t want to green light any mergers?

Rodgin Cohen:

I think that will be a very unfortunate, if that is where they come out, I think that will be a very unfortunate event and that will in fact lead to more domination. It will lead to more concentration among a handful of banks, which is I think directly antithetical to what the administration ultimately wants. Mergers among the regionals are, I think the answer and the acting controller, Michael Hsu, even though expressing concerns about safety and soundness in these mergers and that they be well constructed, recognize that he said, we’re not going to stop approving mergers because if so, we’re just going to put in cement a system where there are a handful of banks which are nationwide banks, and nobody can ever really compete at the same level.

Chana Schoenberger:

So you think we need more medium sized banks? Yes. Interesting. Okay. We’re all going to keep an eye on that. Next question.

Audience member:

Rodge, you mentioned that the bank run of last week was a little bit different than what you might see in the movies in “It’s A Wonderful Life.” This was not retail depositors lining up outside of a bank branch so much as corporate depositors. And I wonder whether in light of last week’s activities, whether the FDIC might decide to bifurcate FDIC insurance coverage because $250,000 is sufficient for 95% of the retail population, but for corporate depositors, nonprofits, HOAs, you name it, almost all of them have more than $250,000 in cash. So I was just curious whether you think that, whether those aspects might change.

Rodgin Cohen:

That is really an intriguing idea. It really is. I hadn’t thought about it before, but it, there’s a real logic to that because it’s the point you made. The $250,000 is supposed to protect households for businesses as you point out. It often will not, and a bifurcated structure makes sense. And yeah, they’re games you could play as to does an individual incorporate to get the higher, but I think trying to deal with the issue that may be a better solution than say, raising the entire cap to from 250 to 500 or a million.

Chana Schoenberger:

Interesting. Okay. Any more questions? Okay. Last question for me then. What is the most interesting thing that you have seen recently in the banking sector?

Rodgin Cohen:

Okay, so, interesting, I don’t mean to play lawyer and say, what does interesting mean?

Chana Schoenberger:

The coolest thing you’ve seen.

Rodgin Cohen:

All right. Coolest. I like that as a better word. I actually think the efforts of a number of banks to improve the inclusivity of our country in banking services in the percentage of underbanked or unbanked, I think by every measure has declined significantly. Probably been cut in half over the last 10 years. And this has been through a lot of group and individual initiatives. If I can get on a soapbox for a moment, what needs to be done though? Those statistics mask a real disparity, and I think it’s the Cleveland Federal Reserve Bank did a study that although the inclusion within the banking ecosystem of minorities and urban areas, low, low and moderate income and majority minority neighborhoods has likewise declined sharply. It is still sharply higher than the populace as a whole. So the soapbox is that’s the area we need to focus because banks can do so much to reduce the, people always refer to it as the wealth gap. I actually think the better term is the living gap for the whole country. I think we’re a better country as a result, but I could go through at length some of the initiatives, these banks individually and again, as groups have conducted. But that is the coolest thing I’ve seen.

Chana Schoenberger:

That’s great. Wonderful. Well, thank you so much.

Rodgin Cohen:

Thank you.

Chana Schoenberger:

We really appreciate you coming up here in the middle of a blizzard.

Rodgin Cohen:

We’re all, but the snow is stopped, I think. Yeah,

Chana Schoenberger:

And we’re all going to be watching to see what happens in the banking sector over the next couple weeks. Hopefully the worst is over now.

Rodgin Cohen:

I would very much hope so. Again, if the deposit, the outflow has stopped and stay stopped, we’re going to be in a lot better shape.

Chana Schoenberger:

Great. Wonderful. Well, thanks.

Rodgin Cohen:

Thank you.