In a recent interview, Zach Warmbrodt of Politico asked me the best big-picture question when it comes to federal preemption: are banks now so petrified of state anti-ESG mandates that a federal law laying out with whom banks may do business is desirable? Banks don’t want anyone telling them how to run their businesses, but workable federal rules are, so the thinking goes, better than high-risk state standards such as Florida’s new requirements. Fears are heightened by the OCC’s hesitancy when it comes to preempting Florida, but the agency is now contending with new restrictions thanks to recent Supreme Court rulings and federal preemption still wouldn’t solve the state-bank predicament. A federal bill might clear these legal issues away, but a sound bill would still have to reckon with complex policy decisions no prior effort to draft preemption bills has conquered.
Indeed, legislative and regulatory efforts to date have been far more ideological than operational. The ESG battles first broke into open warfare during the Obama Administration when the banking agencies issued warnings about lending to payday companies, firearms-related businesses, and a couple of other targets. This campaign came to be known as Operation Chokepoint and, even though all of the agencies quickly backed away, it lives on – see Donald Trump’s promise to end “chokepoint 2.0.”
Things heated up again late in the last decade after BlackRock issued a pro-climate edict when it came to casting its proxies and a few big banks curtailed lending to firearms manufacturers and fossil-fuel entities. This ticked off Republicans, and the Acting Comptroller in 2020 joined in, issuing an edict designed to force the point by demanding “fair access.”
At the same time, Democrats were also dissatisfied with how banks made loans. They cheered the ESG-ish commitments, but demanded much, much more when it comes to racial equity. A bill to this effect was also dubbed “fair access,” making clear that left and right demands that banks do business with those each likes hew in very different directions under the same banner. See here also the united front between Rohit Chopra and conservatives in their battle against “financial censorship.”
When the Biden Administration arrived, it promptly overrode the OCC’s ruling, but none of this solves the underlying policy problem evident in the OCC’s mandate and push-pull Democratic and Republican legislation: There is no easy way to set a bright-line test for those a bank does business with that easily distinguishes sound credit-risk management, capital optimization, and strategic objectives from social-policy promotion.
Several recent bills have, for example, sought to force banks to deny credit only when “quantitative criteria” dictate that a loan may be imprudent. The 2020 OCC edict not only insisted on quantitative credit analysis, but also on “impartial” judgments when it comes to loans and other business dealings. This is a lot easier said than done.
Sound underwriting even for small retail loans takes qualitative criteria into account – for example, banks turn down loans that may well be creditworthy if the amount requested is too small to be profitable. Should we mandate that banks make loans regardless of the amount requested? This may solve a social-justice problem, but it’s another nail in the box that turns banks into public utilities.
What happens if a coal-fired power plant wants a big loan its current finances might float but the bank fears that new rules alter the company’s business prospects and threaten future repayment? Is this ESG or sound credit-risk management.
Loans are only some of the bank products politicians want cleansed of any ulterior social or political motives. Sometimes financial companies do go too far as PayPal fatefully did when it threatened to curtail P2P access if it didn’t like a payee’s politics. Fearing that banks also cut off customers whose political views they disdain, Florida has made it difficult for banks to close deposit accounts without reporting this to state authorities. However, banks close accounts when they suspect criminal activity, filing reports under seal to federal authorities as they move to ensure the bank takes no new risks and the customers have no more access to the payment system through which to launder money and put the citizenry at risk. Banks are required to do this and, for obvious reasons, barred from saying so.
Here, banks are again de facto public utilities, as FinCEN was forced to acknowledge in its latest AML proposal. The same goes for sanctions compliance – banks serve national-security interests by complying with laws that demand they cut off services to customers fingered by the U.S. Government. “Fair access” measures might accommodate this, but they’ll need to be a lot better drafted than any I’ve seen so far, pushing back against the twenty state attorneys general who last week said that even obeying federal law can promote “activist” political agendas and the Biden-Harris’ political goals.
There are many other conflicts between seeking reasonable investor returns and forcing banks to do the public good, but one additional problem is that politicians are far from agreeing as to what that public good may be. This is often a very subjective decision – is it hate speech to talk about “replacement theory” as I and many others think or is it, as a sizeable number of Americans counter, a proven fact? Banks may be poor guardians of the public good except where the law is clear, but banks often do their best and, in any case, they are private companies that must make hard decisions along with public-spirited ones.
Is it simply impossible to bar banks from using their money to take sides in climate, culture, social-welfare, gun-control, climate-change, and all the other issues that vex us? No, but a hard-wired standard will strangle all too many sensible and even essential actions. The reason federal law gives the OCC broad preemption authority even as narrowed by Dodd-Frank is that defining where a bank’s “function” ends and seemingly-reprehensible behavior begins is very difficult to do. The OCC in the past certainly favored the national-bank charter over reasonable state concerns, but the agency now has considerably less discretion to do so. This should help to concentrate its attention on matters that might actually throttle the business of banking, and so it should.
Does OCC preemption suffice if the OCC gets up the gumption to exercise it? No, but it’s a good place to start even as we try as hard as we can to craft a new policy that guides the balance between federal and state edicts better than the “I-know-it-when-I-see-it” approach that has characterized prior federal measures in this troublesome arena.