The politicization of bank regulation

Real problems could arise if diversity mandates or “encouragements” are placed in the hands of safety and soundness examiners.

Environmental, Social and Corporate Governance (ESG), once only the concerns of self-described “socially responsible investors,” are now a major focus of the executive branch of government as well as some states. President Biden’s appointees in a number of agencies have talked about the need for action on climate change and the goal of maximizing diversity, equity and inclusion.

Treasury Secretary Janet Yellen has talked about the priority of analyzing portfolios for potential risks due to climate change. Acting Comptroller of the Currency, Michael Hsu, is on the same page. So is the acting Chairman of the FDIC. 

Speaking of the FDIC, the effective ouster of Jelena McWilliams as Chair pushed aside nearly a century of stability on its Board of Directors. Today the body is no longer independent and is under single party control with social policies leading the Acting Chair’s newly announced priorities. Over and over again, federal regulators seem increasingly concerned with controversial political issues rather than safety and soundness. 

In the arena of corporate governance, corporate diversity requirements have been put in place by Nasdaq, California and New York. They would require board seats to individuals from groups that have been historically under-represented. The New York Department of Financial Services is leading the charge on diversity mandates. The agency would require regulated institutions to report gender, racial and ethnic makeup of their boards and senior management. The goal is to make them take steps to increase diversity to improve the performance of the regulated business. All of these efforts will be challenged on equal-protection grounds.

Last year, Acting-Comptroller Hsu gave a speech on the need for diversity and inclusion in the financial services sector. He stated:

“Diversity is also important from a safety and soundness perspective. Without diverse leadership, banks and their regulators may develop blind spots or suffer from groupthink. These blind spots can lead to the kinds of nasty surprises that threaten safety and soundness — and possibly the financial sector as a whole. There is a growing body of empirical evidence that companies that address these blind spots by having diverse boards of directors have stronger earnings, more efficient corporate governance, better reputations, and less litigation risk.”

He added that the OCC is considering taking steps “like encouraging banks to make it a practice to nominate or consider a diverse range of candidates.” 

Banks have made significant progress in recent years in this regard, but are mandates on the way? Will small community banks be treated like large institutions? 

It is important to note that, along with constitutional problems, there is no statutory authority to impose diversity requirements. Section 342 of the Dodd-Frank Act required each federal regulator to set up an office focused on women and minority inclusion but they can only monitor or survey regulated entities.

Real problems could arise if diversity mandates or “encouragements” are placed in the hands of safety and soundness examiners. It is not too hard to envision that they could impinge on a bank’s management rating.

Over the last year, we have seen that what the progressives in the Biden administration cannot accomplish legislatively, they will attempt through the regulatory process. The problem is they are using the banking sector to advance partisan priorities that they cannot pass through Congress. The industry needs to be prepared to push back on the politicization of banking.