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OCC fights de-banking. Fed moves to climate.

Summary:
Part 1: The OCCThe OCC issued a refreshing rule proposal, covered in a nice WSJ oped by Brian Brooks and Charles Calomiris. It is as interesting as a compendium of what's going on as it is for a rule to put an end to it, especially since enthusiasm for the rule is likely to change about Jan ...

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Part 1: The OCC

The OCC issued a refreshing rule proposal, covered in a nice WSJ oped by Brian Brooks and Charles Calomiris. It is as interesting as a compendium of what's going on as it is for a rule to put an end to it, especially since enthusiasm for the rule is likely to change about Jan 20.  

...practices that amount to redlining whole parts of the economy that banks find politically unpalatable, including independent ATM operators, gun manufacturers, coal producers, private correctional facilities, and energy companies. Also under threat of interest-group pressure campaigns are gasoline-powered car manufacturing, large farms and ranches. Many of the targeted industries are those unpopular on the political left. But we’ve also heard allegations of banks being pressured to cut off programs and business disfavored on the right, such as Planned Parenthood.

Their summary of the rule

Banks may not exclude entire parts of the economy for reasons unrelated to objective, quantifiable risks specific to an individual customer. Banks ... cannot deny a service it provides except on the basis of an objective analysis of the riskiness of the client. Banks are not free to refuse credit simply because they don’t agree with a customer’s business.

I think the latter characterization is a bit wrong. Banks are not all doing this because they don't agree with a customer's business. Banks are doing this because they are afraid of pressure from both right and left. They are afraid of ESG pressure from their investors.  

I suspect banks would enjoy a clear rule, in which case they can say to protesters, shareholders, media and others, we'd love to de-fund your latest cause, but the mean old OCC won't let us do it. 

The proposed rule has a long preamble giving the legal and regulatory history. 

Consistent with the Dodd–Frank Act’s mandate of fair access to financial services and since at least 2014, the OCC has repeatedly stated that while banks are not obligated to offer any particular financial service to their customers, they must make the services they do offer available to all customers except to the extent that risk factors particular to an individual customer dictate otherwise. 

It is clearer about banks are often pressured, rather than choosing to discriminate on their own -- though the later is documented as well. (See the rule for footnotes documenting each case) 

banks are often reacting to pressure from advocates from across the political spectrum whose policy objectives are served when banks deny certain categories of customers access to financial services.

The pressure on banks has come from both the for-profit and nonprofit sectors of the economy and targeted a wide and varied range of individuals, companies, organizations, and industries. For example, there have been calls for boycotts of banks that support certain health care and social service providers, including family planning organizations, and some banks have reportedly denied financial services to customers in these industries. Some banks have reportedly ceased to provide financial services to owners of privately owned correctional facilities that operate under contracts with the Federal government and various state governments.

Makers of shotguns and hunting rifles have reportedly been debanked in recent years. Independent, nonbank automated teller machine operators that provide access to cash settlement and other operational accounts, particularly in low-income communities and thinly-populated rural areas, have been affected. Globally, there have been calls to de-bank large farming operations and other agricultural business...

They don't mention pot farmers, presumably because they are still illegal under federal law.  

In June 2020, the Alaska Congressional delegation sent a letter to the OCC discussing decisions by several of the nation’s largest banks to stop lending to new oil and gas projects in the Arctic....The letter also stated that, although the authors believed that the banks’ rationale was political in nature, the banks had ostensibly relied on claims of reputation risk to justify their decisions.

In response to this letter, the OCC requested information from several large banks to better understand their decisionmaking. The responses received indicate that, over the course of 2019 and 2020, these banks had decided to cease providing financial services to one or more major energy industry categories, including coal mining, coal-fired electricity generation, and/or oil exploration in the Arctic region. The terminated services were not limited to lending, where risk factors might justify not serving a particular client (e.g., when a bank lacked the expertise to evaluate the collateral value of mineral rights in a particular region or because of a bank’s concern about commodity price volatility). Instead, certain banks indicated that they were also terminating advisory and other services that are unconnected to credit or operational risk. In several instances, the banks indicated that they intend only to make exceptions when benchmarks unrelated to financial risk are met, such as whether the country in which a project is located has committed to international climate agreements and whether the project controls carbon emissions sufficiently.

My emphasis. 

The actual rule is mercifully short and clear. After definitions (including  that "person" includes "Any partnership, corporation, or other business or legal entity."

(b) To provide fair access to financial services, a covered bank shall:

(1) Make each financial service it offers available to all persons in the geographic market served by the covered bank on proportionally equal terms;

(2) Not deny any person a financial service the bank offers except to the extent justifiedby such person’s quantified and documented failure to meet quantitative, impartial risk-based standards established in advance by the covered bank;

(3) Not deny any person a financial service the bank offers when the effect of the denial is to prevent, limit, or otherwise disadvantage the person:

(i) From entering or competing in a market or business segment; or

(ii) In such a way that benefits another person or business activity in which the covered bank has a financial interest; and

(4) Not deny, in coordination with others, any person a financial service the bank offers.

Of course, the chance of this rule surviving and being implemented as it stands in the new administration is small. But not all de-banking comes from the left, and perhaps there is hope that keeping funding open to, say, planned parenthood, and seeing the danger that banks can also be pressured by right-wing groups  will encourage them to put climate-based squeezing of fossil fuel companies where it belongs in EPA or elsewhere rather than try to pressure banks to do it. 

***

Part 2: The Fed

The IMF, BIS, ECB, BoE, are embarking on just such de-funding of fossil fuels, this time mandated by regulators. (Previous posts here and here.) I had praised the Fed and its chair Gerome Powell in particular for eschewing this mounting pressure. 

It seems the Fed's resolve is weakening. As reported by Andrew Stuttaford

The Federal Reserve on Monday for the first time formally highlighted climate change as a potential threat to the stability of the financial system and said it is working to better understand that danger.

In its semiannual report on financial stability, the Fed said it would be helpful for financial firms to provide more information about how their investments could be affected by frequent and severe weather and could improve the pricing of climate risks, “thereby reducing the probability of sudden changes in asset prices.” 

which is, on account of weather, negligible, and the unknown probabilities of which, due to climate change, are precisely zero. 

It also said it expects banks “to have systems in place that appropriately identify, measure, control, and monitor all of their material risks, which for many banks are likely to extend to climate risks.”...

It always starts with "disclosure." Then the activists and ESG funds know where to go.   

Fed Chair Jerome Powell said last week that the “science and art” of incorporating climate change into financial regulation is new but that the Fed is “very actively in the early stages” of getting up to speed and working with officials around the world....

See previous posts for what those officials are up to.  

If you had asked me then what my test would have been to determine whether the Fed had finally succumbed to the mission creep that he described so well, it would have been the news that it had finally applied to join the Network of Central Banks and Supervisors for Greening the Financial System (NGFS).

"The Federal Reserve expects in coming months to join the Network for Greening the Financial System, a group of 75 central banks set up to combat climate change by better understanding the risks it poses to economies.

“We have requested membership. I expect that it will be granted,” Fed Vice Chair for Supervision Randal Quarles told a hearing before the Senate Banking Committee Tuesday. He said the Fed could probably join before the NGFS’s annual meeting in April."

Especially if you see the climate as a present crisis, and you wish to have a coherent, sustainable, cost-benefit tested policy that actually reduces carbon, I hope you recognize how nutty and absolutely dishonest it is to address climate by having bank regulators force banks to make up  imaginary "climate risks" to the financial system to justify near-term de-funding fossil fuel companies. A policy built on a lie will either require us to descend to Soviet style lie-repetition, or will blow up just as we need a coherent carbon policy. 

***

Part 3: Regulatory competition. 

If the OCC rule goes through, the OCC will forbid what the Fed requires. This will be fun. The OCC will lose, but at least it shines a bright light on what's going on. 

It is common to bemoan America's fractured and overlapping regulatory system, with an alphabet soup of agencies all trying to do the same thing. Centralization and uniformity always sound great. Here is a case where regulatory competition looks like a very good thing. At a minimum one regulator can shine a light on what the other is doing, and at best competing regulators can limit regulatory damage. 

Update: I am informed that the OCC rule may in fact be final before Jan 20, which would make it much harder to overturn. It doesn't have to be enforced, of course. 

John H. Cochrane
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!

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