Chapter content - Free access1 2 Regulatory architecture: overview of banking regulators and key regulations 3 Recent regulatory themes and key regulatory developments in the United States 4 Bank governance and internal controls 5 Bank capital and liquidity requirements 6 Rules governing banks’ relationships with their customers and other third parties 7 The banking industry has long been one of the most highly regulated industries in the United States, based on the “special” role that banks play in taking deposits, allocating credit, and operating the payments system. This chapter provides an overview of the current U.S. bank regulatory framework at the federal level. The United States has what is called a “dual banking system”, meaning that U.S. banks can be chartered by one of the 50 states or at the federal level. However, whether state or federally chartered, a bank will have at least one federal supervisor. Most banks in the U.S. are owned by bank holding companies (“BHCs”) which are generally prohibited from owning or controlling entities other than banks or companies engaged in activities that are “closely related to banking”. For BHCs that elect to be treated as financial holding companies (“FHCs”), the standard is “activities that are financial in nature or complementary to a financial activity”. A foreign banking organisation (“FBO”) may establish a banking presence in the United States through a branch or agency or by establishing or acquiring a U.S. bank or Edge Act Corporation subsidiary. Over the past several years, many regulatory initiatives in the United States derived from the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), which was a vast set of reforms enacted in 2010 in response to the financial crisis of 2007–2009. Many provisions of the Dodd-Frank Act focus on the largest financial institutions due to their perceived role in causing the financial crisis and the perception of such institutions as “too-big-to-fail”. More recently, legislation passed by the Congress and regulatory initiatives undertaken by U.S. federal regulatory entities have repealed or revised certain provisions of Dodd-Frank, with several initiatives being focused on “tailoring” regulatory and supervisory requirements based on the risk profiles of banking organisations. In November 2019, the U.S. federal banking agencies issued several final regulations that established different categories of banking institutions (based on size and risk profile) and applied capital, liquidity, risk management, resolution planning and other prudential standards to U.S. BHCs and the U.S. operations of FBOs based on those categories (the “tailoring rules”). The United States has a complex regulatory framework that features a myriad of federal regulatory agencies having often overlapping responsibility for banking regulation. A brief description of the relevant bank regulatory agencies follows:
Primary federal banking statutes
Political change U.S. banking regulators have frequently implemented a more stringent (“super equivalent”) version of rules that are part of the post-financial crisis regulatory agenda established by the Dodd-Frank Act and by international standard-setting groups such as the Group of Twenty, the Basel Committee on Banking Supervision (the “Basel Committee”) and the Financial Stability Board. This trend toward super equivalent rules has likely ended, and current efforts are mainly focused on tailoring and adding transparency to regulatory requirements. President Trump has issued several executive orders aimed at halting additional financial regulation (and regulation more generally). On May 24, 2018, President Trump signed the EGRRCPA law, which, among other things, tailored certain provisions of the Dodd-Frank Act and generally reduced regulatory requirements for banks holding less than $250bn in total consolidated assets. Addressing innovation Another area of increasing regulatory focus is the potential licensing of financial technology companies (“fintech”). Some states have issued limited-purpose bank charters to such companies. The OCC is also considering granting special purpose federal bank charters to fintech companies. The grant of such special purpose federal charters would allow fintech companies to comply with a single set of national standards, rather than having to comply with the regulations of multiple states. In 2017, the OCC adopted a new rule creating a formal receivership process for uninsured special purpose national banks. In July 2018, the OCC issued a supplement to its Licensing Manual explaining how it would apply its existing standards to fintech companies applying for special purpose national bank charters. State regulatory authorities have challenged (with some success so far) the OCC’s authority to issue such charters. These such challenges are pending as of January 2020. In June 2019, Facebook released the Libra White Paper, which outlines its plans for “a new decentralized blockchain, a low-volatility cryptocurrency, and a smart contract platform that together aim to create a new opportunity for responsible financial services innovation”. Such plans have been met with heavy regulatory and legislative scrutiny, including with respect to AML and privacy issues. Cybersecurity Cybersecurity has also been an area of increasing focus, and the U.S. federal banking agencies have issued potential standards for comment. Moreover, the New York State Department of Financial Services (“NYSDFS”) now requires banks, insurance companies, and other NYSDFS-regulated institutions to adopt a cybersecurity programme that meets certain minimum standards. Full compliance was required by March 1, 2019. The board of directors and senior management of a banking organisation are responsible for ensuring that the institution’s internal controls operate effectively in order to ensure the safety and soundness of the institution. Improving bank governance and increasing the role and responsibilities of boards of directors and the risk management function of banking organisations have been key areas of focus for U.S. banking regulators. Board of directors Generally, U.S. corporate law requires that boards of directors exercise a fiduciary duty of loyalty and duty of care to the corporation and its shareholders. Boards of directors of banking organisations must perform these duties, with a focus on preserving the safety and soundness of the bank. State and federal law also impose various citizenship, residency, independence, and expertise requirements on bank boards of directors. While many regulations make it clear that the board’s role is to oversee and delegate to management, bank boards of directors also have significant responsibilities for overseeing and approving many of the actions taken by the institution under a variety of statutes, regulations, and supervisory guidance. For example, boards of directors are required to approve an institution’s resolution plan, various risk tolerance levels and policies and procedures for stress testing. In August 2017, the Federal Reserve Board requested public comment on a proposed new rule aimed at clarifying and narrowing the respective responsibilities of boards of directors and management, with the purpose of allowing boards of directors to focus their time and energy on their core responsibilities. The proposal remains pending. Boards of directors themselves have also recently become subject to additional prescriptive requirements regarding their structure and composition. For example, the OCC has adopted “heightened standards” applicable to large national banks that require a bank’s board of directors to include two independent members and impose specific requirements on the board regarding recruitment and succession planning. Risk management Risk management is a critical function within banking organisations, and the function has been subject to increasingly prescriptive regulation because risk-management failures were perceived to be a significant cause of the financial crisis. Banks subject to the OCC’s heightened standards guidelines are required to have one or more Chief Risk Executives who report directly to the CEO and have unrestricted access to the board and its committees to escalate risks. Such banks also must have a written risk-governance framework, a risk-appetite statement, and a strategic plan that is reviewed and approved by the board or the board’s risk committee. U.S. BHCs with total consolidated assets of $50bn or more must establish a risk-management framework, designate a Chief Risk Officer (“CRO”), and establish a board-level risk committee with at least one independent member and one risk-management expert. FBOs also must maintain a U.S. risk committee, and larger FBOs are also required to appoint a U.S. CRO who is employed and located in the U.S. and reports directly to the U.S. risk committee and the global CRO or equivalent officials. The tailoring rules eliminated the U.S. risk-committee requirement for FBOs with less than $50bn in total consolidated assets and require only those FBOs with $100bn in total consolidated assets and $50bn of combined U.S. assets to appoint a U.S. CRO. Internal and external audit The internal audit function within banking organisations generally is responsible for ensuring that the bank complies with its own policies and procedures and those required by law and regulation. In the United States, internal audit must be positioned within the institution in a way that ensures impartiality and sufficient independence. Internal audit must maintain a detailed risk assessment methodology, an audit plan, audit programme, and audit report. The frequency of the internal audit review must be consistent with the nature, complexity, and risk of the institution’s activities. The audit committee is responsible for overseeing the internal audit function. The composition of the audit committee has similar requirements to that of the risk committee, depending on the size of the institution and supervising federal regulator. FDIC regulations impose specific independent audit committee requirements on depository institutions that vary by the size of the institution, with institutions having total assets of more than $3bn subject to the most stringent requirements. The OCC heightened standards guidelines additionally require that the audit function of banks subject to the guidelines be led by a Chief Audit Executive who must be one level below the CEO, have unfettered access to the board, and report regularly to the audit committee of the board. U.S. regulators also expect the internal audit function of foreign banks to cover their U.S. activities and offices, including U.S. representative offices. Compensation In the mid-1990s, the U.S. federal banking agencies adopted standards prohibiting compensation arrangements that were excessive or could lead to a material financial loss. After the financial crisis, new legislation introduced significant restrictions on compensation for senior executive officers of firms that received certain forms of government assistance, including limits on bonuses, clawback requirements, and various governance requirements. The U.S. federal banking agencies issued guidance on sound incentive-compensation policies in 2010 which applies to all banking organisations supervised by the agencies and is structured around three key principles: (i) balance between risks and results; (ii) risk controls; and (iii) strong corporate governance. The federal banking regulators and several other regulatory agencies issued a proposed rule in April 2011, and a re-proposal in May 2016, that would generally prohibit the use of incentive-compensation programmes that encourage inappropriate and excessive risk-taking for financial institutions with more than $50bn in total consolidated assets. As of January 2020, the rule has not yet been finalised. Intermediate holding company (“IHC”) requirement Implementing a major change in the U.S. regulation of foreign banks, the Federal Reserve required FBOs with $50bn or more in U.S. non-branch or non-agency assets to establish an IHC by July 1, 2016. The IHC must hold an FBO’s U.S. BHC and bank subsidiaries and substantially all other U.S. non-bank subsidiaries. The IHC is subject to, with limited exceptions, the enhanced prudential standards applicable to U.S. BHCs. In some cases, the Federal Reserve permits an FBO to establish more than one IHC to hold its U.S. subsidiaries. The tailoring rules did not change the $50bn threshold that triggers the requirement to form an IHC, but less stringent prudential standards apply to the IHC if the FBO has combined U.S. assets of less than $100bn. Resolution plans and related matters Under the Dodd-Frank Act, large BHCs and FBOs with total global consolidated assets of $50bn or more, and non-bank financial companies designated by FSOC as SIFIs, were required to develop, maintain and file a resolution plan (so-called “living will”) with the Federal Reserve and the FDIC. The resolution plan must detail the firm’s strategy for rapid and orderly resolution in the event of material financial distress or failure under the U.S. Bankruptcy Code. Firms that do not submit credible plans are subject to the imposition of stricter regulatory requirements. Since the enactment of Dodd-Frank, firms have been through several rounds of resolution plans. EGRRCPA and subsequent rulemaking raised the thresholds at which the resolution plan requirement applies and generally aligned the precise requirements with the categories used for the application of other enhanced prudential standards. Under the new rules, global systemically important banks (“GSIBs”) would be subject to the strictest rule, which requires filing a resolution plan every two years, alternating between full plans and targeted plans. FBOs with more than $250bn of consolidated assets are subject to some level of resolution plan requirement. BHCs with less than $100bn of consolidated assets, and certain BHCs with less than $250bn of consolidated assets, are no longer subject to resolution plan requirements. In addition, FDIC-insured depository institutions (“IDIs”) with $50bn or more in total assets have been required to submit a separate resolution plan to the FDIC under regulations administered only by the FDIC. In April 2019, the FDIC issued an advanced notice of proposed rulemaking (“ANPR”) that aims to revisit the resolution planning requirements for IDIs of $50b or more in assets. Specifically, the ANPR focuses on ensuring that the appropriate scope, content, and frequency of resolution plans for various types of banks are tailored to each bank’s size, complexity, and level of risk. In 2016, the OCC issued guidelines for recovery planning by certain banks (and federal branches of FBOs) with $50bn or more in total assets. The U.S. banking agencies have issued substantially similar rules that require global systemically important institutions (including the U.S. operations of systemically important FBOs) to amend certain qualified financial contracts to prohibit the immediate termination of such contracts and the exercise of certain other default rights by counterparties if the firm enters bankruptcy or a special resolution proceeding. U.S. banks and BHCs have long been subject to risk-based capital requirements based on standards adopted by the Basel Committee (the “Basel Framework”). In July 2013, the U.S. regulatory authorities adopted a sweeping overhaul (the “Revised Capital Framework”) of their regulations to implement both the Basel III Accord, including both advanced approaches and standardised methodologies, and requirements set forth in the Dodd-Frank Act. The Revised Capital Framework took effect for all institutions subject to the rules (generally those with more than $1bn in total consolidated assets) on January 1, 2015. On November 21, 2017, U.S. regulators announced an indefinite extension of certain existing capital requirements for banking organisations not subject to the advanced approaches capital rules. U.S. banking organisations with $250bn in total consolidated assets, or $10bn in on-balance sheet foreign exposure, had been subject to the advanced approaches methodology as well as a capital floor established under the standardised approach. Under the tailoring rules adopted by the three U.S. federal banking agencies effective December 31, 2019, only banking organisations with $700bn or more in total consolidated assets or $75bn or more in cross-jurisdictional activity are subject to the advanced approaches methodology. Other banking organisations are generally subject only to the standardised approach. U.S. top-tier BHC subsidiaries of FBOs are generally subject to minimum U.S. capital requirements, although they may elect to use the U.S. standardised approach to calculate their risk-based and leverage capital ratios regardless of their size. Components of capital The Basel Framework and the Revised Capital Framework emphasise the importance of common equity Tier 1 capital (“CET1”), set standards for instruments to qualify as CET1, additional Tier 1, and Tier 2 capital, and phase out the qualification of certain hybrid instruments from inclusion as capital. Minimum capital ratios The Revised Capital Framework sets forth the minimum risk-based capital ratios for CET1 (4.5%), Tier 1 capital (6%), and total capital (8%). In addition, as of January 1, 2019, banks must hold a capital conservation buffer in the form of CET1 of 2.5%. An institution that fails to maintain capital in excess of the buffer will be restricted in its ability to make capital distributions or pay discretionary executive bonuses. The U.S. regulators are also authorised to impose an additional countercyclical capital buffer of up to 2.5%. No such buffer has been imposed. GSIB Surcharge The eight largest U.S. banking organisations, which are global systemically important banks (“GSIBs”), are subject to an additional capital surcharge (the “GSIB Surcharge”). The amount of the GSIB Surcharge is the higher of two measures that each bank must calculate. The calculations take into account a firm’s size, interconnectedness, substitutability, complexity, cross-jurisdictional activity and, under one method, reliance on short-term wholesale funding instead of substitutability. Risk-weighted assets Although the Revised Capital Framework is largely consistent with the Basel Framework, one important difference arises from the absence of the use of external credit ratings for the risk-weighting of assets in the Revised Capital Framework due to the prohibition in Section 939A of the Dodd-Frank Act on the use of external credit ratings. More generally, comparability of risk-weighting of assets across institutions and jurisdictions has become a matter of significant regulatory attention. In addition, in 2019, the U.S. federal banking agencies adopted the Standardised Approach to Counterparty Credit Risk (“SA-CCR”) in calculating the exposure in derivative contracts. It will be effective on April 1, 2020, with a mandatory compliance date of January 1, 2022. Market risk capital charge The Revised Capital Framework also includes a market risk capital charge (implementing the Basel II.5 Framework (introduced in July 2009)) for assets held in the trading book that applies to banks and BHCs with significant trading positions. Unlike the Basel II.5 Framework, the U.S. rules do not rely on credit ratings to determine specific capital requirements for certain instruments. The Basel Committee adopted a revised capital requirement for market risk framework in January 2016 to ensure standardisation and promote consistent implementation globally. Key features include a revised boundary between the trading and banking book, a revised standardised and internal models approach for market risk, and incorporation of the risk of market illiquidity. In January 2019, the Basel Committee issued revised standards, which will come into effect in January 2022. U.S. regulators have not issued proposed regulations to implement the framework in the United States. Leverage ratio U.S. banking organisations have long been subject to a minimum leverage ratio. The Revised Capital Framework includes two separate leverage requirements. The 4% minimum leverage ratio requirement represents a continuation of a ratio that has been in place for years (in general, Tier 1 capital divided by average consolidated assets, less deductions). The other applies only to large banking organisations subject to the advanced approaches methodologies and is based on the 3% supplementary leverage ratio in the Basel Framework, which includes certain off-balance-sheet exposures in the calculation of required capital. In addition, the largest U.S. banking organisations (those with at least $700bn in total assets or $10tn in assets under custody) were subject to an “enhanced” supplementary leverage ratio from January 1, 2018. Covered BHCs that do not maintain a ratio of at least 5% will be subject to limitations on capital distributions and discretionary bonus payments, while depository institutions will be required to maintain a ratio of at least 6% under the prompt corrective action framework (described below). In October 2019, the U.S. federal banking agencies finalised a rule that tailors the enhanced supplemental leverage ratio requirements to the specific business activities and risk profiles of each firm, with the effect of relaxing the enhanced supplemental leverage ratio requirement. Consequences of capital ratios The U.S. prudential bank regulatory framework has several components based on an institution’s capital ratios. For example, in order for a U.S. BHC to qualify as an FHC, it must meet a well-capitalised standard. Similarly, FBOs that seek FHC status must demonstrate that they meet comparable standards under their home country’s capital requirements. Capital levels also form the basis for the level of deposit insurance premiums payable to the FDIC by depository institutions, the ability of depository institutions to accept brokered deposits, qualification of banking organisations for streamlined processing of applications to make acquisitions or engage in new businesses, as well as other filings with bank supervisors under various laws and regulations. Capital levels also form the basis for the prompt corrective action framework applicable to depository institutions (which provides for early supervisory intervention in a depository institution as its capital levels decline). Stress testing and capital planning Stress testing is a key supervisory technique used by U.S. federal banking regulators and in many cases constitutes the binding constraint on large banking organisations. The quantitative results from the supervisory stress tests are used as part of the Federal Reserve’s analysis under the Comprehensive Capital Analysis and Review (“CCAR”). The tailoring rules revised the stress-testing and CCAR requirements so as to reduce the compliance burden on firms in lower-risk categories. Under this revised regime, U.S. BHCs and IHCs are required to run company-run stress tests and supervisory stress tests either annually or biannually, depending on the applicable category of standards under the tailoring rules. The Federal Reserve’s tailoring rules eliminated the company-run stress test requirement for FBOs with less than $50bn in total consolidated assets. The CCAR is an annual exercise the Federal Reserve undertakes at the largest U.S. BHCs to evaluate a firm’s capital planning processes and capital adequacy, including planned capital distributions, to ensure the firm has sufficient capital in times of stress. The Federal Reserve can object to a firm’s capital plan on either a quantitative basis (i.e., a firm’s projected capital ratio under a confidential stressed scenario would not meet minimum requirements) or a qualitative one (i.e., inadequate capital planning process). In recent years, the Federal Reserve has primarily objected to firms’ capital plans for qualitative reasons. There were 18 firms subject to the CCAR process in 2019. Based on the results of the 2019 stress tests, the Federal Reserve concluded that the nation’s largest BHCs have capital levels able to withstand even a severe recession. TLAC In December 2016, the Federal Reserve and FDIC adopted final rules requiring the largest U.S. GSIBs and certain U.S. IHCs of non-U.S. GSIBs to comply with new capital-related requirements, including “clean” holding company requirements (relating to short-term debt and derivatives). These requirements are aimed at improving the prospects for the orderly resolution of such an institution. The Rule includes an external long-term debt (“LTD”) requirement and a related total loss-absorbing capacity (“TLAC”) requirement applicable to the top-tier holding company of a U.S. GSIB and an internal LTD and related TLAC requirement applicable to U.S. IHCs. Long-term debt issued on or prior to December 31, 2016, was grandfathered from provisions of the rule that prohibit certain contractual provisions. Compliance was required by January 1, 2019. Liquidity Liquidity has become a key focus of U.S. (and international) regulators in recent years and has become subject to detailed regulations setting quantitative standards in a manner analogous to the risk-based capital regime. The U.S. LCR, like that released by the Basel Committee, requires firms to hold a prescribed ratio of high-quality liquid assets to withstand a 30-day stress scenario. In 2014, the U.S. agencies finalised the U.S. Liquidity Coverage Ratio (“U.S. LCR”), which included a “full” approach for the largest banks that exceed $250bn in consolidated assets or $10bn in on-balance sheet foreign exposure and a more limited, “modified” approach for smaller BHCs that exceed $50bn in consolidated assets. Under the tailoring rules, banking organisations with between $250bn and $700bn in total consolidated assets are subject to the full daily LCR requirement only if their average short-term wholesale funding profile exceeds certain thresholds. IHCs are subject to LCR requirements based on their own risk profile rather than the combined U.S. operations of the FBO. The Federal Reserve has stated that it may develop and propose a quantitative LCR-based liquidity requirement applicable to the U.S. branches and agencies of an FBO. In 2016, the Federal Reserve approved a final rule requiring all institutions subject to the U.S. LCR to publicly disclose their liquidity coverage ratio on a quarterly basis in a direct and prominent manner. In 2016, the U.S. federal banking agencies proposed a net stable funding ratio (“NSFR”) rule to implement the final standard previously released by the Basel Committee. Many significant comments were submitted, and the rule was not finalised as of the end of 2019. Generally, the NSFR requires covered firms to hold a specified ratio of high-quality liquid assets sufficient to cover the outflows of a one-year stress scenario. On October 6, 2017, the Basel Committee announced its decision to allow national discretion over the NSFR’s treatment of derivative liabilities. In particular, it allowed national jurisdictions to lower the NSFR’s “required stable funding” factor in the NSFR from 20% to as low as 5%. Regulators have also addressed liquidity in the U.S. by requiring certain firms to conduct liquidity stress tests. Deposit-taking activities As a general matter under U.S. federal and state banking law, deposit-taking is limited to duly chartered banks, savings associations, and credit unions. Properly licensed non-U.S. banks also have the same general authority to accept customer deposits as U.S. banks, except that non-U.S. banks (other than several grandfathered branch offices) that wish to accept retail deposits must establish a separately chartered U.S. bank subsidiary. Virtually all U.S. commercial banks are required to be insured by the FDIC. Deposits are generally insured up to $250,000 per depositor in each ownership capacity (such as in an individual account and a joint account). Except for grandfathered offices, U.S. branch offices of non-U.S. banks are not eligible for FDIC insurance. Funds on deposit in a non-U.S. branch office of a U.S. bank are not treated as FDIC-insured deposits. Also, they are not entitled to the benefits of the depositor preference provisions of the FDI Act unless such deposits are by their terms dually payable at an office of the bank inside the United States. The FDIC requires FDIC-insured institutions with more than two million deposit accounts to maintain complete and accurate data on each depositor and to implement information technology systems capable of calculating the amount of insured money for depositors within 24 hours of a failure. Longer periods are permitted for certain deposit accounts with “pass through” deposit insurance coverage, including trust and brokered deposits. Brokered deposits are a matter of supervisory concern, and a bank’s reliance on brokered deposits can have a number of adverse supervisory consequences. In 2016, the FDIC issued Frequently Asked Questions that address the identification, acceptance, and reporting of brokered deposits. In December 2018, the FDIC sought public comment on an Advance Notice of Proposed Rulemaking that would address the changes in the financial market and the economic environment since the rules on brokered deposits were last amended in 1991. In December 2019, the FDIC issued a proposed rule that would make several changes to brokered deposit rules in order to modernise its framework and adapt to the introduction of financial technology companies into the industry. Consumer deposit accounts are subject to CFPB regulations that require banking organisations to make disclosures regarding interest rates and fees and certain other terms and conditions associated with such accounts. Deposit accounts are also subject to Federal Reserve regulations regarding funds availability and the collection of cheques. In recent years, fees associated with various types of overdraft protection products have generated significant litigation and regulatory attention. In addition, banks are generally subject to reserve requirements with respect to their transaction accounts. Accounts that are not transaction accounts, such as money market deposit accounts, have limitations on the number of certain types of withdrawals or payments that can be made from such an account in any one month. Lending activities The lending activities of banks are subject to prudential and consumer protection requirements. Banks are generally limited to extending credit to one person in an amount not exceeding 15% of the bank’s capital. Banking laws generally permit banks to extend credit equal to an additional 10% of capital if the credit is secured by readily marketable collateral. Lending limits also now generally include credit exposure arising from derivative transactions, and in the case of national banks and U.S. offices of non-U.S. banks, securities financing transactions. The lending limits applicable to the U.S. offices of non-U.S. banks are based on the capital of the parent bank. In August 2018, the Federal Reserve adopted a final rule (with compliance required in 2020) to establish single-counterparty credit limits (“SCCL”) for BHCs and non-U.S. banks with $250bn or more in total consolidated assets, including IHCs with $50bn or more in total consolidated assets. FBOs can meet limits applicable to their combined U.S. operations by certifying that they meet home country SCCL standards. The exact requirements applicable to IHCs are based on their size. In November 2019, the Federal Reserve proposed to amend the final SCCL rule to extend the initial compliance dates for the combined U.S. operations of FBOs by 18 months. Lending to consumers is generally subject to a number of U.S. federal and state consumer protection statutes that require the disclosure of interest rates, other loan charges, and other terms and conditions related to the making and the repayment of an extension of credit. A more recent rule requires creditors to make a reasonable, good faith determination of a consumer’s ability to repay any consumer credit transaction secured by a dwelling. Banking organisations are generally required under the Community Reinvestment Act to meet the credit needs of the communities in which they operate, including low- and moderate-income neighbourhoods. The Home Mortgage Disclosure Act requires banks (and certain non-bank lenders) located in metropolitan areas to collect and report data about their residential mortgage lending activities (e.g., loan applications, approvals, and denials). In December 2019, the FDIC and OCC published a set of proposed rules that amend the agencies regulations under the Community Reinvestment Act. The Federal Reserve did not join that proposal. Anti-tying statutes generally prohibit a bank from extending credit (or providing other services) to any person on the condition that the person also obtain some other product or service (other than certain traditional bank products) from the bank or an affiliate. Leveraged lending and commercial real estate lending are additional areas of particular supervisory focus, and interagency guidance has been released with respect to both activities. In October 2017, the U.S. Government Accountability Office stated that the leveraged lending guidelines amount to an actual rule and consequently are subject to Congressional review, which means that Congress could possibly overturn them. In September 2018, the U.S. federal banking agencies issued a statement to the effect that interagency guidance is not binding, such that failure to comply with such guidance in itself should not be cited as a violation of law. This continues to be a topic of active discussion in the U.S. Volcker Rule The Volcker Rule is a complex rule that prohibits banking entities from engaging in proprietary trading activities and from sponsoring or investing in, or having certain relationships with, hedge funds and private equity funds (“covered funds”), subject to certain exceptions and exemptions, and generally requires banking entities to adopt an appropriate compliance programme. Banking entities are generally defined to include insured depository institutions, BHCs, FBOs that are treated as BHCs under the IBA (which includes a non-U.S. bank that operates a U.S. branch or agency office), and any subsidiary or affiliate of any of these entities. The ban on proprietary trading essentially prohibits a banking entity from trading as principal in most financial instruments for short-term gain. Exemptions are permitted for (among other activities) underwriting, market-making, hedging and, for FBOs, activities conducted solely outside of the United States. Covered funds are generally issuers that would be considered an investment company under the Investment Company Act of 1940 but for the exemptions under Section 3(c)(1) or 3(c)(7) of such Act. Exceptions are available for (among other activities) traditional asset management activities and, for FBOs, activities conducted solely outside the United States. One apparently unintended consequence of the Volcker Rule is that foreign funds that have no U.S. investors but are controlled by FBOs (“foreign excluded funds”) are treated as banking entities that are subject to the proprietary trading limits of the Volcker Rule. The U.S. regulatory agencies provided temporary relief until July 21, 2021, pending a more permanent solution. The EGRRCPA exempts banks from the Volcker Rule that do not have and are not controlled by companies that have: (i) more than $10bn in total consolidated assets; and (ii) trading assets and liabilities of more than 5% of total consolidated assets. The EGRRCPA also relaxed certain naming restrictions that applied to covered funds sponsored or advised by a banking entity. In 2019, U.S. agencies adopted regulatory changes to the Volcker Rule that, among other things, limit the application of a comprehensive compliance programme to banks with $10bn or more in trading assets and liabilities, while requiring smaller banks to incorporate the Volcker Rule into the general compliance policies. The revised framework also presumes compliance for banking entities with less than $1bn in trading assets and liabilities, absent an agency finding to the contrary. The revisions also expand the exemption for foreign banking entities’ activities outside the United States. Furthermore, the revisions create a presumption of compliance for trading desks engaged in market making and underwriting activity that establish, implement, and enforce internal limits that are designed not to exceed the reasonable expected near-term demand of customer, clients, or counterparties. Other restrictions on activities The National Bank Act limits the activities of national banks to those specifically authorised by statute, which includes activities incidental to the business of banking. State banks are subject to state laws, and their activities are conducted in a principal capacity also limited to those permissible for national banks under federal law, unless the FDIC specifically approves the activity. The activities of a U.S. branch of a foreign bank are basically subject to the same limits that apply to a U.S. bank. The BHC Act generally restricts BHCs and FHCs from engaging directly or indirectly in non-financial activities. BHCs that successfully elect to be treated as FHCs may engage in a broader range of activities than BHCs that do not make such an election, such as securities underwriting, merchant banking, and insurance underwriting. FBOs are generally treated as BHCs or FHCs with respect to the activities of their nonbanking subsidiaries. In addition, an FBO that meets the requirements of a qualifying foreign banking organisation may engage in a broad range of banking and nonbanking activities outside the United States. Complaints Consumers can submit complaints about banks (and other consumer product providers) online through the CFPB’s website. Banks are generally required to respond to complaints and are expected to resolve most complaints within 60 days. The CFPB publishes a database of (non-personal) complaint information. Investment services Banks with trust powers are generally permitted to provide fiduciary services and investment advisory services to clients. Banks also have limited authority to provide specified securities brokerage services to clients. Full-service brokerage services are typically provided by a broker-dealer affiliate or subsidiary of a bank. One of the more significant issues affecting broker-dealers in the United States, including broker-dealers owned by BHC, FHC, and FBOs, is the recent promulgation of Regulation Best Interest (“Reg BI”) by the Securities and Exchange Commission (“SEC”), which went into effect on September 10, 2019, with a compliance deadline of June 30, 2020. Earlier, the Department of Labor (the “DOL”) had adopted a rule that would have subjected many investment recommendations related to individual retirement accounts to ERISA fiduciary standards and remedies. That rule was successfully challenged in court. Subsequently, the SEC adopted Regulation BI, which imposes a higher standard of care (and other attendant obligations) on U.S. broker-dealers in certain circumstances. Reg BI consists of four prongs that broker-dealers must meet to discharge their obligation under the rule: (i) fulfill the standard of care (i.e., act in the best interest of “retail customers” when making “recommendations”); (ii) make certain disclosures; (iii) mitigate or eliminate conflicts of interest; and (iv) enhance compliance programmes. In the wake of Reg BI, the DOL indicated that it intends to re-propose its Fiduciary Rule in a revised form to work in harmony with these Reg BI obligations. Proprietary trading activities Subject to the limitations of the Volcker Rule, banks generally have the authority to engage in proprietary investment or trading with respect to a range of financial instruments, subject to certain limitations. For example, banks are typically confined to purchasing securities that qualify as investment securities under specified criteria. Banks also generally are not authorised to underwrite or deal in securities, subject to certain exceptions. However, subject to the Volcker Rule, FHCs generally may engage in such activities through broker-dealer subsidiaries. Money laundering Banks are subject to extensive and evolving obligations under anti-money laundering laws and economic sanctions requirements. Basic anti-money laundering requirements include know-your-customer (and know-your-customer’s-customer) obligations, suspicious activity reporting, and currency transaction reporting. Compliance with U.S. requirements has proved to be an ongoing challenge for banking organisations, particularly for non-U.S. banks. Deficiencies can result not only in administrative sanctions, but criminal proceedings involving law enforcement authorities. Recent enforcement actions have required banking organisations to dismiss certain specified personnel identified as responsible for compliance deficiencies. State laws may also apply. In 2016, the NYSDFS adopted an anti-terrorism and anti-money laundering regulation that imposes various detailed requirements on the transaction monitoring and filtering programmes of New York-regulated institutions. In December 2018, the U.S. federal banking agencies and the Financial Crimes Enforcement Network (“FinCEN”) issued guidance to the effect that banks should use innovative technology for AML purposes. Furthermore, in July 2019, as part of their efforts to promote a risk-focused approach to supervision and examination of bank BSA/AML compliance programmes, the U.S. federal bank regulatory agencies and FinCEN issued a joint statement outlining common practices for assessing a bank’s AML and terrorist financing risk profile and initially evaluating the adequacy of its BSA/AML compliance programme. Outsourcing Banks often rely on third parties to deliver various products to their customers and otherwise support their daily operations. While such arrangements are generally permissible, recent regulatory guidance has highlighted the need for banks to carefully manage the risks (including reputational) associated with such outsourcing relationships. Enforcement actions U.S. regulators have principally directed enforcement actions at institutions and not individuals at those institutions. However, along with a renewed focus on governance and management, U.S. regulators are now placing more emphasis on the need to hold individuals accountable for their wrongdoing. For example, in 2015, the U.S. Department of Justice issued guidance to bolster its ability to pursue individuals in corporate cases. Under the guidance, cooperation credit for corporations requires that the corporation provide information to the Department of Justice about the role of individual employees in the misconduct, and prosecutors are instructed not to release culpable individuals from civil or criminal liability as part of the resolution of a matter with the corporation. More generally, enforcement actions aimed at anti-money laundering compliance and improper sales incentives (relating, especially, to cross-marketing activities) are expected in 2020 and beyond. In early 2020, the OCC issued significant enforcement actions against several former executives of a large U.S. bank related to systemic sales practices misconduct. Banking regulation in the United States remains an evolving and complex area as regulations and supervisory guidance implementing the Dodd-Frank Act and other post-crisis reforms are revised by the Trump administration that seeks to reduce regulatory burden on the industry or certain portions of it. Navigating the new framework requires not only a deep understanding of the complexity and nuances of U.S. banking laws but an alert eye to ongoing developments. In addition, some of the requirements being imposed on the U.S. operations of non-U.S. banks (such as the intermediate holding company requirement) are now being replicated outside the United States, thereby impacting the overseas activities of U.S. banking organisations. Acknowledgment The authors would like to acknowledge Le-el Sinai, Caitlin Hutchinson, and Andrew Lewis, associates at Shearman & Sterling, for their assistance in preparing this chapter. Contributing firm(s)
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