#319—A new approach to regulating banks

From one of the top contenders for FDIC chief

Jan 13, 2025

Welcome to Yaka Stuff, our weekly newsletter that covers news, industry perspectives, and updates from the Hard Yaka ecosystem. Check out our last report here.

This week:

A new approach to regulating banks
Greg Kidd: What’s next for digital asset innovation in the U.S.
Stuff happens

1. A new approach to regulating banks

The times, they are a-changin’. That’s the tone set by the imminent arrival of the Trump administration, and FDIC Vice Chair Travis Hill matched that tone in a speech he made last week. (Via Jun Hiraga)

Current FDIC Chairman Martin Gruenberg will resign this weekend and while President Biden had previously named Christy Goldsmith Romero as his successor, that initiative lost momentum in the Senate during the lame duck session.

As such, Vice Chair Hill will become Acting Chair of the FDIC and is considered a top choice for the permanent role, according to Politico.

As such, Hill took the opportunity to set the stage for what’s to come and focused on a few core themes in his speech including supervision, innovation, and debanking.

On the issue of supervision, Hill called out the agency for a culture that’s all too focused on process rather than actual financial risk, and while the intentions are good, the ultimate result is a bit of checklist theater:

Following the regional bank failures in 2023, the public release of the Silicon Valley Bank (SVB) exam reports and supervisory findings drew attention to bank regulators’ emphasis on process rather than core financial risks.1 At the time of failure, SVB was subject to a long list of supervisory criticisms, but most were unrelated to financial risks, and the one criticism related to interest rate risk was focused on the bank’s modeling, not on the actual hole in the bank’s balance sheet.2
There are times when institutions have obvious, well-known management, governance, or control issues that can potentially threaten the safety and soundness of the institution. But today, these are outlier cases. What is far more common is for examiners to focus on a litany of process-related issues that have little bearing on a bank’s core financial condition or solvency.
One example is our approach to “sensitivity to market risk,” the “S” prong of the CAMELS rating system. Recently, some banks have experienced downgrades of the S rating despite being relatively resilient to interest rate shocks. These downgrades can occur for a variety of process-related reasons, ranging from inadequate documentation, to an inability to explain assumptions in models used by outside vendors, to insufficient focus in minutes at Board of Directors meetings. Meanwhile, leading up to the Federal Reserve’s interest rate increases, some banks that were relatively vulnerable to interest rate shocks nonetheless maintained a satisfactory S rating because they had checked all the process-related boxes. These are opposite sides of the same coin.
There are a number of reasons behind the focus on process, which is deeply entrenched in our manuals and guidance.3 It is partly rooted in so-called “forward-looking supervision,” a desire to address weaknesses before they show up in financial metrics. It is also rooted in the fact that it can be comparatively hard to second-guess a banker’s decision about the appropriate resilience to interest rate shocks or the proper loan loss reserve, while it is comparatively easier to run down a checklist of process-related items.

Hill also urged the agency to be forthright and transparent in its approach to new technologies rather than the existing status quo of guidance through enforcement, which ends up stifling innovation (perhaps by design, as we’ll see in his comments on debanking):

The FDIC should also consider issuing additional guidance on several topics, such as fintech partnerships, artificial intelligence, and digital assets and tokenization. With respect to fintech partnerships, over the past few years, the FDIC and other banking agencies have issued a series of enforcement actions against banks that have adopted a partnership model.5 Notwithstanding whether some of these actions may have been warranted, I generally think a much better approach would have been to lay out our expectations clearly and transparently on the front end, with an opportunity for the public to comment and provide feedback, rather than go down the line hammering each bank one by one, forcing the industry to reevaluate its compliance approach after every new order.
It is also worth revisiting the possibility of a public-private standard setting organization that would establish standards for due diligence of fintech vendors and technologies, which would reduce the need for each bank that partners with a fintech to conduct costly, time-consuming due diligence of its own.6 This effort could leverage and build on recent work in this area by the private sector.

More specifically, he highlights the need for the agency to get smart on digital assets and tokenization with a cohesive regulatory framework rather than forcing banks to engage with the FDIC on a case-by-case basis:

Another area in which a reset is sorely needed is the agency’s approach to digital assets and tokenization. In 2021, the banking agencies issued a roadmap describing plans to publish various policy documents in 2022 detailing the agencies’ expectations for banks engaging in activities related to digital assets.7 Ultimately, this work was discontinued in early 2022 following a change in leadership at the FDIC, and instead the agencies established processes in which each institution must engage with its regulator on an individual basis before engaging in any activities related to digital assets or blockchain.8
I have talked in the past about how damaging this approach has been, as it has stifled innovation and contributed to a public perception that the FDIC is closed for business if institutions are interested in anything related to blockchain or distributed ledger technology.9 Recent disclosures that the FDIC sent “pause” letters to more than twenty banks instructing them to refrain from “all crypto-related activity” have reinforced this perception.10 I continue to think a much better approach would have been — and remains — for the agencies to clearly and transparently describe for the public what activities are legally permissible and how to conduct them in accordance with safety and soundness standards. And if regulatory approvals are needed, those must be acted upon in a timely way, which has not been the case in recent years.

Finally, Hill directly calls out Operation Choke Point, which essentially debanked law abiding businesses:

Closely related to the agencies’ recent approach to digital assets is the problem of “debanking.” Over the past few years, there have been various accounts of individuals and businesses associated with the crypto industry losing access to bank accounts without explanation. This follows a long history of other types of customers experiencing the problem of debanking, including the politically disfavored business groups targeted by the original “Operation Choke Point,”11 individuals associated with certain religious or political groups,12 and many others.13
Access to a bank account is essential for individuals and businesses to participate in many aspects of the modern economy. A longstanding goal of the FDIC’s has been to decrease the number of people who are unbanked. Efforts to debank law-abiding customers are unacceptable, regulators must work to end it, and there is no place at the FDIC for anyone who has pushed — explicitly or implicitly — banks to stop serving law-abiding customers.

Check out Vice Chairman Travis Hill’s full speech here.

2. Greg Kidd: What’s next for digital asset innovation in the U.S.

Hard Yaka co-founder and CEO Greg Kidd recently joined the True Global Ventures podcast, hosted by founder Dušan Stojanović, where he covered a bevy of topics including the impact of the incoming Trump administration, the future of digital asset innovation here in the U.S., as well as the potential for a strategic Bitcoin reserve. (The episode is also available on Spotify.)

And if you enjoyed that, be sure to check out their next episode featuring Validation Cloud, which focuses on the intersection of AI and blockchain, one of the topics that came up during Greg and Dušan’s chat.

That episode will be streamed live tomorrow, January 14, 2025 at 9am ET.

Yaka Stuff

#319—A new approach to regulating banks

From one of the top contenders for FDIC chief

1. A new approach to regulating banks

2. Greg Kidd: What’s next for digital asset innovation in the U.S.

3. Stuff happens

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