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Republicans on the Senate Banking Committee have advanced a bill that aims to scrap the concept of "reputational risk" in federal banking supervision.
Last week, the committee voted to mark up the Financial Integrity and Regulation Management (FIRM) Act, clearing it for a vote on the Senate floor.
If enacted, the FIRM Act will eliminate all references to reputational risk as a measure to determine the safety and soundness of regulated financial institutions.
The term “reputational risk” does not currently appear in any statute, but it does appear in rules, regulations, guidance and examination materials that are used by federal banking agencies.
For the Republicans who authored the bill, the scrapping of reputational risk would represent the “first step” towards ending the scourge of unfair debanking.
“It’s clear that federal regulators have abused reputational risk by carrying out a political agenda,” said Senator Tim Scott (R-SC), chair of the Senate Banking Committee.
“Federal banking agencies use reputational risk to prevent banks from providing financial services to industries that the agencies disfavor.”
Subjectivity and targeting of certain businesses
In the opening pages of the bill, lawmakers state that the concept of reputational risk allows federal banking agencies to regulate based on a “subjective view” of negative publicity.
They also write that it "provides cover” for the agencies to pursue political aims that are unrelated to the safety and soundness of the financial institutions they supervise.
In 2018, the Federal Deposit Insurance Corporation (FDIC) acknowledged the use of reputational risk reviews to limit access to financial services by certain businesses, such as firearms dealers and gambling operators.
Efforts made to shut these businesses out of the financial system became known as Operation Chokepoint and, according to the Republicans on the committee, an Operation Chokepoint 2.0 is currently taking place against digital asset companies.
If the bill is passed in its current form, federal banking regulators must conduct a review of all regulations issued within the past seven years.
If a regulation is to be revised under the FIRM Act, the changes must be completed no later than three years from the date of its enactment.
No later than one year after its enactment, and annually thereafter, each federal banking regulator must submit to Congress a report on actions taken under the FIRM Act.
No later than 18 months after its enactment, they must submit to Congress a report on the “modernisation” of banking supervision.
This should include changes to bank business models, workload and training of examiners, structure of supervisory activities and the use of supervisory technology pursuant to the FIRM Act.
Democrats oppose debanking, but also oppose FIRM Act
During the markup hearing, Democrats on the committee expressed support in principle for measures to end unfair debanking, but argued that the FIRM Act would be counter-productive.
Senator Jack Reed (D-RI) proposed an amendment that would scrap the FIRM Act and replace it with his bipartisan SAFER Banking Act, which he originally filed in 2023.
Reed’s bill was primarily designed to offer protections for federally regulated financial institutions that serve state-sanctioned marijuana businesses.
However, the bill would also prohibit federal banking regulators from requesting or requiring banks to close deposit accounts in cases where reputational risk was the "dispositive factor”.
Reed, whose amendment was rejected, argued that scrapping reputational risk would be an “overly broad” intervention, and would ultimately lead to safety and soundness weaknesses.
Senator Catherine Cortez Masto (D-NV) tabled another amendment designed to protect consumers who have been debanked due to their use of overdrafts — a key concern among Democrats on the committee.
Masto’s amendment would have required federal banking regulators to publish the names of all financial institutions that generate more than half of their net income from overdraft fees and/or insufficient funds fees.
Blacklisting of consumers
As the committee heard in previous hearings, these financial institutions are known to blacklist customers after receiving their fee income.
The blacklists are then shared with other banks, leading to difficulties opening accounts at other institutions.
“Debanking happens when a bank shuts down a customer’s bank account because they think that account poses a financial, legal or reputational risk to the bank,” said Senator Elizabeth Warren (D-MA).
“Once the bank shuts someone out, they may share that information with companies that get paid to maintain a Do Not Bank list — with the result that the customer is blacklisted everywhere.”
Previously, Warren’s staff identified 11,955 complaints of debanking by consumers during the past three years, a number that covers only those who took the time to file a complaint.
In reality, the Massachusetts senator said the scale of the problem is much larger, with tens of millions of customers having been blacklisted because they “overdrafted their account a few times”.
Masto’s amendment was also rejected, and the FIRM Act was advanced with unanimous Republican support.
