Fed Proposes Easing 'Reputational Risk' Rules for Banks
The Federal Reserve has proposed prohibiting examiners from penalizing banks over "reputational risk." The move, now open for public comment, is a response to industry concerns that ambiguous criteria were stifling innovation and partnerships with fintechs and crypto firms. The policy shift aims to reduce arbitrary account closures and promote fairer access to financial services.
- The use of "reputational risk" as a supervisory category gained prominence in the 1990s as regulators shifted to a risk-focused approach, expanding to include risks from third-party relationships, such as lending to companies perceived by the public as negligent. - This policy shift is seen as a response to "Operation Choke Point," a controversial Obama-era initiative where the Department of Justice and regulators were accused of pressuring banks to terminate relationships with legal but disfavored industries, such as firearm dealers and payday lenders, by citing reputational risk. - The change could particularly impact bank-fintech partnerships, as the previous ambiguity around reputational risk was seen as a barrier to banks engaging with firms in emerging sectors like digital assets. - While the Fed's proposal removes reputational risk from examiner-led penalties, banks are still expected to manage their own risk, and the underlying safety, soundness, and compliance obligations remain unchanged. - The move aligns the Federal Reserve with the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC), which have also committed to removing reputational risk from their supervisory frameworks. - For real-time payment networks like FedNow, the focus on more concrete risks sharpens the need for robust, real-time fraud detection and mitigation tools, as the speed and irrevocability of these payments present unique challenges. - The international Financial Stability Board (FSB) has also been scrutinizing the link between traditional finance and crypto-assets, highlighting potential stability risks from unbacked crypto-assets and stablecoins as their interconnectedness grows. - This regulatory evolution occurs alongside updated interagency guidance on third-party risk management, which emphasizes a continuous life-cycle approach—from planning and due diligence to ongoing monitoring and termination—without diminishing the bank's ultimate responsibility for activities handled by partners.
