The Acting Comptroller of the OCC discussed the limits of large bank manageability and the steps that regulators can take to address the risks posed by size and complexity.

On January 17, 2023, Acting Comptroller of the US Office of the Comptroller of the Currency (OCC) Michael Hsu delivered a speech titled “Detecting, Preventing, and Addressing Too Big to Manage.” The OCC charters, regulates, and supervises all national banks and federal savings associations as well as federal branches and agencies of non-US banks. The speech is the latest statement by the leader of the OCC on US bank size in the wake of substantial mergers in the banking sector, which have become a political as well as supervisory issue.

Acting Comptroller Hsu indicated that certain large banks may have become “too big to manage” — that is, overly large and complex, and prone to attenuated risk management and “negative surprises.” In his view, “effective management is not infinitely scalable.” When banks are too big to manage, detecting, preventing, and addressing risks becomes more difficult, and misdiagnosis and ineffective treatment becomes more likely. The results are potential harm to consumers, households, communities, counterparties, the financial system, and the wider economy.

To the Acting Comptroller, some of the hallmarks of being too big to manage include:

• A reliance on risk materiality determinations that may be flawed or statistically skewed due to the organization’s relative size, thus minimizing real risks
• A tendency to assume that a detected problem is isolated or superficial rather than widespread or deep, such that unseen root causes may not be discovered
• When bank supervisors and examiners consistently identify and drive remediation of more issues than the bank’s own internal risk and control functions
• Senior management indifference (or worse, contempt) for addressing examiner-flagged risks or matters requiring attention (MRAs, i.e., non-public supervisory findings resulting from an examination)
• Lack of attention to the organization’s “diseconomies of scale” in the wake of a merger or acquisition, such that poor post-transaction integration leads to inefficiencies, misalignments, fragmentation, dilution of risk and control functions, and governance complexities

Acting Comptroller Hsu acknowledged that addressing banks that have become too big to manage through the most effective supervisory remedy — shrinking their size via divestitures — raises due process and fairness concerns. This is an issue that US supervisors have noted in other areas of supervision: for example, former Federal Reserve Vice Chair Randal Quarles stated during his term that bank supervision “is currently not subject to any specific process constraint promoting publicity or universality,” leaving it “open to the charge, and sometimes to the fact, of capriciousness, unaccountability, unequal application, and excessive burden.”[1]

For the Acting Comptroller, the solution to the due process issue is designing a clear escalation framework. He stated that the OCC is using a four-level framework:

1. putting the bank on notice via MRAs and other adverse examination findings;
2. imposing a public enforcement action or civil money penalty for failure to fully remediate deficiencies;
3. restricting growth and business activities, imposing capital actions, or using some combination of the foregoing if deficiencies continue after a public enforcement action; and
4. simplification via divestiture (“breaking up the bank”) if the bank fails to remediate its problems notwithstanding restrictions on growth or activities.

To date, there has not been a public divestiture order from the OCC, although certain large banks have undertaken substantial simplification of their operations. Acting Comptroller Hsu argued that large bank resolution planning since the financial crisis of 2008 has required large banks to identify lines of business and portfolios that can be sold quickly in the event of insolvency, thus making a required divestiture for supervisory issues a more viable option.

It has been some time since a supervisor has publicly mentioned bank breakups. For example, the Dodd-Frank Act includes a provision that permits the Federal Reserve, if it finds that a large banking organization poses a “grave threat” to financial stability, and other measures are inadequate to mitigate such a threat, to order the bank to sell assets or off-balance sheet items, but little attention has been paid to such provision. With more US bank operations increasing in size, the OCC’s escalation framework could be more frequently tested.

Endnote

[1] See Spontaneity and Order: Transparency, Accountability, and Fairness in Bank Supervision, Vice Chair for Supervision Randal K. Quarles, at the American Bar Association Banking Law Committee 2020 (Jan. 17, 2020), available at https://www.federalreserve.gov/newsevents/speech/quarles20200117a.htm.