In a recent speech at Vanderbilt University, Acting Comptroller of the Currency Michael Hsu discussed his views on the potential risk of financial instability due to the merging boundaries between banking and commerce. In his speech, Comptroller Hsu underscored the importance of vigilance, especially in the realms of payments and private credit/equity, where he predicts the risk of this ‘blurring’ is most imminent. The Comptroller also advocated for the analytic framework recently adopted by the Financial Stability Oversight Council (FSOC) as having the greatest potential to identify and address emerging financial stability risks.

Historical Perspective

Comptroller Hsu noted that American economic and banking history is punctuated by numerous financial crises, such as the Panic of 1907, the Great Crash of 1929, and the 2008 Global Financial Crisis. According to Comptroller Hsu, each of these crises was preceded by a period of “great blurring,” a time when the distinction between banking and commerce became unclear. According to Comptroller Hsu, over the next decade the greatest risk of blurring is in two areas: payments and private credit/equity. In this context, the challenge lies in maintaining regulatory and supervisory vigilance to avert the next “great blurring.”

The Changing Landscape of the Payment Sector

In the past decade, a wide range of nonbanks have been able to use technological innovations to compete in the payments arena — including the surge of peer-to-peer payments, the metamorphosis of point-of-sale terminals, and the automation of business-to-business payments. As the digitalization of the economy continues, open banking and real-time payments are likely to further accelerate digitalization trends in banking. Comptroller Hsu emphasized the necessity of regulatory focus to ensure bank safety, consumer protection, and a level playing field. He also expressed apprehension about nonbank entities bundling banking services, which he fears could blur the line between banks and nonbanks, potentially causing financial instability.

Private Equity and Private Credit

Comptroller Hsu also highlighted the burgeoning private equity (PE) and private credit sectors as other potential areas of “blurring” and financial instability — observing increased interactions between banks and PE firms and the expansion of PE firms into the private credit market. The Comptroller’s concern here is the increased holdings of PE firms in the insurance industry, which — based on past crises — has the potential to lead to risky and interdependent activities that, without clear regulatory and supervisory boundaries, make market instability more challenging to detect and mitigate.

Regulatory Tools and Approaches

Comptroller Hsu outlined certain regulatory tools he believes could mitigate risks from the blurring of banking and commerce. Emphasizing the role of bank regulators in overseeing nonbank activities, Comptroller Hsu proposed direct oversight of nonbanks by functional regulators and legal limitations on deposit taking by nonbanks. He also suggested that a federal framework for payments regulation (that would overlay the current state-by-state structure) would provide a clearer path for innovation and growth in payments with less risk of blurring and financial instability.

The “Trip Wire Approach”

Comptroller Hsu also proposed a “trip wire approach” for identifying financial stability risks, where certain metrics and thresholds would trigger an assessment of systemic risk. Comptroller Hsu envisioned a transparent approach that would only prompt an assessment, not immediate supervisory action. According to Comptroller Hsu, “the key benefit of a trip wire approach is that it combines transparency with awareness before a systemic risk becomes too big to mitigate. The objective is to use the space created by the analytic framework to enable focused analysis and escalation as warranted. Instead of going straight to the process of designation and under- or over-reacting to potential systemic risks, a trip wire approach would help operationalize the progressive scrutiny and action inherent in the analytic framework. The transparency it affords would provide clarity ex ante to companies or industries as to when they might be blurring banking and commerce.”