Question and Answer with Keith Noreika: Perspectives on Issues Facing Banks Now

In the following interview, Keith Noreika shares his thoughts on issues facing banks today as well as current events and regulatory developments shaping the near-term horizon.

Mr. Noreika joined Patomak Global Partners in July 2022 as Executive Vice President and Chairman of the Banking Supervision and Regulation Group. He leads Patomak’s projects related to the U.S. banking industry, as well as those clients that include financial technology and cryptocurrency companies. Prior to joining Patomak, Mr. Noreika was a partner at Simpson Thacher & Bartlett LLP, focusing on banking regulation, bank mergers and acquisitions, bank and fintech securities offerings, and private equity transactions. In 2017, he served as acting Comptroller of the Currency where he led the 4,000-person independent agency responsible for chartering, regulating, and supervising all national banks and federal savings associations as well as federal branches and agencies of foreign banks in the United States. In this role, he also served as director of the Federal Deposit Insurance Corporation and member of the Financial Stability Oversight Council.

What are the most significant headwinds facing banking institutions as concerns of a recession grow?

Banks should always start with safety and soundness. Bank financial performance faces challenges from inflation, rising interest rates, as well as geopolitical events. Credit risk remains moderate but is on the radar as asset quality comes under pressure, especially due to the unknown impact of inflation on borrowers and balance sheets. Strategic risk is another big factor in this competitive environment with non-bank firms growing so quickly, the regulatory environment becoming increasingly critical, global opportunities presenting themselves, and staffing concerns continuing to grow. I also think all banks should be concerned with Compliance risk. As conditions get tighter, bankers reach for yield, expand into new markets and products, and look for ways to improve the bottom line. Controls and policies that help ensure compliance get tested. History also shows that enforcement actions rise significantly during economic downturns.

Inflation is the highest it has been in 40 years. How can banks manage the risks they face in this environment?

Banks must focus on core aspects of their businesses. We have lived in an environment of loose monetary policy, low interest rates, and low inflation for a generation. There will be effects from that as those policies recede. Banks must make sure the fundamentals are sound—manage asset quality, look closely at exposures and interest rate risk, examine existing credit and new credit closely while maintain credit for creditworthy clients. Basic blocking and tackling goes a long way when things get tight.

While the economy is cyclical, not every recession is the same. What do you think will be different this time and how should banks prepare?

Commercial banks are in far better condition than in 2008 and 2009. Capital is up. Risk management and corporate governance are better. Asset quality is stronger. That’s the good news. The bad news is we don’t know what we don’t know. There will be impacts from inflation and a generation of loose monetary and fiscal policy. And, a great deal of banking activity is done outside the regulated space today. While that has provided consumers greater choice and resulted in a great deal of innovation, regulators don’t have a great deal if insight into the risks there and few levers to pull. Fortunately, well-run banks should have a clear view of the risks in their portfolios and a better idea of how they should perform under stress, even if regulators do not.

How will banks perform in the next recession?

The banks that enter a downturn in a position of strength—both financially as well as from an operational and compliances perspective—will have an opportunity to gain market share by delivering confidence, service, and being a shelter in the storm. There will be real opportunities. The most recent stress tests from the Federal Reserve reveal that the largest banks are strong and will be able to withstand a recession and continue to lend. Let’s hope they are right, and I am optimistic that many banks will do just that. However, we know some won’t and we know that regulatory scrutiny increases 10-fold during hard times. That means bank executives and management need to be at the top of their game (and indeed ahead of the curve) in identifying opportunities and weaknesses, managing relationships, remediating vulnerabilities, and being prepared to act.

Some have criticized mergers and acquisitions that create bigger and bigger banks. You are, at least partly, involved in advising banks on such mergers. How do you react to criticism of mergers and acquisitions and the specter of bigger, anticompetitive banks?

There are several parts to the question. First, a good merger or a smart acquisition makes the institution (and the whole regulated banking system) stronger and more resilient, not less. That’s good for the economy, good for consumers, and good for safety and soundness. Second, I think more competition among big banks is a good thing. We should encourage that, not restrict it. Otherwise, we are just building moats around the biggest institutions. Third, whether a company is too big to fail is a policy decision. Aside from those three points, I would also stress the importance of banks having good strategic advice and counsel when taking on a challenge like a merger. It is more complex than most people imagine, and it is helpful to hear from people who have done it before.

Deference to administrative agencies’ rulemakings has been in the news a lot lately. Do you see that doctrine going away and what would happen if it does? 

For the past 30 years, federal courts have adhered to a rule of deference, known as the Chevron doctrine, that asks if Congress has left a “gap” or “ambiguity” in a statute, and then allows the federal agency charged by Congress with the discretion to fill that gap or clarify that ambiguity so long as the agency’s actions are “reasonable.” The idea was to get unelected judges out of the process and put political appointees back on the spot and accountable to the electorate.

But, more recently, there has been a concern that the administrative state eludes political accountability. So, the question is whether courts should continue to afford Chevron-type deference to agency pronouncements where they are implementing a statute for which they are given responsibility by Congress?

The problem, it seems to me, is what do you replace Chevron deference with? Is it better to have unelected judges making policy decisions rather than unelected civil servants (who ultimately still must answer to a political appointee)?

The Supreme Court’s most recent pronouncement in the West Virginia v. EPA case may be the solution to this dilemma. The effect of the Court’s recent EPA decision is to cabin in Chevron deference by asking whether the agency’s policy decision is within the ambit of what Congress reasonably could have contemplated when enacting the statute at issue. If not, the agency then lacks authority over the disputed issue entirely, and the issue is thrown back to Congress to enact new legislation.

In this way, courts play their traditional “referee” function of determining whether the agency is acting within its delegated authority from Congress. If the issue is one that goes beyond what could have been reasonably been foreseeable at the time of the statute’s enactment, courts can intervene, but only to send the issue back to Congress (or the states). And, in the absence of further Congressional action, the federal agency will be prohibited from acting or adjudicating on the challenged issue.

Obviously, in the financial world, this clarification with respect to scope of federal agency powers is monumental. Agencies will be more constrained from generously interpreting their authority to address “new” issues and must always remember “first principles” in deciding what and how to regulate. Otherwise, agency actions may be subject to judicial review as beyond the scope of their statutory authority.

Regulators continue to struggle with creating a framework for understanding and regulating cryptocurrency. At the same time, we are seeing just how volatile that segment of the market is. What’s stopping regulators from making more progress? How should companies engaged in crypto be thinking about the current regulatory environment? 

Those are two very different questions. Let’s start with the first question, why is it hard to make more progress on creating cohesive policy regarding cryptocurrency? Part of that answer is that cryptocurrency is not just one “thing.” It’s a new technology. It involves new players. It is allowing us to do things differently and in some way rethink very old ways of conducting business. That involves a large number of competing interests, interlacing legal frameworks, and multiple agencies. So, part of the answer is that it is just very complicated, and part of the answer is parochialism.

The second question is just as complex because what do we mean by “being engaged in cryptocurrency”? Are you mining the currency? Providing custody services for those who have it? Trading it? Lending against it? Using it to modernize your own operations? Each question involves a different set of rules and unique expertise. One of the strengths of Patomak is that all the principals here have been engaged in these complex questions for years and can help clients get those answers sorted based on their unique business models and situations.

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