The top official at the Office of the Comptroller of the Currency sent "a new warning" when he cautioned that big, complex banks could face divestiture if they fail to fix longstanding problems, according to analysts and attorneys.
Acting Comptroller Michael Hsu applied pressure on "too-big-to-manage" banks in a recent speech. In what industry experts dubbed a significant announcement, Hsu made clear that a four-step escalation framework could end in banks being broken up into smaller pieces. However, he noted that the OCC would approach this step with "great care" and with input from other regulators. He stressed that the OCC is sharply focused on whether banks are timely in correcting deficiencies.
Hsu publicly saying the agency would consider divestiture as the fourth stage in the process is perceived as a shot across the bow, some said.
"I view this as less of a new framework and more of a new warning about how the existing regulatory framework could be used to escalate pressure on large banks," James Stevens, co-leader of the financial institutions group at Troutman Pepper, told S&P Global Market Intelligence.
While divestiture is "extreme and unlikely," Stevens said, "the pronouncement of the possibility is intended to change behavior to avoid its need."
Some believe Hsu was sending a message to banks with long-term problems with which the OCC is running out of patience, instead of signaling an attack on all large banks.
"He's not saying, 'Let's waltz into a bank that isn't necessarily having big problems and just chop it out,'" said Ian Katz, managing director at Capital Alpha Partners.
'Drastic remedy'
Speaking at the Brookings Institution on Jan. 17, Hsu zeroed in on complex banks where "control failures, risk management breakdowns, and negative surprises occur too frequently." In those cases, the size and complexity of the bank "is the core problem that needs to be solved, not the weaknesses of its systems and processes or the unwillingness or incompetence of its senior leaders," Hsu said.
Hsu laid out a four-step escalation process that first includes private notices for the bank to fix identified problems. If the problems are not resolved, the agency would move to public enforcement actions to try to prompt change. From there, if problems persist, the OCC could move to growth restrictions and then to divestitures, according to Hsu.
In some cases "the most effective and efficient way to successfully fix issues at a [too-big-to-manage] bank is to simplify it — by divesting businesses, curtailing operations, and reducing complexity," he said.
Industry experts disagreed.
Divestitures would be "a drastic remedy," said Carleton Goss, an attorney at Hunton Andrews Kurth who works on OCC bank examination cases, in an interview. "I don't recall any of the regulators ever doing something like that before."
The Hunton attorney also noted that requiring a bank to divest a business or a region might not lead to smaller, more manageable institutions.
"You'd have to think about who you would sell them to, without creating the problems you're trying to avoid. The buyer would have to be someone that was pretty big already," Goss told S&P Global.
In the speech, Hsu stressed that the OCC will not make decisions on when to restrict or break up a large bank lightly. Any such actions from the agency are likely far off in the future, industry experts said.
"If they change the rules of the game, we have to pay attention," Christopher Marinac, director of research at Janney Montgomery Scott, said in an interview. "But I think that this is still a hypothetical situation. Regulations are going to put this into action."
Other agencies could take note
Other agencies may take cues from Hsu's speech, according to Raymond James analyst Ed Mills.
Hsu's speech signals "a continued interest in Washington in implementing an increasingly aggressive regulatory stance on financial institutions" and "continues a theme of Hsu advancing thought leadership that foreshadows later action by other bank regulators implementing his suggested reforms," Mills wrote in a note.
While other agencies may follow suit, the process Hsu laid out is largely not new, experts said.
Troutman Pepper's Stevens said the details Hsu provided on the four steps in the framework are helpful, but the first three steps in which the OCC engages in non-public enforcement, then public enforcement, and then business restrictions, are common in bank regulatory compliance processes.
"We see the first three levels all the time," Stevens said in emailed comments. "All banks receive notices of matters that require attention and many are subjected to public enforcement actions. We have also seen a few banks receive growth restrictions."
Recent examples of the escalation framework include Citigroup Inc.'s consent order with the OCC in which the agency announced enforcement actions and a $400 million fine in October 2020, indicating the bank got to at least stage two.
Meanwhile, Wells Fargo & Co. experienced the third level of the framework when the Federal Reserve ordered the bank to keep its assets below $1.95 trillion until it improved its governance and risk controls.
