Major Shift In Fed Policy: No More Reputation Risk In Bank Regulation

• The US Federal Reserve Board has eliminated Reputational Risk from its supervision criteria for banks, marking a monumental win over debanking.
• The Fed’s recent activities signal a more progressive approach towards banking regulation that promotes crypto and financial innovation

On Monday, the Federal Reserve Board announced its removal of Reputational Risk from the elements of its banking supervision programs. The elimination of this criterion has dealt a significant blow to Biden-era debanking practices, which were implemented under the guise of this criterion.

Fed Ramps Up Banking Regulatory Clarity

“The Board has started the process of reviewing and removing references to reputation and reputational risk from its supervisory materials, including examination manuals, and, where appropriate, replacing those references with more specific discussions of financial risk,” said the Fed.

By eliminating reputational risk from its supervisory criteria, the Fed creates space for greater regulatory clarity for financial institutions under its oversight, while removing barriers to seamless banking integration with crypto and other emerging financial technologies.

ADVERTISEMENTThe Federal Reserve used the “reputational risk” tag to stamp out activities, services, and affiliations that they deemed harmful to the bank’s or its financial viability, based on potential public image concerns

While this regulatory pattern was meant to protect banks, its downsides seemingly outweighed its advantages. For instance, banks raised concerns of a lack of regulatory clarity, since the Fed could just flag any activity as harmful based on poor public opinion or a political conspiracy to flag down such activities or services.

Furthermore, the reputational risk factor was highly discriminatory against certain industries and clients. In a bid to avoid fallouts with the regulator, banks stopped attending to certain clients or sectors, such as those involved with cryptocurrency and select industries.

ADVERTISEMENTThe tag was also a major vehicle for Operation Choke Point 2.0—a major assault on allegedly controversial clients like crypto firms, payday lenders, gun producers, the cannabis industry, and others—penalizing banks for serving such players, even if they were legal, owing to perceived reputation threats.

Banks to Increase Crypto Services, Following Reputational Risk Elimination

In April, the Fed rescinded four of its Biden-era anti-crypto guidelines, most of which were virtually impracticable, leading to banks refraining from many crypto services

Regardless of this move, Senator Cynthia Lummis still maintained that it was “lip service” if the regulator did not refrain from its use of reputation risk in bank supervision and reversed its stance on digital assets being “unsafe and unsound.”

While Lummis calls the removal of the reputation risk a win, she believes there is “still more work to be done.” As Custodia Bank CEO Caitlin Long also noted, some of the tools used to implement Operation Choke Point 2.0 are still in place and need to be scrapped as well.

The Fed’s move will allow banks to offer crypto services more freely, while enjoying more objective supervision. Meanwhile, the Board says that the latest change does not alter its expectation for banks to “maintain strong risk management to ensure safety and soundness and compliance with law and regulation.”

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