Three Big Banking Challenges for the Biden Administration

The new White House will be pushed for answers on bank consolidation, fintech companies and what banks should do about climate change

By Thomas Hoenig

After a Trump administration that eased banking and finance rules as part of its effort to speed up the economy, the Biden White House is taking office with different regulatory instincts. What this means in practice will be seen as its new banking and finance officials confront three big issues: the industry’s consolidation, the impact of fintech and nonbank companies, and efforts to expand banking’s role in addressing climate change.

The Biden administration, however, is unlikely to change many of the prudential regulations for banks. Neither political party seems eager to reinstitute banking rules that were eased over the past four years, such as capital requirements, margin requirements for derivatives and related instruments, and the Volcker rule, which limits banks trading for their own accounts. There’s a perception that banks have weathered the COVID-19 crisis well and, therefore, the current prudential standards are adequate. Also, the new Treasury secretary, Janet Yellen, was cautious in instituting and enforcing new standards when she led the Federal Reserve, and it seems reasonable that she will continue with that approach.

Bank Concentration Is Trending

Bank concentration is receiving considerable attention from progressives and populists. It’s led, for example, to the establishment of the Open Markets Institute, a nonprofit launched in 2017 “to expose the dangers of monopolization.” This group will likely grow in importance during a Biden administration.

Over the past 20 years, the number of banks in the U.S. has declined from more than 8,300 to fewer than 4,000, and this consolidation continues at a rate exceeding 4% a year. The five largest U.S. banking companies now control half of the industry’s assets, up from around a third at the beginning of that period. They now process nearly half of all payment transactions. They dominate the derivatives market as a counterparty for transactions with notional values in the trillions of dollars.

What’s further driving this trend? Mergers between regional banks seeking to spread their fixed costs over more customers to compete in an industry where scale matters. When Sun Trust and BB&T merged in 2019 to create a company with $500 billion in assets, they said their goal was to achieve operational scale and gain access to costlier but better technology. Late last year PNC said it will acquire BVBA’s U.S. assets, which means its total assets will exceed $500 billion.

To what extent this scrutiny will lead to antitrust actions may depend on whether the largest banks can show that the benefits they bring to the market exceed the cost of their institutional advantages and protections. Importantly, it also may depend on how much new competitors in the market are able to disrupt the industry.

Fintech and Nonbank Companies Want In

Indeed, the emergence of financial technology companies and other nonbanks may be the dynamic that changes the concentration debate. Fintech companies generally enter banking by offering payment products, then joining with banks that have deposits and clearing their payments through those banks. Using new technology and mobile platforms, fintech companies provide fast and reliable payment methods and convenient financial products. As they grow, they look to expand their lending facilities and their access to deposits, central bank clearing and, ultimately, deposit insurance. In doing so, they gain the privileges and protections of a bank but become subject to more regulation. Fintech businesses Square and SoFi appear to be following this path.

A variant of the fintech model is “stable coin,” in which a company issues its own currency backed by “highly safe assets” as an efficient means of payment across markets and national borders. An example is Facebook’s proposed Diem (formerly Libra) currency; its value is tied to a basket of sovereign currencies held as reserves against outstanding Diem balances. Other alternatives to banks that are candidates to issue currencies include Google Pay, Amazon Pay, Apple Pay, WeChat Pay, Alipay and Walmart, which have extensive global networks and millions of account holders.

Some nonbanks have acquired state-chartered industrial loan companies, which are in essence commercial banks, to gain access to deposits insured by the Federal Deposit Insurance Corp. These companies are exempt from the Bank Holding Company Act, enabling nonbanks to break into commercial banking with less regulatory oversight. General Motors, for example, is seeking to form an industrial loan company, which would allow it to substitute lower-cost insured deposits for corporate debt to fund its lending.

As fintech and industrial loan companies increasingly compete with commercial banks, the largest banks will become less dominant, making the argument for antitrust action less persuasive. But there are policy issues with opening banking to more players. One is whether companies that own banks should continue to be prohibited from owning businesses that are not banks while companies that don’t own banks, such as General Motors, are allowed to own a fintech or industrial loan company and still remain exempt from bank regulations and supervision.

Such a difference in treatment provides an advantage that’s hard to justify. This inconsistency can be addressed by rebuilding the wall between companies that own banks and those that don’t, while those that don't should be required to divest their fintech and industrial loan companies. Alternatively, the statutes could be amended to allow companies to engage in both nonbank and bank activities and abide by the same rules.

Another issue is whether to bail out companies that conduct bank-like activities, such as managing money market funds or engaging in investment banking. Currently when these companies come under severe pressure in a financial crisis, the government feels compelled to rescue them. This tendency will intensify as more outfits gain access to insured deposits and central bank payments clearing.   Allowing an ever-larger cadre of corporations to become banks will increase the government’s subsidies and its potential bailout costs, which are ultimately paid by taxpayers.

The Biden administration needs to determine whether the benefits of nonbanks entering banking outweigh the costs. The issue is growing in importance as the number of nonbanks wishing to become banks continues to rise. Leaving the matter unresolved would create a chaotic environment as nonbanks push to join the market and the government is forced to take an uneven regulatory approach to overseeing the different players.

Calling on Banks to Fight Climate Change

Enlisting banks to help counter climate change will be a priority for the Biden administration as it moves past the pandemic. Activists have long argued that banks should direct capital toward what they see as socially important industries and causes, especially given the advantages they get from the government. Climate change is at the top of the list of what are called ESG issues—environmental, social and governance.

Climate change is a legitimate topic for concern, and it’s not surprising that governments are turning to banks to help address it. The Financial Stability Board, an international group of central banks and bank supervisors, has established the Task Force on Climate-related Financial Disclosure. Complementing this initiative, central banks across the globe have formed the Network of Central Banks and Supervisors for Greening the Financial System.

Central banks are using groups such as these two to develop climate models to nudge banks away from funding carbon-based industries and toward allocating more capital to “green” industries such as solar energy and electric cars. However, as well-intentioned as such efforts might be, they come with significant risks. For example, the task force’s model estimates an “implied temperature rise” for evaluating the risks and opportunities of portfolios as global temperatures change. The task force acknowledges the high level of uncertainty around the index, and politics will add to the uncertainty as interest groups try to influence the index.

Such models are as likely to lead to misallocating resources as to guiding capital toward desired results. Their use and outcomes may mimic the models associated with the Basel risk-weighted capital standard; researchers have repeatedly demonstrated that these models have led to poor results in judging asset risks and financial stability.

What’s more, central banks building and employing climate models to influence the flow of capital to preferred industries is outside their mandate. It expands their mission beyond fundamental monetary policy. Such mission drift has already begun, with the Fed purchasing mortgage-backed securities and corporate bonds. To insist that it also direct capital to industries seen as “green” undermines the justification for its political and policy independence. There very well may be a role for government to address climate change, but it should be done through legislators, not central bank administrators.

As the new White House starts to tackle these three challenges, the debates will be intense. The policies and actions that follow will affect capital flows, the business model for banking and, ultimately, the performance of the economy well into the future.