Your Consumer Health: Recent actions limit ability to ‘debank’ account holders

Consider the outright shock and abject panic you would experience if a bank closed your savings and checking/debit accounts, canceled your credit cards and called for full payment of your car loans and home mortgage. Then consider the possibility that your name is placed on an informal list which may be unofficially shared with other financial institutions, eliminating your ability to secure banking services elsewhere.

You would have no debit or credit cards, no access to the financial system, digital or otherwise, and you would have to insist that you be paid in cash, which would then have to be carried on your person or secreted away. This is known as "debanking" and is the equivalent of a financial nuclear explosion. To say that it presents a serious blow to a consumer's ability to function in society would be an epic understatement.

Banks are guided by federal law and regulatory requirements, such as anti-money laundering statutes and Federal Reserve regulations, to ensure no criminal enterprise is running cash through them to avoid IRS scrutiny. Know Your Customer restrictions permit monitoring of customer accounts to identify other illegitimate or questionable activities. And while banks are prohibited from discriminating against customers because of race, religion, national origin and other basic constitutional considerations, no federal law requires banks to accommodate all individuals or business firms. The opportunity to use the U.S. banking system is a privilege, not a right.

Some recent history is helpful in unwinding this issue. For years, banks relied on the concept of "reputational risk" to determine if customer accounts should be closed, this standard specified clearly in bank regulator guidelines but never specifically defined. If bank officials could find subjective evidence that a customer might be laundering money through accounts or was engaged in other legally questionable activities, they were permitted to conclude that the customer represented a possible RR to the bank's market and financial standing. RR was, in essence, a "look and feel" test, although one uncomplimentary commentator referred to it as a management "vibe check," the implication being that there was no substance to these risk assessments. Relying on RR, banks had the power to close accounts held by industries considered outside the mainstream, including crypto-currency brokers, payday lenders and legal cannabis dealers, and the banks did just that.

Debanking efforts increased noticeably following the bipartisan passage of the Patriot Act in 2001, which gave federal law enforcement additional surveillance powers to stymie terrorist organizations that were using our banking system. These extra powers provided that where indications or suspicions connected a business or individual with terrorism, the federal government could authorize banks to freeze accounts, thereby denying access to the U.S. financial system. But because RR is a subjective term that can be improperly applied by banks and cause irreparable consumer harm, federal legislation was proposed earlier this year to prevent banks from using it as a qualifier for account closure decisions. However, before that bill had time for Congressional approval, the Federal Reserve officially deleted RR from its formal bank examination guidance on June 25 of this year.

Soon thereafter, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation followed suit, and now all three major federal bank regulators are aligned in the removal of RR from examination guidelines. Instead, federal examiners are obligated to use established objective risk categories, like adequate capital, asset quality and the ability to cover customer cash demands, to make all decisions as to whether consumer accounts should be closed, relegating RR to the scrap pile.

Before the Federal Reserve took this action, Tennessee and Florida passed statutes that prevented debanking of state consumers based on RR. These laws provide consumers with the right to be informed of the reason for bank account closure as well as establishing recourse that includes filing a complaint that triggers a required, formal investigation. In North Carolina, a bill was introduced in the N.C. House of Representatives on April 10 that would have governed only state-chartered banks and made it unlawful to cancel bank accounts based on religious beliefs, personal opinions, speech or other subjective factors unless based on a risk calculation. The proposed law did not advance in the legislature and remains in committee. Finally, how the Tennessee and Florida state laws will interact with federal law that also now prohibits RR remains to be determined.

As I have discussed previously in this space, we are moving toward a financial system that is completely reliant on digital transfers of money, making any action that disenfranchises a bank customer antithetical to that objective. Debanking has been effective both in controlling the financing of terrorism and money laundering, but it has also been misused against consumers who were not engaged in either of these activities. Finally, decisions to debank consumers have cost banks millions of dollars, and the elimination of "reputational risk" from the bank regulation scene should mean that bank account closure decisions will be made more carefully with objective data.