Over objections by bank regulator, GAO makes nine recommendations to prevent ‘regulatory capture’ at agency

Nine recommendations aimed at preventing the federal regulator of national banks from becoming the victim of “regulatory capture” in its supervision of large banks are contained in a report released Monday by the congressional watchdog agency.

Among the recommendations for the agency are: improve the documentation of its supervision process, check for conflicts of interest, periodically assess its ethics program, and expand its approach to addressing the risk of capture across the agency.

The Government Accountability Office (GAO) said its recommendations for the Office of the Comptroller of the Currency (OCC) were derived from its review of the 2007-09 financial crisis, which (the GAO said), was triggered in part by weakness in supervision by federal regulators. Regulatory capture, the GAO said, was one potential cause of the weakness.

The GAO defines regulatory capture as a regulator acting in the interest of the regulated industry rather than in the public interest.

The GAO wrote that the bank regulator supervises some of the largest financial institutions in the United States. It said “it is essential” that OCC staff are not inappropriately influenced by the industry they are regulating. “OCC has identified regulatory capture as a risk and has policies in place that could address this risk,” the report states.

According to the congressional watchdog, OCC has some policies that encourage transparency and accountability in its large bank supervision processes. However, GAO said, weaknesses in documentation requirements may make large bank supervision more vulnerable to regulatory capture. “For example, examination teams are not required to document internal deliberations or communications with banks that lead to consequential decisions for a bank, such as supervisory or enforcement actions.,” GAO wrote.

The OCC, for its part, sees things differently, according to the report. The GAO said of the nine recommendations it made related to managing the risk of regulatory capture, OCC agreed with one recommendation, disagreed with five, and neither agreed nor disagreed with three. “GAO maintains that the recommendations are valid,” the report states.

The recommendations are:

  1. The agency’s Large Bank Supervision (LBS) division should require documentation of examination teams’ internal deliberations that lead to consequential decisions for a bank, such as the decision whether to issue a “Matter Requiring Attention,” among others.
  2. The LBS should require bank examination teams to retain drafts of key documents, including the conclusion memorandum and supervisory letter, that record the supervisory review process.
  3. The LBS should require documentation of communications with banks, including those between executive and senior management and banks, that inform supervisory decisions.
  4. Use of informal recommendations should be systematically tracked and monitored by LBS.
  5. The OCC’s chief counsel should require that staff who review and record employees’ conflict-of-interest information (1) consistently record explanations of changes to scopes of recusals and (2) record waivers of Treasury’s supplemental standards separately from recusals.
  6. The chief counsel should also develop a policy for LBS to (first) check employees’ active conflicts of interests during the staffing process for examinations and other supervisory activities and (second) to document the results of this check.
  7. The chief counsel should also: revise OCC’s instructions for conducting examination workpaper reviews to ensure that they are complete; and communicate the revised instructions to employees.
  8. A periodic self-assessment of the agency’s ethics program, including evaluating the implementation of its associated controls, policies, and guidance should be conducted by the chief counsel, with results documented and action taken (as appropriate) based on the assessment.
  9. The agency’s approach to addressing the risk of regulatory capture, including revising its risk appetite statement to address risk areas other than reputational risk, and identifying additional factors to analyze when assessing the risk of regulatory capture, should be expanded by its chief risk officer.

According to the OCC’s response to the report (dated Dec. 21), the bank regulator appeared to agree with recommendation seven, disagree with recommendations one, three, four, eight and nine – and neither agree or disagree with the rest (two, five and six).

The report on the OCC is the latest warning the GAO has raised about concerns for banking supervisors with regulatory capture. In December 2017, the GAO warned that the Federal Reserve’s failure to progress on a program meant to manage risk among large banks and financial institutions may be leading to a threat to the independence at the central from the industry it regulates.

GAO said then that the failure of the Fed to finalize and implement its enterprise risk management (ERM) framework to balance risks across its Large Institution Supervisory Coordinating Committee (LISCC) program may be risking the condition in which a regulator acts in service of private interests, such as the interests of the regulated industry, at the expense of the public interest.

GAO report on Large Bank Supervision: ‘OCC Could Better Address Risk of Regulatory Capture’