Bank Lawyer's Blog

Enhanced Recordkeeping Proposal: Kill It Before It Multiplies

One of BLB's favorite gadflies, Bert Ely, was at it again last week (paid subscription required). This time, his incredulity was focused on an FDIC proposal to require the country's largest banks (those with over two million deposit accounts) to implement more "robust" (and expensive) systems for determining more quickly, upon failure of the bank, whether a deposit is inured, uninsured, or partially insured. While Bert concedes that the proposed rule initially burdens only 36 banks, "one could imagine a scenario when this regulation could easily be extended to all banks." "One" could. It's called "trickle down" regulation. The CFPB's "race to the overbearing bottom" is a classic example. Therefore, argues Bert, "all banks" should oppose it.

While Bert criticizes the difficulty and expense (FDIC estimates the 36 banks will have to spend $328 million in system upgrades) of the proposal, his real criticism is that, based on recent history, the "proposed rule bears no relationship to reality."

Inasmuch as the FDIC has had the power (since the enactment of FIDICA in 1991) to protect the uninsured deposits of a failed bank if that was a less costly alternative to letting the uninsured depositors "eat cake," and since the panicked lines of depositors at IndyMac in 2008 encouraged The Care Bair and her successor to favor to overwhelmingly favor protecting all depositors in subsequent failures (in 482 of 512 post-IndyMac failures, Ely asserts), there is little likelihood that the FDIC would not protect all depositors from a public relations standpoint. Moreover, Ely argues, because protecting all depositors usually protects the "franchise value" of the failed bank, acquiring institutions are usually motivated to pay enough for the deposits and non-mortally wounded assets of the failed bank that liquidation and "stiffing" the uninsured depositors is not likely to ever be the least costly alternative.

Bert also argues that liquidation "can be very disruptive to the failed bank's lending and other nondeposit relationships. He cites the 2009 liquidation of New Frontier in Greeley, Colorado, as one instance in which local businesses were negatively impacted. Being familiar with that specific example, I can vouch for the veracity of Ely's opinion. Finally, Bert argues that the FDIC's recent concern with the continuing liquidity of banks (especially large banks) in crisis situations would be hampered by liquidations in which uninsured depositors were not paid, and might induce uninsured (and even insured) depositors in other banks to stage runs (ala IndyMac).

All-in-all, says Bert, this proposal is a bad idea and "the FDIC should kill it."

Amen.

Ponzi Not Gone(zi)

Nearly five years ago, we discussed the risk that Ponzi schemes posed to banks and the need for the BSA/AML personnel of the bank to be skilled on detecting the warning signs. The recent judgment against PNC in St. Louis ought to hammer home that point.

A jury in federal court here on Monday awarded $491 million in damages in a civil lawsuit sparked about seven years ago by the collapse of a Clayton-based company selling prepaid funerals.

[...]

After a five-week trial, the jury awarded $355.5 million of compensatory damages and $35.5 million in punitive damages against PNC Bank and $100 million more against Forever Enterprises, the latter being a defunct family-owned holding company.

The suit is based upon the "bad conduct" of officers of a company (NPS) that sold prepaid funeral contracts. PNC's predecessor bank acted as the trustee of the contracts.

NPS promised customers across the country that money from prearranged funeral contracts would be held in trust. Claims were supposed to be funded by life insurance policies payable to the trust. But federal authorities found that company officers and others spent some of the money on lavish lifestyles instead.

Beginning in the early 1990s, liabilities exceeded trust assets, the plaintiffs said, and NPS could pay for funerals only by using cash from new contracts.

More than 97,000 victims — customers, funeral homes, insurers and financial institutions — lost money, federal officials have said.

The officers went to prison. PNC has now taken it in the shorts, financially speaking, although the bank has vowed to appeal. I expect any right-minded financial institution would rather pay lawyers millions to fight a nearly half-billion-dollar verdict than to meekly pay it. After all, you need to send a message to potential plaintiffs' lawyers that you need to come strapped (again, financially speaking) if you're gonna' mess with PNC. In addition, the bank might actually be sincere in its "respectful" position that the jury screwed the pooch (judicially speaking) and that it can win on appeal (even if "win" means paring the size of the verdict down to an amount that won't choke a Clydesdale).

Regardless of the outcome on appeal, the verdict demonstrates why banks need to be locked and loaded when it comes to spotting potential Ponzi schemes. That might be a harder task in a state like Colorado or Oregon, where recreational marijuana use is legal and all of this stuff gets lost in a cloud of smoke, man, and then....ummm...ahhhh... What was I saying?

Oh, yeah: "Beware the Ponzi" or "Man, that rug really tied the room together."

Rant Me A River

When credit union consultant Marvin Umholtz gets worked up, it makes my blogging life a breeze. All I have to do is cut and paste. While a number of bankers would rather drink Drano rather than follow a newsletter dedicated to credit unions, I assure all of you bankers who bleed red rather than blue that you will love Marvin, especially when he goes after one of this blog's bête noire, the Adjustment Bureau, as he did in his latest email newsletter:

This correspondent knew that the self-righteous and meddlesome Consumer Financial Protection Bureau’s (CFPB) www.consumerfinance.gov zealous crusaders had targeted overdraft protection programs for the agency’s peculiar brand of “reforms,” yet the arrival of that CFPB intervention still came in a surprising way. In an 870-page proposed rule http://files.consumerfinance.gov/f/201411_cfpb_regulations_prepaid-nprm.pdf ostensibly regulating prepaid products, the CFPB reclassified overdraft services as an extension of credit and overdraft fees as the cost of credit. The agency has set its precedent in this prepaid products rule for all future treatment of overdraft services. If the CFPB extends the credit definition to all overdraft services in every circumstance as it is expected to do based on this prepaid products proposal, then it will effectively ban overdraft services – period. As a result of the loss of overdraft services many credit unions’ fee income would drop precipitously. The only conclusion that a rational person could come to would be that the CFPB has become the biggest threat to safety and soundness that credit unions now face. And since this proposed prepaid products rule also covers mobile and other electronic prepaid accounts, PayPal, Google Wallet, and scores of other innovators should also watch their backs. The CFPB’s proposed prepaid accounts rule was loaded with intended and unintended consequences.  

The CFPB’s proposed rule amends Regulations Z and E to regulate prepaid cards, codes, or other devices capable of being loaded with funds and usable at unaffiliated merchants or for person-to-person transfers, and that are not gift cards, with overdraft services or credit features. The agency’s action effectively bans overdraft services use with prepaid cards since the CFPB proposal also requires the prepaid card provider determine the customer’s “ability to repay” prior to linking overdraft services to the product. With the added underwriting costs, the overdraft services would likely be uneconomical to the provider. The ramifications from the CFPB reclassifying overdraft services as credit would be widespread. For example, the Department of Defense’s proposed Military Lending Act rule that imposes a 36% federal usury limit on loans to military service members and their families for all consumer loans (other than those secured by real estate or a vehicle) is still pending. Should it be finalized as is expected, it would make the overdraft fee on all CFPB re-defined credit extensions via overdraft coverage have excessive and illegal annual percentage rates (APRs) due to the hefty fee charged for the overdraft. Operationally a credit union could not then allow any service member or member of their family to have overdraft services on their deposit accounts. Such a distorted approach to the marketplace would be problematic at best. It would certainly be inefficient; and it could generate ill will. It might also generate class action lawsuits. And that is just one illustration of the potential fallout from the CFPB’s reclassification of all overdraft services as credit extensions.

According to the CFPB, “Among other things, prepaid cards that access overdraft services or credit features for a fee would generally be credit cards subject to Regulation Z and its credit card rules. Moreover, the proposal would require that consumers consent to overdraft services or credit features and give them at least 21 days to repay the debt incurred in connection with using such services or features. Further, Regulation E would be amended to include disclosures about overdraft services or credit features that could be linked to prepaid accounts. The compulsory use provision under Regulation E would also be amended so that prepaid account issuers would be prohibited from requiring consumers to set up preauthorized electronic fund transfers to repay credit extended through an overdraft service or credit feature.” The CFPB’s lengthy rule included 89 pages of summary and background before it even began to discuss the proposal on a section-by-section basis. The legal language of the rule followed that analysis. Once the rule is published in the Federal Register, there would be a 90-day comment period.

The agency announced the proposed prepaid products rule in a November 13^th press release www.consumerfinance.gov/newsroom/cfpb-proposes-strong-federal-protections-for-prepaid-products and in conjunction held a prepaid accounts field hearing in Wilmington, Delaware. The field hearing included opening remarks by CFPB Director Richard Cordray www.consumerfinance.gov/newsroom/prepared-remarks-of-cfpb-director-richard-cordray-at-the-prepaid-products-field-hearing and a panel presentation featuring prepaid products industry representatives and consumer activists. In his remarks Director Cordray once again made it abundantly clear that the CFPB’s intent was to socially re-engineer the financial services marketplace to meet a decidedly left-leaning partisan agenda. At the close of his speech he said, “Just because consumers may not be able to afford or qualify for a bank account, or just because they do not want to be part of the brick-and-mortar banking system, this does not mean they deserve to be treated as second-class citizens. Like anyone else, they deserve to have a safe place to store their money and a practical means of carrying out financial transactions. And though many prepaid companies already have opted to offer some of these basic, common-sense protections, it is important to ensure that they are not simply optional but instead are cemented as the standard for the industry and enshrined in law.” Apparently, the CFPB knows what is best for all. It seems like the agency routinely uses the “protecting the most vulnerable” as the excuse for big government intervention and the imposition of innovation-crushing regulations.

Every time the in loco parentis CFPB acts purportedly in this correspondent’s best interests it seems more like the agency is trampling on his individual liberties. As a colleague once speculated during a conversation with this correspondent, the next thing the CFPB is likely to do is a full takeover of checking accounts. It’s only a matter of time. The CFPB will tell financial services providers what services people can have, how much service they can have, what they will pay for the service, and when the financial service provider is permitted to stop providing the service. There was also some discussion about the timing of the controversial “overdraft as credit aspect” of this prepaid products rule coming after the midterms rather than before. Was it deliberate or just a coincidence? There certainly were a lot of Democratic members of the House and Senate running for re-election November 4^th who had sponsored legislation that restricted overdraft programs that were probably drafted by the consumer activists. These members of Congress, at least those who were re-elected, and the activists now have the CFPB to do their dirty work.

If you'd like to subscribe to the newsletter, email Marvin at [email protected]. Tell him the Texas curmudgeon referred you. I mean, you simply have to love a guy who uses "in loco parentis" when referring to the Death Star.

CFPB Delenda Est!

Wal-Mart Is Go-Go On GoBank

Not satisfied with prepaid cards from Green Dot or Bluebird Accounts via American Express, Wal-Mart's march into the banking business is now all the way into checking account territory.

Walmart, the nation’s largest retailer, is teaming up with Green Dot, known for its prepaid payment cards, to supply checking accounts to almost anyone over 18 who passes an ID check.

Daniel Eckert, senior vice president at Walmart, said on Tuesday that the accounts would be available nationwide by the end of October. The accounts are intended to be low-cost alternatives to traditional bank checking accounts, with no fees for overdrafts or bounced checks and no minimum account balance.

In comparison, a basic checking account at Citibank charges $12 if a check is returned and $34 for overdrafts.

The new accounts from Green Dot, called GoBank, will cost $8.95 a month if they have direct deposits totaling less than $500 a month. Mr. Eckert said that most people on Social Security or fixed pensions would qualify.

GoBank, as the service is known, is part of Walmart’s long-running push into financial services for people with little or no access to traditional banking.

[...]

Walmart has been eyeing financial services for some time. Two years ago, the company announced a partnership with American Express to offer a prepaid card and debit accounts. Retailers like Target and 7-Eleven also offer prepaid cards.

But the new Walmart initiative will be the first full-blown, off-the-shelf checking account. To help attract customers, Walmart and Green Dot will forgo a screening system many banks use to vet potential customers and rely instead on a proprietary system. The model is expected to allow almost any consumer who passes an identification check to open an account in minutes, according to Green Dot.

In the past, Walmart has tried to secure a federal bank charter to become a deposit-taking bank, but abandoned that effort in 2007 in the face of opposition from the banking industry. Since then, the retailer has assembled an array of services that could be offered without a charter, as well as partnerships with financial service companies like Green Dot.

Five years ago, we discussed how well Wal-Mart was adapting to the stonewalling by the FDIC of its attempt to start or buy an industrial bank. One benefit was that Franken-Dodd's "study of the need for industrial bank charter" may have presaged the demise of that particular charter, making Wal-Mart sorry that it got what it wished for. But there was more to it than merely the form of the charter that it was denied.

It's interesting that Wal-Mart, by not being in the banking business, is side-stepping the public relations backlash that is tainting other bankers who had nothing to do with the causes of the current crisis, such as community banks that are dropping like lawyers on a dove hunt with Dick Cheney. Instead, Wal-Mart is using the avenue open to it (not ideal, but workable) to cement its relationship as a low-cost provider of financial services to working class Americans. The Beast of Bentonville refuses to be tamed.

Wal-Mart didn't get to be a retail "beast" by backing down when confronted. When denied entry through one door, it has relentlessly worked on finding other doors, and then opening them wide. I simply don't see them stopping. As a consequence, of course, lower income citizens who form Wal-Mart's core customer base and who have traditionally had less access to traditional banking services are being "served," but in a beneficial way. Therefore, whether or not bankers are thrilled, the same FDIC that once effectively barred Wal-Mart from the banking business ought to be standing and applauding these latest efforts. Or, at the very least, a squatting ovation seems in order.

Secondary Smoke Allergy

I'm not sure if it's the collateral paranoia engendered by Operation Choke Point, the fact that regulators are on a crusade to root out evil wherever they see it (and they know it when they see it), or if somebody simply got ahold of a bad batch of weed, but the way banks are treating any business remotely (and I mean "remotely") connected with the (state) legal marijuana business has officially jumped the shark. It's time to untwist the knickers and take a deep breath.

We discussed not long ago a Texas promoter of a conference on legal marijuana businesses being cut off by his bank. More recently, we've discovered that Wells Fargo has thrown one of its Washington customers under the bus because he publishes a magazine with the word "marijuana" in the title.

Last week, Marijuana Venture magazine publisher Greg James said he was informed that Wells Fargo Bank would not accept deposits from the limited liability company that publishes the magazine.

Never mind that Marijuana Venture merely writes about the legal cannabis industry and does not promote marijuana use. "We are simply running stories on how to navigate the industry and promoting best of breed business practices," James said.

[...]

James is not the first person in Washington to find it difficult to work with banks because his business has at least some connection to marijuana. A banker told one Seattle-area entrepreneur who grows medical marijuana to stop bringing cash that reeks of weed into the branch. But James' business has nothing to do with the growing, processing or sales of actual marijuana. He's publishing a magazine about marijuana.

I get the "cash that reeks of weed" repugnance. After all, the largest banks only desire "cash that reeks of greed." That stink smells like a whiff of heaven to them.

James makes the valid point that once you start down the slippery slope of "unbanking" publishers of newspapers and magazines that are focused on discussing legal marijuana issues, you're not just on a slippery slope, you're riding a waxed toboggan down the slope.

James wonders whether banks would not deal with the Puget Sound Business Journal because the paper reports on the marijuana business. And what about the Denver Post, which has a marijuana editor?

I assume that the Post's marijuana editor had just consumed an entire bag of "Hashey's" bars and was "unavailable for comment."

The longer the federal bank regulators take to issue guidance on this issue, the longer it will take for the smoke to clear. Even though no one expects the regulatory agencies to put their seal of approval on banking MJ businesses themselves, they could give banks some comfort about banking the businesses that serve those businesses, like the landscape company that irrigates the plants or the electrical contractor that services the heat lamps. At the very least, they could assure quivering masses of protoplasm like Wells Fargo that the risk posed by Marijuana Venture is acceptable, especially compared to the risks of, for example, banking folks who are actually on OFAC's SDN list.

BancSouth Wins Big

A recent Eighth Circuit Court of Appeals decision in favor of BankSouth bodes well for financial institutions who understand their obligations under UCC Article 4A and take those obligations seriously. Unlike consumer customers, who are pretty much protected against unauthorized funds transfers by Regulation E if they examine their monthly bank statements and promptly inform their banks of any unauthorized transactions, business customers whose bank accounts are compromised by cybercrooks have much less protection. As the 8th Circuit points out, the inquiry in such instances is focused on whether the bank and customer had agreed upon commercially reasonable security procedures that the bank would use to determine whether or not a purported funds transfer was authorized by the customer and, if so, whether or not the bank employed those security procedures in good faith. If the bank meets that two-pronged test, the business customer is stuck with liability for any unauthorized transfer.

The controversy usually arises when an employee of the business customer has fallen for a "phishing" scheme, clicking on link in an email that causes malware to be downloaded that allows the crooks to learn the user name and password that the employee uses to log in to the online banking system of the bank. In the BancSouth case, that apparently occurred. However, regardless of how access to the password and user name was obtained, the focus of the court was, as it should have been, whether the agreed upon security procedures used by the bank were commercially reasonable and employed by the bank in good faith. In this instance, the court (and the trial court) found that they were.

While the customer's attorneys argued that the use of a user name and password was "one-factor authentication" that is contrary to FFIEC guidance that advises that "multi-factor authentication" processes should be used, the court countered that argument by finding that the bank offered "dual controls" for wire transfer (separate persons must authorize the initial funds transfer request and the confirmation of that transfer order), the customer opted not to use such a procedure on the grounds that it was "inconvenient." More cautious banks not only offer dual controls, they require it unless the customer signs a separate agreement or waiver under which it indemnifies the bank from any claims, loss, or liability arising out of unauthorized transfers from the account under a single-control authorization process. BancSouth had such a waiver and the customer signed it.

BancSouth's online banking agreement also contained an indemnification provision that is common in online banking agreements in one form or another, pursuant to which the customer agreed to indemnify and hold the bank harmless from claims, losses, liabilities, costs and expenses, including reasonable attorneys' fees, arising out of the bank's provision of services, as long as the bank fulfilled its obligations. The appellate court ruled that this provision provided a sufficient basis for the bank to pursue a claim against its customer for payment of attorneys' fees, and overturned the trial court's denial of a counterclaim by the bank for such fees. Again, well-drafted online banking agreements ought to contain a similar provision.

Dan Mitchell, an attorney who has been involved in other high-profile litigation on this subject, and another commenter, had some cogent observations on the implications of this decision.

Perhaps most significantly, Mitchell said, the decision could be a blow to companies trying to recover cyberheist losses from their banks. Bancorp South had asserted at the trial court level that its contract with Choice Escrow indemnified it against paying legal fees in such a dispute. The trial court dismissed that claim, but the appeals court said in its decision that the bank could recover the costs from the escrow firm.

"The bank had asserted a counterclaim that the customer should pay the bank’s legal fees," said Mitchell, who battled similar claims in which Patco — a Maine construction firm — successfully sued its bank over a $588,000 cyberheist. "There’s no other federal circuit court case other than Patco that has gotten up to that level. The appeals court said the bank can now pursue its legal fees against the customer. And that may end up being the important part of this opinion in the long run if [plaintiffs are] looking at not only have to pay their lawyers to pursue a loss but also those of the bank."

Charisse Castagnoli, an adjunct professor of law at the John Marshall Law School, said the appeals court decision means that indemnification is now the ‘law of the land’ in the 8th Circuit.

Castagnoli said she expects two results from this decision: that banks which don’t already have these clauses in their online banking agreements will add them; and that cyberheist victims will think more cautiously about bringing a lawsuit.

"This is the first time a court has ruled on fee shifting, and that will certainly have a chilling effect on litigation," Castagnoli said.

The opinion contains other nuances that are worth considering. The linked article from Brian Krebs' excellent blog contains a link to the opinion.

Governors Ask For Guidance

It's not merely Colorado marijuana-related businesses that are having a tough time finding a bank that won't kick them to the curb. A Texas businessman suddenly found that his Texas bank considered him akin to a Typhoid Mary when it discovered that he was hosting a marijuana business investors conference in Houston.

Stuart Maudlin, the Houston entrepreneur behind Marijuana Investment Conferences, has closed his account at Amegy Bank, a unit of Salt Lake City-base Zions Bancorporation (Nasdaq: ZION) and Houston's fifth largest financial institution with nearly $10 billion in local deposits, after receiving a letter that the account would be closed within 10 days.

Maudlin received a letter from Amegy Bank dated May 15, which he shared with the HBJ, that said, "Amegy Bank regrets to notify you that we will be closing the Amegy Bank account referenced above."

The account is listed as Silent Auction Services Inc., DBA Marijuana Investment Conferences.

"I can reasonably infer that they're worried about having drug money show up in my account," Maudlin said.

The bank declined to say why it was closing the account.

My guess is that if he'd had the foresight to name the account "Silent Auction Services Inc., DBA Hooters Investment Conferences," he would have been A-OK with bankers in Texas.

The ongoing failure of Mary Jane-centric businesses to obtain access to the banking system has prompted the governors of Colorado and Washington to, again, write the federal banking regulators and ask them for guidance. They did this last October. The regulators told them they'd take a look at the need for guidance once the DOJ and FinCEN responded with their concerns. FinCEN did that in February, but that "guidance" not only didn't help matters, it made them somewhat worse. Banks are more afraid of enforcement action by their primary federal banking regulator than they are of a criminal indictment from the DOJ, although they're worried about both possibilities. The bottom line is that banks need to know what the bank regulators might do to them if they bank a (state law) legitimate marijuana business, or a business that sells products or services to a legitimate marijuana business. By legitimate, I mean one that is legal under Colorado (and, in the near future, Washington) state law.

Some critics think that Colorado and Washington deserve to stew in their own juices, since they are arguably "outliers" in the drive to legalize the recreational use of marijuana. However, other states are considering similar laws, and 20 states have medical marijuana laws that also violate federal laws. Heck, even a stalwart conservative crank like Texas Governor Rick Perry is publicly in favor of legalizing recreational marijuana use.

[As an aside--can you imagine how even more daffy Perry might end up sounding like in a 2016 presidential primary debate if he starts toking?]

The point is, sooner or later, the federal banking regulators need to come to grips with this issue. They might as well do it sooner than later, because this reefer madness is not likely to abate, but only to snowball until this country becomes one stoned-out, unbanked mass of munchie-seekers torn between the need for Doritos and the fear that the fifty thousand dollars in cash they carry in their underpants makes it unsafe for them to venture outside to buy a bag.

Porn Stars Held To Be "Un-accountable"

Operation Choke Point, and the general attitude of the federal banking regulators toward businesses that they've picked (for reasons best known to themselves) as worthy of being branded with a Scarlet Letter, are causing cautious banks to drop customers who might be engaged in perfectly legal activities. Apparently, the latest victims are porn stars (paid subscription required).

A new war is brewing between banks and their customers, and the fight is going public.

PR black eyes of the past would have come from ATM surcharges or foreclosure injustices. Now, news reports are stacking up about angry customers — payday lenders, check cashers, telemarketers, gun dealers and even adult entertainers — who are complaining that their accounts have been, or could be, unfairly terminated.

[...]

The pornography sweep in particular only strengthens bankers' suspicions that regulators are forcing them to play the role of morality police. And it raises more practical questions for bankers: How do they balance public perception and compliance? What industry will they feel compelled to shut out next?

Look, porn stars ought to be banned from access to money due primarily to their utter lack of acting chops.

"Hi, I'm Eva. I'm from the maid service. I'm here to clean your house."

"Hey, Eva, would you start with cleaning...THIS?!?"

"Oh, baby! Yeah...yeah...oh...oh..uhh..uhhhh...OHHHHHHHHHHH!!!"

Yet, in this great country we call "The Land of the Free and the Home of the Horny," the "adult entertainment business" is legal. As is payday lending (in many states), check cashing, renting-to-own, deposit advances, tax anticipation refund lending, and being a "Pawn Star." However, all of those businesses have a "common taint": the DOJ and federal bank regulators don't like them. While the ostensible rationale for that dislike may be that they pose higher risks of money laundering or other illegal activities by some of their members than do other business (like insidre trading investment advisers to members of Congress), I've not seen the evidence that Teagen Presley is a crook, albeit you might argue, with some support, that she's a "bad actor."

Reporter Andy Peters points to a problematic FDIC report from 2011 that listed the current crop of the disfavored, and that may be a guide to "who's next."

Pornography is one of several potentially problematic industries listed in an FDIC report in June 2011 that warns banks about managing third-party payment processor relationships. Ties between banks and processors that handle transactions for the problematic industry sectors can expose banks to "greater strategic, credit, compliance, transaction, legal and reputation risk," the FDIC said.

[...]

In addition to pornography, the other high-risk industries the FDIC identified included ammunition and firearms sales, credit-repair services, drug paraphernalia, fireworks sales, dating services, racist materials and tobacco sales.

Dating services?

Peters quotes Bill Isaacs, the former FDIC Chairman who's been a fierce critic of Operation Choke Point: "Banks are left to guess who deserves access to the banking system and who doesn’t."

I'd say "deserve" has nothing to do with it. "Whim" appears to be the criteria being applied.

The More Things Change

Six years ago, right before the Big Bang that sunk this country's economy, we discussed problems of declining net interest margin on bank profitability, the ineffectiveness of the rate-cutting efforts of the Federal Reserve to boost that margin, and that banks were desperately seeking income from all sorts of other fees (including overdraft fees) and new lines of business to combat the problem. Over half of a decade later, the situation sounds distressingly similar.

Central Massachusetts banks are feeling the squeeze — the interest rate squeeze.

Financial performance among banks based in Worcester County during 2013 reflected the fine line institutions are facing as they grapple with slim margins while investing in technology and working to comply with new federal regulatory requirements.

"We really, over the last five to six years, have seen the net interest margin shrinking year after year," said Thomas J. O'Connor, vice president in charge of the financial institutions practice at G.T. Reilly & Co. of Milton, an accounting and consulting firm that works with community banks. "It's really the market conditions. These aren't institutions that have done anything wrong. If anything, they've done everything right."

[...]

All the banks face a common problem: Costs to manage customers' deposits while complying with federal regulations, especially reforms enacted under Dodd-Frank legislation in 2010, are steady to rising. Yet interest rates paid by borrowers taking out new loans are low.

The result is low net interest margins, or the net income that banks make charging and paying interest relative to the bank's assets. In Central Massachusetts, eight banks had net interest margins smaller than overhead costs relative to assets during 2013.

"Bank earnings are going to be suppressed until interest rates start to rise at some time in the future," said Commerce Bank President and Chief Executive Brian W. Thompson. "I don't think there's any expectation that's going to happen until sometime in 2015."

You can substitute "Central Massachusetts" with pretty much any other geographic area, and you'll have the same problem as far as the interest rate yield curve is considered.

The yield curve problems go back even further than 2008, when the world came crashing down around us. The following is from a blog post I wrote in August 2005:

The underlying economic problem for the banks is the flat yield curve. It's frankly without precedent (outside of a recession), or at least that's what my bank and hedge fund clients tell me. I defer to them on such matters, because I'm merely their mouthpiece with no mind of my own. However, assuming that this is true, banks can't make nearly enough money making conventional loans for the simple reason that the spread between what they pay to borrow the money (for example, by issuing a certificate of deposit to a consumer) and what interest rate they can charge on a loan they make with the funds borrowed, isn't enough to cover operating expenses, much less make a profit. That's the problem when the spread between two- and ten-year bonds is 20 basis points (0.02%), and the spread between two- and thirty year bonds is 40 basis points (0.04%). Thus, there has  been increasing pressure on banks to increase fee income, from whatever sources are legal.  The fees charged are legal. The banks are trying to make money. It's what they do.

Later that year, the curve became inverted.

If Mr. Thompson is correct, the interest rate squeeze will have lasted over a decade. Thus, while much has changed in the world of banking in the last nine years, banks find themselves in a distressingly similar place today: trying to make a buck from sources other than interest rate spread. They are trying to do so while coping with a post-Dodd-Frank world in which the elephant in the room, the CFPB, sets the tone for vigorous opposition to "taking advantage" of "fog-brained consumers" who don't have a clue what's in their own interests. "Taking advantage" means "making any money from banking services provided to." Thus, overdraft fees have been savaged, debit card interchange fees have been squeezed, proprietary trading hammered, and "subprime," "payday," "tax refund anticipation," and "deposit advance" all have been rendered to be four-letter words by the federal banking regulators.

The future sure looks rosy, doesn't it?

Banks Steering Clear of "Targeted" Businesses

Wall Street Journal reporter Robin Sidel, along with Andrew Johnson, reported on the success that the federal government is having in barring access to the banking system for a number of businesses. As we've discussed previously, "Operation Choke Point" and related arm-twisting efforts by the Feds are aimed at making life difficult for a variety of targeted businesses. Among those disfavored businesses are online lenders, payday lenders, check cashers, virtual currency dealers, gaming businesses, and marijuana-related businesses (although our beloved US Attorney General has been making noises that he simply will look the other way when it comes to enforcing federal drug laws against marijuana businesses that are operating legally under state law).

Even at a time when many banks can use every dime they can scrape up, the risk is simply not worth the potential pain.

While the temptation to deal with certain businesses might be high, some banking-industry veterans said, it isn't worth provoking regulators or adding more resources to ensure that the clients are meeting industry standards. And in the overall banking industry, such pullbacks aren't likely to hurt profits.

"Banks are making practical decisions about profitability versus risk exposure, and they are concluding this hill isn't worth the battle," said Gerard Comizio, a partner who specializes in banking at law firm Paul Hastings LLP.

Mr. Comizio sums up the thought process of bankers very well.

In the article and a companion audio interview, Sidel states that the primary concern appears to be with the difficulty of complying with BSA and money laundering risk. While that's certainly true with many of the businesses, it's also true that some of the businesses have been targeted by the regulators for extra scrutiny because they're in a line of business, like payday lending, where the regulators simply don't like the business model on social policy grounds. If we see the Feds back off of weed but still keep the heat on payday lenders, then the argument that it's all about money laundering risk becomes a bit tenuous.

One "human interest" portion of the article caught my attention. A medical marijuana businessman related how his bank not only dumped his marijuana business accounts, but his personal accounts and the accounts of his "unrelated " pizza businesses (in the audio, Ms. Sidel adds that the bank also dumped his business partner's personal accounts). I thought that it was a stroke of pure genius to own a business that creates "the munchies" and another business that feeds "the munchies." You'd want to find a way to back that kind of ingenuity, if possible.

The owner claims that he's found another bank to handle his marijuana business account "on the down low." He claims that removing the word "marijuana" from the business' name somehow gives the bank comfort that the bank can fly under the Feds' radar screen. After reading that story, I can't imagine that the FDIC, the FRB, and the OCC aren't doing a little digging to try to find out who's trying to pull that sleight of hand. While the regulators may eventually come out with guidance that permits banks to deal with legal (under state law, at least) marijuana businesses, I doubt that "disguising the true nature of the account owner's line of business" will ever become an accepted practice. It runs counter to the "know your customer" ethos.

An underlying concern continues to be the fact that the regulators are picking winners and losers among legal businesses, and preventing those businesses that they deem to be "losers" from having access to the banking system. That rubs many people the wrong way, and not all of those people are bankers.