Late last week, the Office of the Comptroller of the Currency (OCC) released a notice of proposed rulemaking (Proposal) that, if adopted, would prohibit national banks and federal savings associations (together, national banks) from categorically declining to provide financial services to industries engaged in lawful business activities. Instead, national banks would need to perform a risk evaluation of each customer before declining the customer service.
The OCC focuses much of its discussion on bank lending activities, but the Proposal would change how national banks may offer every type of banking, payment, and financial service to business customers. For some in the banking industry, this may be a welcome development, as the industry has pushed back in the past against governmental pressure to shut down lawful businesses. For others, the Proposal may be viewed as limiting the ability of national banks to control their own risk management policies, including the ability of a national bank to decide not to provide services to industries that the bank has determined it is not equipped to underwrite and manage.
We discuss the scope of the Proposal and these tensions below, with a particular focus on how the Proposal may impact the payments industry, given the industry's frequent use of "prohibited" and "restricted" merchant lists to manage risk. The OCC is accepting comments on the Proposal through January 4, 2021. If you are interested in submitting comments about the Proposal or gaining better understanding of how the Proposal would impact your business, please reach out to us.
Overview of the Proposal
According to the OCC, the Proposal would increase fairness in providing financial services to businesses. The OCC writes that it is unfair for a bank not to lend to whole categories or types of businesses, such as oil and gas producers, carbon intensive industries, family planning services, or weapons manufacturers.
The OCC based its authority to issue the Proposal on the Dodd-Frank Act amendment of its mission to include ensuring "fair access to financial services, and fair treatment of customers." The Proposal asserts that fair access is a "distinct concept [from anti-discrimination] that implies a right of individual bank customers, whether natural persons or organizations, to have access to financial services based on their individual characteristics." However, the OCC does not provide any statutory or jurisprudential support for this view in its Proposal.
The Proposal's fairness and nondiscrimination provisions are relatively simple. A national bank must "[m]ake each financial service it offers available to all persons in the geographic market served by the covered bank on proportionally equal terms" and it cannot "deny any person a financial service the bank offers except to the extent justified by such person's quantified and documented failure to meet quantitative, impartial risk-based standards." The Proposal defines "person" as any natural person or business or legal entity, and it defines "financial service" merely as "a financial product or service."
If finalized, the Proposal would bar a national bank from refusing to offer financial services of any kind to a company based on characteristics of its line of business or industry. Instead, the Proposal suggests that a national bank would need to conduct individual, case-by-case underwriting of each potential business customer against standards the bank sets in advance of offering such services.
The OCC recognizes that individual underwriting would be a significant burden, and the Proposal therefore applies only to national banks with $100 billion or more in total assets. The Proposal also sets forth an alternative test that would apply the requirements to any national bank with the ability to raise prices to a customer.
Based on the asset threshold test, currently only 20 financial institutions would be subject to the Proposal. But those national banks have significant presence across every financial services sector, and the Proposal, if implemented, would dramatically change how they serve their commercial customers. Moreover, if adopted, the Proposal may influence other federal and state banking regulators to adopt similar prohibitions—whether through their own rulemakings or through the supervisory process.
What Does the Proposal Mean?
With respect to lending—which is the only financial service discussed at length in the Proposal—the OCC states, "It is one thing for a bank not to lend to oil companies because it lacks the expertise to value or manage the associated collateral rights; it is another for a bank to make that decision because it believes the United States should abide by the standards set in an international climate treaty." This statement could be interpreted to suggest that it would be acceptable for a national bank not to lend to oil companies if it lacks the necessary expertise to manage the risk.
Later, however, the OCC asserts that "[A] bank's decision not to serve a particular customer must be based on an individual risk management decision about that individual customer, not on the fact that the customer operates in an industry subject to a broad categorical exclusion created by the bank." It appears, then, that a national bank would still be required to engage in an underwriting analysis for each potential customer even if the bank lacks expertise in that customer's industry.
Furthermore, the OCC does not distinguish among types of lending services. In the Proposal, the OCC explains if a national bank offers "commercial lending and specifically provides such services to a large retailer, the bank would be required to offer such services to any other lawful business . . . on proportionally equal terms." Despite existing OCC rules and guidance on lending operations and concentration limits recognizing that risks vary among distinct categories of borrowers—size, industry, seasonality, business cycle dependence, interconnectedness, and overseas operations, to name a few—the Proposal appears to consider lending to a large retailer as essentially the same as lending to any other type of lawful business.
Impact on the Payments Industry
As noted above, the Proposal does not address other services, such as payment processing and merchant services, even though it would apply broadly to all financial services. However, in support of the Proposal, the OCC points to Operation Choke Point as an example of practices that are "inconsistent with a bank's legal responsibility to provide fair access to financial services." As described by the OCC, the "now-discredited" Operation Choke Point resulted in government agencies pressuring banks to cut off services to disfavored but not unlawful sectors of the economy.
Many of the national banks that would be subject to the Proposal are major participants in the card payment processing networks (e.g., Visa and Mastercard). These networks' rules include prohibited and higher-risk classifications of merchants, and the use of prohibited and high-risk merchant lists is a common practice by merchant acquiring banks and their partners to manage payment processing risks and compliance. More specifically, many sponsor banks have adopted policies that prohibit the provision of merchant services to businesses in industries that present a higher risk of chargebacks, card laundering, illicit sales transactions, and fraud.
If taken at face value, the Proposal would appear to bar the use of prohibited and high-risk merchant lists and force affected national banks to underwrite each prospective merchant processing customer individually.
If that is the case, it is difficult to square the Proposal with existing guidance that the OCC has issued for banks engaged in merchant processing. The OCC not only allows but has actively encouraged sponsor banks to treat business categories and industry segments differently. It is worth quoting the OCC's merchant processing guidance at length:
When evaluating merchants' credit quality, banks must consider the business lines and any products the merchants offer. The bank card associations segment businesses by activity, and acquiring banks should analyze merchants along similar lines on an ongoing basis. Most acquiring banks compile lists of prohibited or restricted merchants, describing the types of merchants they are unwilling to sign or are willing to sign only under certain circumstances. Certain types of businesses are inherently more risky.
It is unclear how the OCC plans to reconcile this guidance with the Proposal. Presumably, it would not be enough, under the Proposal, for a national bank to find that a merchant's line of business has a high propensity for fraud. Instead, if the national bank did not want to sponsor the merchant, it would have to find that the individual applicant shows a "quantified and documented failure to meet quantitative standards."
Ripple effects of the Proposal are also unclear. The Federal Trade Commission (FTC), for example, frequently orders credit card processing companies—which depend on bank sponsors to provide their services and act on behalf of the bank—to refrain from serving entire lines of business, such as credit repair, identity theft protection, debt collection, mortgage or loan modification, outbound telemarketing, and timeshare resellers.
For example, in a recent FTC consent order with First Data, the FTC required First Data and its merchant processing sales partners to "[e]stablish and enforce . . . policies and procedures [that] identify and describe in detail: (1) prohibited and restricted merchant categories . . . ." If a sponsor bank must evaluate all prospective merchants on an individual, rather than categorical basis, must their non-bank processing partners also follow suit? How the Proposal reconciles with actions by other government agencies that prescribe risk management by avoidance remains unknown.
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We do not know whether this Proposal will have enough traction to lead to a finalized rule. Regardless, national banks and their financial services partners should pay close attention to the Proposal, including the opportunity to submit comments until January 4, 2020.