Banks, State Regulators Slam FDIC’s Bank Board Director Proposal

Banks and an unexpected ally—state bank regulators—are rejecting a proposal from the Federal Deposit Insurance Corp. to increase board directors’ risk-management responsibilities following a series of bank failures last year.

The FDIC wants to require bank board directors to manage the risk profile of their financial institutions and minimize potential conflicts of interest among board members. But that would clash with state corporate governance laws and create a potential unequal playing field for banks overseen by other federal regulators, the Conference of State Bank Supervisors said in a comment letter last week.

The state bank regulators’ letter echoed comments from banking trade groups and individual banks about the FDIC’s proposal, previewing arguments that will likely arise in any suit challenging the rule—and teeing up a rare legal fight between state and federal regulators.

“With little to no data or factual support and no clear authority for doing so, the Governance Proposal would set aside state laws and precedent for covered banks. Without a clearly defined problem, the proposal would also create confusing and conflicting mandates at the federal and state level,” CSBS wrote. The group has signaled a renewed focus on asserting its role under new CEO and president Brandon Milhorn, a former FDIC official.

The state bank regulators, along with banking trade groups, want the FDIC to withdraw its proposal.

The FDIC approved publishing the proposed rule in a 3-2 vote in October, with Republican appointees opposing its release. The comment period closed Feb. 9.

Bank Failures

The FDIC’s proposal followed the failures of Silicon Valley Bank, Signature Bank, and First Republic Bank beginning last March. The FDIC was the primary federal regulator for Signature and First Republic.

Those failures highlighted the need to ramp up board responsibilities, Better Markets, an organization pushing for tougher bank regulations, said in a comment letter on the FDIC rule.

“Covered firms should be held accountable for appropriate corporate governance and risk management to protect all stakeholders and the financial system,” the group said.

Supporters also praised a proposal to restrict directors from sitting on the boards of both a bank and its parent company.

Increasing bank board independence is necessary because the holding company and the FDIC-insured depository institution may have conflicting risk profiles and goals, Jeremy Kress, a professor at the University of Michigan Ross School of Business who studies bank boards of directors, said in a comment letter.

“When a bank’s directors also sit on the board of the bank’s holding company, the directors have an incentive to allow the holding company and its nonbank subsidiaries to take advantage of the bank and thereby benefit from federal safety net subsidies,” Kress said.

Kress, a former Federal Reserve attorney, separately filed petitions Feb. 8 asking the Fed and the Office of the Comptroller of the Currency to tighten their unaffiliated director standards. While there isn’t a deadline for the regulators to reply, the Administrative Procedure Act requires agencies to respond to “within a reasonable time.”

Uneven Field

But banking trade groups and state bank regulators raised concerns the FDIC’s proposal would disadvantage the banks it regulates. If the FDIC moves forward alone, banks supervised by the OCC and the Fed will operate under different board requirements, they say.

The FDIC proposal applies to banks for which it serves as the primary federal regulator—lenders with at least $10 billion in total assets. That would include nearly 60 of the roughly 2,900 banks overseen by both a state regulator and the FDIC, according to the CSBS letter.

The FDIC could also extend the requirements to any bank it deems “highly complex,” even if its assets are under the $10 billion threshold.

By contrast, the OCC’s more relaxed board governance directives apply to national banks with at least $50 billion in total assets.

That means some smaller banks targeted by the FDIC would operate under stricter board guidance simply because of who their federal regulator is, the CSBS letter said.

“No policy argument has been proffered as to why one group of banks should have a dramatically different set of corporate governance and risk management requirements than others,” the state regulators’ letter said.

Bank trade groups echoed those sentiments, and raised concerns the FDIC’s proposed rule would conflict with state corporate governance laws.

The FDIC’s proposal would require directors to look out for the best interests of banks’ multiple stakeholders, beyond just shareholders, including customers, regulators, and the public. That puts directors in conflict with fiduciary requirements at the state level, the Bank Policy Institute and the American Association of Bank Directors said in a joint comment letter.

It “exposes directors to risk of an adverse action by the FDIC if they consider the interests of the parent, despite owing fiduciary duties to that parent under state law,” the industry letter said.

Legal Battles

BPI and the bank directors’ trade group raised procedural concerns, including what they say was an insufficient cost-benefit analysis by the FDIC. Those types of concerns often feature prominently in industry lawsuits challenging regulations.

State bank regulators voiced similar procedural complaints with the FDIC’s proposal, including the lack of discussion about holding the directors of failed banks liable.

While lawsuits between state and federal regulators are rare, they do happen.

Most recently, CSBS and New York’s Department of Financial Services filed separate lawsuits against the OCC over a proposed special-purpose federal charter for financial technology companies.

The US Court of Appeals for the Second Circuit in June 2021 ordered the case dismissed after determining the OCC hadn’t yet issued a fintech charter. CSBS voluntarily dismissed its lawsuit later that year as the Biden-era OCC reviewed whether to continue the fintech charter policy.