Bank Regulators Never 'Encourage,' They Require

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The National Credit Union Administration marked Earth Day on Monday by issuing a press release celebrating the agency's various green initiatives. Along with conserving energy and urging employees to bicycle to work and grow plants in their offices, the NCUA "encourage[s] credit unions to make the same commitment to incorporating greater environmental awareness into their daily operations." This statement sounds harmless enough, but-given the complexity of the relationship between regulators and the entities they regulate-even statements urging "credit unions to lead in environmental stewardship" must be made with care.

Because financial regulators wield tremendous control over the fate of the banks, credit unions, and other entities they regulate, those entities live in fear of getting on the bad side of their regulators. Raising questions about a proposed rule can raise the regulator's hackles. Bringing a lawsuit to challenge a rule after it is adopted is sure to engender rage. Challenging the competence of bank examiners is risky too. Any of these actions could result in new regulatory demands or a harsher examination than the bank or credit union otherwise would have experienced. Many financial institutions consequently conclude that the wisest course is silent compliance with the regulator's commands.

Sometimes those commands come in the form of regulations adopted under the Administrative Procedure Act. Sometimes they come in the form of a phone call from a bank examiner. As a recent Wall Street Journal article reported, it took just a few phone calls from the Federal Reserve to affect the way the largest banks pay their executives. A press release that encourages financial institutions to take or not to take certain actions can have the same effect as a rule or a phone call.

For this reason, regulators need to be careful about what they say and how they say it. They should exercise particular care when urging financial institutions to take actions that are not relevant to their job of fostering financial safety and soundness. Otherwise, private financial institutions will become nothing more than government-controlled entities that make all of their decisions in response to regulatory commands rather than their own business judgment and understanding of the marketplace.

As the NCUA acknowledged in its 2011 annual report, its job as regulator is "to ensure that credit unions are empowered to make the necessary business decisions to serve the diverse needs of their existing members and potential members." Rather than making those decisions for them, the "NCUA achieves this objective by establishing a regulatory environment that encourages innovation, flexibility, and continued focus on attracting new members and improving service to existing members." The NCUA's Earth Day message is an example of undue interference with day-to-day decision making that is better left to credit unions, which are best able to respond to the concerns of their members.

Regulators should not underestimate the power of their words. They need to be reminded how easily a word of "encouragement" can become a de facto requirement for the entities they regulate.

Hester Peirce is a senior research fellow at the Mercatus Center at George Mason University. 

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