Radical change is possible in the banking sector. It’s already happened, actually. Over the past 30 years, the U.S. banking sector went from one dominated by small, community banks to one dominated by massive, global banks. Public policy was a major driver of that shift.
Some have spent the last decade or longer searching for ways to restore some community-mindedness to the banking sector. That search has found more momentum recently, due to the urgency around responding to climate change, continued racial inequity, and now COVID-19.
Some of the ideas floating around to change the banking sector are closer to a reality than others. Some require creating totally new institutions or mechanisms that don’t exist yet, some are more about re-instituting policies that banking industry lobbyists have had taken away over the past few decades. Some are about protecting or strengthening existing policies.
We can’t possibly list them all, but here are some of the ones we’ll be watching closely as the COVID-19 pandemic drags out into an economic recession and eventual recovery.
Restoring Glass-Steagall and interstate banking walls
Part of the Banking Act of 1933 that also created the FDIC, Glass-Steagall is the name most commonly used to refer to that act’s prohibition against commercial banks and investment banks affiliating with each other. At the time, investment banking was seen as riskier than commercial banking, the former dealing in stocks and bonds and the latter dealing in loans to people and businesses. Some have disputed whether that distinction is a meaningful one, since loans are risky, too.
Coupled with state-based restrictions on banks operating across state lines, Glass-Steagall was also part of the regulatory regime that ensured the banking sector for the following 50 years would be dominated by small community banks. State-based restrictions on interstate banking were largely eliminated in the 1980s, and the Riegle-Neal Act of 1994 eliminated most federal restrictions on interstate banking. The Gramm-Leach-Bliley Act followed in 1999, effectively repealing Glass-Steagall. The banking lobby and its allies continue to make a case that larger banks offer more cost-effective and convenient banking for consumers.
According to Stacy Mitchell, co-director of the Institute for Local Self-Reliance, bringing back Glass-Steagall and re-creating some kind of modern-day version of interstate banking restrictions would help tilt the banking sector bank in favor of smaller, community banks. Senator Elizabeth Warren worked with former Senator John McCain in 2017 to introduce the 21st Century Glass-Steagall Act. More small banks would mean greater access to lending especially for small business, as evidenced by the correlation between the prevalence of community banks and the number of Paycheck Protection Program loans relative to each state’s population, Mitchell argues.
Reforming the Community Reinvestment Act
This reform seems to be moving forward, whether it makes sense during a pandemic or not. Upon his appointment as Comptroller of the Currency at the beginning of the Trump Administration, Joseph Otting has been looking to make changes to the regulations around the enforcement of the Community Reinvestment Act of 1977. The law gives banks a “continuing and affirmative obligation” to safely and responsibly meet the credit needs of the communities where they do business, with a focus on low-to-moderate income communities. But the law gives regulators wide discretion in how to enforce compliance, and Otting’s stated goal has been to modernize CRA enforcement, which has not been through a major update since 1995.
Part of the challenge is that there are three federal agencies who jointly enforce the law — the Office of the Comptroller of the Currency, the FDIC, and the Federal Reserve. Of the three, the Federal Reserve has not yet signed onto the regulatory reforms drafted under the leadership of Otting’s agency. Since the comment period on the proposed new regulations closed on April 8, there is a minimum of 60 days the two agencies have to consider comments submitted before issuing final regulations. If they issue those regulations, it would mean there are two sets of rules for banks to follow, and some would have to follow both, depending on each bank’s particular legal structure.
The Comptroller and the FDIC have consistently stated their intent with the reforms is to give banks more clarity and consistency with regard to how CRA regulations are enforced. While there is widespread agreement with the need for clarity and consistency, there is also widespread opposition to the proposed changes.
Opponents include civil rights advocates, community development lenders and community banks, mayors, economic development agencies and thousands of others who submitted comments all oppose the proposed regulatory changes. They say the proposed changes from the Comptroller’s office and the FDIC would re-legalize redlining, the practice of denying loans to certain individuals or neighborhoods based on race, while also reducing access to small business lending particularly for black-owned businesses, which are typically just a fraction of the size of white-owned businesses in any given metropolitan area.
The Federal Reserve has not yet issued a full proposal, but it has outlined its thoughts on modernizing CRA regulations — which were received with much more welcoming arms, including from banks themselves.
Bring back postal banking
In 1910, responding to the populist, anti-monopoly sentiment of the times, Congress passed and President William Taft signed legislation authorizing the U.S. Postal Service to begin providing savings accounts for individuals. Postal offices began taking deposits the next year, and were slow at first, but by the 1930s there were $1.2 billion in savings deposited with the U.S. Postal Service.
Postal banking recently made an appearance on Last Week Tonight with John Oliver. The program made the U.S. Postal Service effectively the largest savings bank in the country — although technically, under the 1910 law, each post office pooled savings from households and deposited them at local banks, where it would earn 2.5 percent interest. The postal service paid its depositors two percent, and it used the difference to cover the operations of the program.
One of the reasons why the post office was so popular as a savings bank, besides its ubiquitous presence in literally every community around the country, was that many trusted a federal government agency more than banks at the time. It wasn’t till 1933 that Congress created the FDIC and federal deposit insurance for private banks. Savings deposited at the post office peaked at almost $3.4 billion, in 1947.
With the onset of federal deposit insurance and higher savings rates offered by private banks, post office savings accounts slowly faded in popularity. By 1966, the U.S. Postal Service stopped opening new accounts and stopped accepting deposits into existing accounts. In June 1969, the Postal Service turned over the remaining deposits and account records to the Department of the Treasury.
Author and advocate Mehrsa Baradaran has been speaking out to bring back postal banking, and building on its previous incarnation by granting the U.S. Postal Service a full bank charter so that it can use low-cost savings accounts to finance low-cost alternatives to payday loans and other predatory lending products. Oliver’s show consulted her on its post office segment. She’s argued that postal banking could help provide needed banking services for the roughly one in four U.S. households that are underbanked, including eight million unbanked households. Seventeen percent of black households and fourteen percent of Hispanic households are unbanked, compared with just three percent of white households.
As defined by the Public Banking Institute, a public bank is a bank “owned by a government unit — a state, county, city, territory, tribe, or nation — serving as a depository for public funds, and mandated to serve a public mission reflecting the values and needs of the public it represents.” They’ve existed throughout history, in the U.S. and around the world, operating with a wide range of models, some focused on consumer services, others not.
According to a report commissioned by the California State Treasurer’s Office, there were 29 public banks commissioned from 1917 to 2017, and most have ceased to exist either by regulatory order, financial failure, or the state or municipality closing the public bank. Three remain in operation — the state-owned Bank of North Dakota, established in 1919; Native American Bank, established by a consortium of tribal nations and Alaska Native Corporations in 2001; and the Bank of American Samoa, established by the territorial government in 2018.
Since its inception, the Bank of North Dakota has been prohibited by law from competing with private banks. Instead, it partners with them. It has no branches and doesn’t offer ATM access or debit cards. The state-owned bank gets 98 percent of its deposits from the state, which is required by law to deposit all state income and sales taxes, fees and other revenues into the Bank of North Dakota. Other than student loans, it rarely originates its own loans. Instead, the vast majority of its lending is done through loan participations, meaning local lenders originate loans and manage borrower relationships, while the Bank of North Dakota supplies part of the borrowed amount and takes a portion of the interest paid on each loan. Loan participations let local lenders share the risk of making loans with the much larger state-owned bank, giving them more flexibility and capacity than they would have by themselves, without worrying that they’ll lose their clients to the state-owned bank.
The Bank of North Dakota’s main public mission is to support economic development, alongside state and local government financing, so most of the bank’s loan participations go to businesses and farmers across the state. Most borrowers don’t even realize that the state-owned bank has supplied part of their loan. In large part due to the Bank of North Dakota’s model, which supports local lenders, North Dakota has more banking institutions relative to its population than any other state.
The Public Banking Institute is tracking dozens of states and cities from coast to coast that have taken steps recently toward the establishment of more public banks. California passed legislation last year establishing a process for cities and counties in that state to establish public banks. As of yet no public banks have been created as a result of California’s legislation, but several cities including San Francisco, Los Angeles, Oakland, San Diego, Santa Clara County (which includes San Jose) and Long Beach are at various points along the process. New York has similar legislation in the works.
Critics charge public banks would unfairly compete with private banks, and would provide an irresistible temptation for public officials to meddle in lending decisions. Supporters of public banks, including organizers as well as public officials, continue to point to the Bank of North Dakota’s model as evidence that a public bank can operate with relatively little political interference, while supporting local community banks and credit unions, and at a profit — 2019 was the Bank of North Dakota’s 16th straight year of record profits, and it has turned over $1 billion in surplus profits back to the state since inception.
Inclusive value ledgers
In October 2019, New York State Assembly Member Ron Kim introduced legislation to create what’s known as an “inclusive value ledger,” basically a state-owned electronic payments platform similar to PayPal or Venmo. It would start out as a lower cost, lower-hassle way to distribute public benefits, but could expand to become a payments platform between any person or business.
Supporters tout the benefits of relying less on check cashier storefronts that beneficiaries pay to access public aid, as well as smoothing out the process of accessing state-administered benefits like unemployment or various tax credits — access gaps that the COVID-19 pandemic has helped to expose. Kim’s bill is based on a proposal from Cornell University Law School professor Robert Hockett.
The Chinese-American Planning Council, one of the largest nonprofits in New York City, supports the legislation as a tool to reduce living costs and exposure to more predatory financial services, which are more likely to affect low-income immigrant communities like those CAPC serves.
Crises have long been the impetus for significant changes in the banking sector.
The first U.S. debt crisis was right after the revolutionary war, when states had trouble repaying the debts they’d incurred to pay the revolutionary armies. That crisis led to Alexander Hamilton’s proposal to have the federal government assume those debts and start paying them off instead. That put the U.S. Treasury on the path to eventually becoming considered the world’s safest investment, a reality that is now part of the foundation for the entire global financial system.
During the Civil War, President Abraham Lincoln worked with Congress to create the Office of the Comptroller of the Currency. The new Comptroller of the Currency would for the first time issue federal charters for banks to take deposits nationwide. Those banks would also be first to issue national currency, which gradually came to replace all other state- or locally based currencies that existed before the Civil War. That national currency would be replaced by the U.S. dollar shortly after the turn of the 20th century.
The Panic of 1907 was the first global financial crisis of the 20th century, and it sparked the eventual creation of the Federal Reserve system in 1913. The Great Depression sparked the creation of the FDIC in 1933, federal home mortgage insurance in 1934 and Fannie Mae in 1938. The spate of racial uprisings in cities across the country at the tail end of the civil rights era sparked the Equal Credit Opportunity Act of 1974 and the Community Reinvestment Act.
Hopefully, whatever comes out of this crisis is an improvement on what was really the main financial sector innovation that came out of the 2008-2009 financial crisis — private equity firms taking over millions of single-family homes and turning them into rental housing instead of selling them back to homeowners.
This article is part of The Bottom Line, a series exploring scalable solutions for problems related to affordability, inclusive economic growth and access to capital. Click here to subscribe to our Bottom Line newsletter. The Bottom Line is made possible with support from Citi.
Oscar is Next City's senior economics correspondent. He previously served as Next City’s editor from 2018-2019, and was a Next City Equitable Cities Fellow from 2015-2016. Since 2011, Oscar has covered community development finance, community banking, impact investing, economic development, housing and more for media outlets such as Shelterforce, B Magazine, Impact Alpha, and Fast Company.