Wells Fargo's wealth cap turns 5 years old. how will it end (2023)

On Friday, February 2, 2018 at 6:15 p.m. m., the Board of Governors of the Federal Reserve announcedan executive actionagainst Wells Fargo, which imposed a new condition on the bank: It would be prohibited from growing above $1.95 trillion in assets, its size as of December 31, 2017.

The unprecedented move was the central bank's long-awaited response to a series of scandals that have plagued the San Francisco-based bank in recent years. The most visible of these scandals relates to the candor of bank employeesMillions of unauthorized credit cards and checking accountsunder the name of unknown clients, butother revelationsabuses in the bank's auto and mortgage departments further tarnished its public image.

The Fed said in its enforcement action that the wealth limit was imposed in response to "widespread consumer abuse and other compliance violations" at the bank and will remain in place "until its governance and controls improve sufficiently," creating a cloud uncertainty about raises the bank's growth prospects indefinitely.

But that night five years ago, then-Wells Fargo CEO Tim Sloan tried to allay those concerns. In a phone call with analysts, he downplayed the sincere nature of the consent order and struck a bullish tone about the bank's ability to meet the Fed's requirements to lift it, saying the bank has until September 30 to address the Fed's concerns this year. Year.

"Hopefully we can get it done sooner," Sloan said on the call. “And then the Fed will look at that and react. So we're in the fast lane here and look forward to making the necessary improvements."

In May of this year, Sloan said the bank had received "very detailed feedback" from the Fed and now expects the asset ceiling to hold through "the first part of 2019." In early 2019, Wells Fargo pushed the deadline past the end of the year. Sloan unexpectedly resigned as CEO in March 2019, and two weeks later the companystopped speculatingabout when the asset limit can be lifted.

Sloan, contacted at private equity firm Fortress Investment Group, where he has worked since 2020, declined to comment on the asset ceiling or his time at Wells Fargo.

The consent order and asset ceiling remain in effect to this day, with no end in sight. While the wealth limit remains unchanged, Wells Fargo has evolved and adapted over the last five years. Wells' current CEO Charlie Scharf, who joined in October 2019, is credited with focusing on fixing the bank's risk management problems once and for all and has repeatedly stressed that Wells Fargo is a "different bank "today, with new leadership, better oversight, and significant progress in resolving outstanding issues.

sena kwon

When asked for comment, a Wells Fargo spokesperson said: "Today we are a different company that has made significant strides in improving the customer experience, delivering innovative products and services, and improving our risks and controls. We know there's still a lot to do, can be done, and we're confident we have the right people and plans in place to transform this company."

Scharf cautioned that despite these gains, "setbacks" are likely to occur. One of those setbacks occurred in September 2021,when regulators fined Wells Fargo $250 millionand cited ongoing problems in its mortgage department.

Then in December a$3.7 billion settlementwith the Consumer Financial Protection Bureau came with a vague warning from director Rohit Chopra. While the deal opened a path for the bank to resolve outstanding issues with the CFPB, Chopra also said the bank is not moving fast enough with its reform.

“As regulators, we must collectively consider whether it is necessary to place additional restrictions on Wells Fargo,” he said.

The promise of progress and the attendant threat of new regulatory sanctions are emblematic of Wells's life below the wealth ceiling: Even as Wells Fargo is removing consent orders from its long list of regulatory duties, no one outside the Fed and the Bank really knows with some specificity. if Wells with the Fed wealth ceiling nearing the finish line. The inner workings of consent orders are sensitive supervisory information and therefore not publicly available. And because of that, there's no way to know for sure how close or how far Wells is from meeting the Fed's demands, or what those demands are.

“The asset ceiling will go away when the regulators say so, and not a moment before,” said Scott Siefers, an analyst at Piper Sandler, adding that the “big mistake we all made was setting our own TBD schedule.”

But while the wealth cap has lasted much longer than initially thought, it may not be permanent. Something will have to give.

Either Wells will eventually make enough changes to his internal controls and risk management to appease the Fed, or the Fed will decide that the bank itself needs to be restructured.

That could come through "serious house cleaning" or the closure of Wells Fargo businesses, said Mayra Rodríguez Valladares, an industry risk advisor and general manager at MRV Associates.

“If that doesn't wake her up, I don't know what would,” Rodríguez Valladares said.

Then there is the nuclear option. Dennis Kelleher, head of consumer protection group Better Markets, said bankruptcy was "clearly still on the table."

"The fact that five years have passed and they haven't done so strongly suggests that regulators should start thinking about whether they need to liquidate the bank to bring them online," Kelleher said.

Zach Gibson/Bloomberg

“Problematic not transparent”

The silence from Wells and the Fed is typical of enforcement actions, which are usually enacted and completed with little fanfare and minimal description of what happened to justify a sanction or removal. They also don't usually have an expiration date, so it's not uncommon for issues to take several years to resolve: 2013 Fedsexecution actionagainst JPMorgan Chase, for example, over the London Whale fiascofinally locked upsoy 2019

At best, the Fed will publish certain information from a third-party review of Wells Fargo's activities after the enforcement action is complete. He agreed to this modest disclosure only after pressure from Sen. Elizabeth Warren, D-Massachusetts, one of the bank's biggest critics.

“They were basically forced to do it by public and political pressure,” Kelleher said.

Consumer advocates aren't the only ones frustrated by the Fed's disclosure of such precedent-setting action. David Zaring, a professor at the Wharton School of Business at the University of Pennsylvania who focuses on financial regulation and administrative law, said the Fed's handling of the asset ceiling has been "problematically opaque."

From the outside, Zaring said, the Fed's justification for the cap appears to lump a series of scandals under the umbrella of mismanaging risk. Although Wells Fargo's practices were clearly flawed, he said what constitutes good or bad risk management is subjective, making it a dangerous precedent for imposing controls as stringent as an asset ceiling.

“The problem is internal controls and risk management practices, and it is serious. If a really big bank doesn't have effective internal controls, it can be systemically risky,” he said. "But it's also the kind of thesis for a consent order that any banking regulator can impose on any financial institution at any time."

There is no question that the wealth limit had a major financial impact on Wells Fargo. While its peers have grown by hundreds of billions of dollars in the last five years, Wells Fargo has held steady and its market capitalization has increased.fell drastically.

Enforcement and fines have long been a way for bank regulators to get the attention of banks and force them to take certain actions, said Sean Vanatta, a professor of US economic and financial history at the University of Glasgow in Scotland. But where the asset ceiling is truly new, Vanatta explained, is the Fed's ambition to fix a broken culture at a bank as large and sprawling as Wells Fargo.

“It ties into a lot of the problems that have been highlighted since the financial crisis, like too big to fail, too big to manage, too big to monitor,” he said. "How do you deal with a large company of this size?"

In the absence of an objective measure of Wells' progress, frustration is growing among those who want to ensure Wells Fargo's problems are properly addressed and among those who are concerned about the fairness of the process.

Greg Baer, ​​president and CEO of the Bank Policy Institute, a trade group representing large commercial banks, noted Wells Fargo's significant progress to date and urged the Fed to provide more information on the bank's position o remove the cap completely.

"Otherwise, the question of how to prevent Wells Fargo from opening more branches or writing additional municipal bonds, making it safer and more robust, remains unanswered," he said. "As an industry, all banks and financial institutions will benefit from the lens of greater regulatory transparency in actions like these."

Despite the nature of the asset ceiling precedent and possible future implications for other banks, requests for more information about what goes on behind regulatory curtains will likely go unanswered, he said.

Karen Petrou, executive director of Washington, D.C. resident consultant Federal Financial Analytics.

"It's an institution," Petrou said. “It's not like the multi-access app, where you can collect data and provide useful policy or guidance without providing proprietary information about a single institution. I do not think that's possible".

Al Drago/Bloomberg

(Video) Tales Of Wells Fargo, S01E06 - Shotgun Messenger, Classic Western TV, Michael Landon

"A very clear message"

Wells Fargo's asset ceiling marks the first time the Fed has so completely constrained a bank's growth; For that reason alone, the agency finds itself in uncharted waters.

However, it is not clear to what extent the approach deviates from the old traditions of banking regulation and supervision. Petrou said growth restrictions have been a common tool for bank regulators, albeit generally with a much narrower focus. Traditionally, she said, they have been used as a way to encourage banks to raise capital levels.

“It's not that caps on wealth growth are unprecedented. Actually, they are common for undercapitalized institutions,” Petrou said. "That this was done for various consumer and control issues was an unprecedented move and sets an important precedent for any future incidents where a banking organization is found to be seriously off the mark on critical issues of good practice."

Vanatta said that the behavior of bank directors has changed since the inception of the Federal Deposit Insurance Corporation. a key component of banking supervision. in the 1930s. With the government forced to bail out depositors when a bank fails, regulators have a renewed interest in overseeing bank management practices and preventing banks from failing in the first place, she said.

That interest deepened with the passage of the Bank Mergers Act of 1960, which made bank management a primary criteria for regulators to consider when evaluating a potential bank merger, Vanatta said.

"In that sense, the Federal Government is always interested in evaluating management and, in that sense, risk management when looking at the growth of banks," he said. "He can stop the growth of the bank if he finds the management and risk management inadequate."

However, the rationale for intervention and the mechanisms used to measure good and bad management have changed significantly over the last century. Initially, supervision focused mainly on credit quality, portfolio construction and credit utilization, Vanatta said, with managers receiving ratings at the discretion of each supervisor.

But over time, regulators have become increasingly aware of the risks to the financial system as a whole, and supervision has become more nuanced, sophisticated and complicated as a result, Vanatta said.

The size of megabanks like Wells Fargo, which are considered systemically important and too big to fail, further increased regulatory risks, he said.

“Supervision as a set of practices arose in a unique banking world where banks were small and the state was large. Now the state is still big, but the prospect of a bank the size of Wells Fargo going under is terrifying,” Vanatta said. "Part of what the cap indicates is that there is a size issue, that limiting growth will help the government understand these giant banks, value these giant banks and ultimately trust these giant banks."

What Vanatta calls the natural evolution of regulatory practices, Zaring describes as an extension of traditional banking regulatory principles. He sees Wells Fargo's wealth ceiling as a continuation of the Federal Reserve's efforts to ensure banks are not only financially sound but also morally sound.

"Perhaps this no-growth order could encourage the bank to take a different approach to internal culture, and if that's the case, that's new," Zaring said. "It's consistent with the Fed's interest in this area, but it often seems to me that the Fed's interest in ethical regulation was... to try to outsource good behavior to the banks themselves and encourage them to get rid of bad apples." . , do not skimp and do so by adopting an ethical banker paradigm.

That paradigm, Zaring said, aligns with an emerging view that since banks have government powers to take insured deposits and conduct financial transactions, the government has a say in how they do it.

That raises a fundamental question about whether banking is a profession or a business, he said.

"People of different professions have codes of ethics... Physicians are required to obey the Hippocratic Oath, lawyers are judicial officers, they have duties to their clients. Professions may have codes of ethics that require specific behaviors that bite the bullet." somehow," Zaring said. "That's not to say that business ethics aren't important at General Motors, but no one believes that the CEO of General Motors has a special duty to his customers, the people to whom they sell cars. You have to obey the law, but there is no ethical obligation beyond that."

Whether the wealth limit was a minor deviation from past regulatory practices or a significant deviation, many in and around the regulator say the move was proportionate to Wells Fargo's wrongdoing.

“This was a very serious and unprecedented offense by this institution. Charging bogus accounts is very serious,” said Thomas Hoenig, former president of the Federal Reserve Bank of Kansas City. "The Fed felt compelled and I think it put pressure on the Fed and others to resolve this very firmly."

Hoenig, who is now a distinguished senior fellow at the Mercatus Center, said the Fed's Board of Governors must "send a very clear message to both Wells Fargo and the broader banking industry that this is not acceptable."

“This is a clear signal for banks to pay attention. Pay attention to your culture, pay attention to your incentive structures,” he said. “That is the message that has been given and probably received by more than one major institution.

It was probably received by all major institutions. That was probably what the Fed intended, and in that sense it has served its purpose."

David Paul Morris/Bloomberg

"handcuffed"

Since the cap was introduced, Wells Fargo's national share of deposits has fallen relative to its two largest peers. According to S&P Global Market Intelligence, market capitalization has fallen nearly 50% since the asset cap was put in place, from nearly $300 billion at the end of 2017 to $157 billion at the end of the year.

JPMorgan Chase's market capitalization rose slightly to $393 billion over the same period, and Bank of America's fell 12% to about $266 billion.

While the asset cap is far from fatal, it has given the bank less room to expand into lucrative businesses like the capital markets, where meeting the business and financial needs of corporations, governments and other institutional clients requires keeping more assets in place. the bank balance. Sheet.

"Having to live below that limit has really captivated the flexibility they have with their balance sheets and their ability to get involved in specific businesses," Siefers said.

Scharf often says the asset cap doesn't limit Wells Fargo's ability to borrow more. As the demand for loans began to increase in 2021, Scharfanalysts saidThe bank was "as open for business as anyone on the asset side" as it was able to make adjustments to ensure it could meet clients' credit needs.

"If you're struggling to do business, we can certainly accommodate your needs," Scharf said in October 2021.

In December,Sharp said that each divisionAt Wells Fargo, he had "growth opportunities" and he took advantage of them, unlike in previous years when growth was "not the focus of the company."

The bank introduced Wells Fargo Premier for wealthier clients. It has tried to consolidate its investment banking operations,lead to some successin increasing negotiations. and is releaseda new range of credit cards, an area in which Wells has long underperformed, according to Scharf, a former head of retail banking at JPMorgan Chase and chief executive of Visa.

"There's an energy and enthusiasm within the company that certainly wasn't there three months ago because we're bringing things to market," Scharf said at a conference in December.

At least one regulator has taken note of Wells' growth efforts and is not happy. Chopra said he was concerned that the initiatives would act as a distraction from the bank's critical work to clean up its internal controls.

"We are concerned that the bank's product launches, growth initiatives and other efforts to increase profits have delayed much-needed reform," the CFPB director said.

For all its efforts to grow in recent years, Wells Fargo has also shrunk in some areas and sold entire companies. These changes are part of an effort to streamline services and focus on the services needed by its largest customers.

The bankgot out of the student loan businessand sold his $10 billion portfolio. He sold his Corporate Trust Services division for $750 million. yours soldCanadian Department of Direct Equipment Financingto the Dominion Bank of Toronto. And thesold its wealth management divisionfor $2.1 billion.

Scharf said the departures were driven by executives' vision of what Wells Fargo should be like in the long term, not wealth caps.

"To the extent that it helps us with the asset ceiling, that's certainly an advantage," Scharf said in January 2021. "But that's not the lens through which we look at it."

The most notable impact of the wealth limit was on Wells Fargo deposits. Shortly after its launch, Wells Fargo began avoiding some less desirable types of deposits, such as those from large institutions that typically charge higher interest rates, to make room for consumer deposits and customers' "working" money. corporate. , which is the daily cash that businesses need for payroll and other expenses.

Prioritizing some deposits over others may have been an unintended consequence of the wealth cap, particularly in the early stages of the pandemic when deposits swept through the banking system, but it may also have prepared Wells Fargo to face an increasingly deposit environment. ever more saturated.Pressure to pay the depositorIt's more when interest rates go up.

According to a research note by UBS analyst Erika Najarian, Wells Fargo's deposit base is more consumer-focused than almost any other major or regional bank. With consumers charging much lower fees than business customers, Najarian and other analysts expect Wells Fargo to see less pressure on deposit costs.

"The results from our Deposit Quality Scorecard support our positive inventory of beliefs," Wells Fargo's Najarian wrote.

„Marathon statt Sprint“

According to Scharf, he spends more than half his time making sure Wells Fargo teams are on track to build the kind of risk infrastructure regulators want. This is no easy task given the multitude of compliance violations that have led regulators to enact the asset cap.

At the heart of many of Wells Fargo's problems was the lack of a proper company-wide risk management program, one that would track compliance violations in each business unit and then report the risks to senior management.

Finally, the 2018 Fed rule requires Wells Fargo to implement a risk management process "appropriate to the size and complexity of the bank."

Wells Fargo executives are "confident that we not only understand the work that needs to be done, but that we have completely changed our approach," Scharf told analysts in June. It's a "huge, huge job" that requires developing massive plans, hiring people to execute them, creating new technology and making sure improvements last over time, Scharf said.

"You don't just build. You have to be sustainable for months," Scharf said. "We have to do our own internal [quality assurance] on all the different lines of defense. And then the regulators have to step in and do that."

One could argue that one day, when its regulatory problems are resolved, Wells Fargo could have a world-class risk management program that will quickly prevent any hint of similar problems in the future.

"If we go through this ordeal from worst to first, so to speak, if we can come to a new standard of what good controls are, then in a way it will have served its purpose," analyst Siefers said.

Investors remain confident in Scharf's ability to fix Wells Fargo and break through the asset ceiling, but "there will always be some sort of timer," Siefers said.

“I think as we go forward, the market will understand that this is a marathon and not a race,” Siefers said.

RBC Capital Markets analyst Gerard Cassidy said questions for Scharf and his team could rise if the end is not in sight for two years.

“At the moment I think that each one decides when in doubt. They're doing everything they can," Cassidy said. "If it drags on, that could change."

The effectiveness of the wealth limit as a monitoring tool is also unclear. The cap made life difficult for Wells Fargo and prompted a number of changes at the bank, though measuring cultural attitudes is inherently subjective. On the other hand, the fact that the Federal Reserve took such a drastic step was something of a wake-up call for the banking industry in general.

"Virtually all the banks, certainly the ones that are watching this from the outside, would go to the ends of the world to make sure this doesn't happen to them," Siefers said.

Whether asset limits will be used again depends on individual circumstances, but Hoenig said action will likely be reserved for the most serious violations.

"If something like this came up again, they would do it again," Hoenig said. “It would be more than just a civil fine. It would be something like limiting growth or laying off certain employees. Whatever the cause of the problem, they would want to push that source to fix it."

Hopes that Wells Fargo could resolve the underlying cap problems in a few months were misguided. Compliance actions take time to resolve and can take even longer as cultures change.

Few expect the limit to reach 10 years, but that doesn't mean the bank should expect to die of old age, said Todd Phillips, a former FDIC attorney and current director of Phillips Policy Consulting.

"The Fed would probably agree to an indefinite wealth limit until Wells Fargo shows that it can be a good corporate citizen," Phillips said. “It is not difficult for the Fed to maintain the asset ceiling. It's not spending federal funds, it's just there."

Given the size of Wells Fargo, the nature of the underlying scandals and the asset growth cap precedent, Vanatta said that every time the Fed lifts compliance action, the move comes under scrutiny. With that in mind, he won't let Wells Fargo get away with it until he's sure all the bank's problems are behind him.

"Supervisors know that revoking the consent order is going to be important," Vanatta said. "It's going to be a very important moment and they want to do it right so that it sends the right message and they trust that a year, two years, three years later it won't surprise them."