Senate Moves To End "Operation Choke Point" De-Banking With New Bill—But More Protections Are Needed

Following a key hearing in February, Senate Banking Committee Chairman Tim Scott (R-SC) is seeking to protect financial freedom with the introduction of the Financial Integrity and Regulation Management (FIRM) Act. The committee's Republican members unanimously support the bill, which aims to curb the practice of "de-banking," where the federal banking agencies pressure financial institutions to close accounts or refuse services to lawful industries using the supervisory process, including vague and malleable "reputational risk" concerns.

As we have noted previously, de-banking is nothing new. In its first iteration from 2012-2017, it was known as Operation Choke Point—where through informal guidance, the federal banking agencies (the Federal Reserve, OCC, FDIC, NCUA) leveraged reputational risk as part of the supervisory ratings to pressure banks to refuse banking services or to close the accounts of lawful businesses, primarily from the same industries that were not favored by the leadership of the federal banking agencies at the time. This practice was roundly condemned in Congress by former agency chairs and industry alike. Unfortunately, the agencies failed to learn from the past. Operation Choke Point 2.0—a "whole of government" initiative aimed at crippling the digital asset and blockchain ("crypto") industry—employed the same tactics in recent years.[1]

What Would the FIRM Act Do?

The FIRM Act would ensure that banks make decisions based on clear, objective criteria such as financial health and compliance with the law—not subjective judgments about the reputational risk of certain industries, including cryptocurrency.[2] The bill would prohibit banks from refusing to serve legal businesses unless there is a legitimate financial risk involved.

By adding more transparency and safeguards against politically or socially motivated financial exclusions that are not related to the objective financial condition of a bank, the bill would protect individuals and businesses from being unfairly de-banked, thereby refocusing on the primary objective of financial regulation and supervision—safety and soundness.

The bill defines "reputational risk" as:

[T]he potential that negative publicity or negative public opinion regarding an institution's business practices, whether true or not, will cause a decline in confidence in the institution or a decline in the customer base, costly litigation, or revenue reductions or otherwise adversely impact the depository institution.

To this end, the bill mandates that all federal banking agencies "remove from any guidance, rule, examination manual, or similar document established by the agency any reference to reputational risk, or any term substantially similar, regarding the supervision of depository institutions such that reputational risk, or any term substantially similar, is no longer taken into consideration by the Federal banking agency when examining and supervising a depository institution."

The federal banking agencies would be prohibited from relying on reputational risk or any substantially similar term, including when:

• Establishing any rule, regulation, requirement, standard or supervisory expectation
• Conducting any examination, assessment, data collection, or other supervisory exercise
• Issuing examination findings or communications
• Making any supervisory ratings decision or determination
• Taking any formal or informal enforcement action

The federal banking agencies would also be required to submit to Congress a report confirming their implementation of the legislation and describing any changes made to internal policies as a result of the FIRM Act. That description of changes made would be revealing and a significant first step toward a fairer and more transparent framework for bank examinations but only if made a standard part of the regulatory examination process. It will shine a light on what has worked and what does not work and is fully consistent with the old saying that "you can't know where you're going unless you know where you've been."

New Approaches To Protect Regulated Parties

The FIRM Act has already gained support from various banking groups that emphasize the need for a fair and transparent banking environment to foster innovation without undue discrimination. And while the bill represents a significant step toward safeguarding the rights of individuals and businesses from improperly motivated financial exclusion, there is more that can be done, particularly in two areas:

The Need for Due Process

If Operation Choke Point 1.0 and 2.0 have taught the banking industry anything, it is that due process is required for the bank supervision and examination process. This is especially so where the regulatory action is based on a claim of "need" which, however sincere, is not rooted in clear law or regulation. Bank regulators often justify the use of vague and ambiguous standards by citing necessity, but this is not a valid reason for exceeding the legal authority that Congress gave them by statute. The Constitution grants Congress, not regulators, the exclusive power to make laws under the Necessary and Proper Clause, requiring actions to be taken within those laws. The Supreme Court has consistently upheld this fact, most notably in Youngstown Steel, which held that "[t]he need for new legislation does not enact it. Nor does it repeal or amend existing law."[3] Accordingly, regulators may not simply expand their powers due to perceived "necessity." They must work within the statutory framework and refrain from creating and enforcing arbitrary or personal standards.

For this reason, due process must be upheld throughout the examination process. Executive Order 13892 mandates transparency and fairness, requiring agencies to avoid unfair surprises and provide clear explanations for legal decisions. It also stipulates that new regulatory claims must be published before they apply, and individuals must have the opportunity to be heard, which we have previously discussed. Actions with "legal consequences" affect substantive rights, and banking agencies must adhere to these standards. Congress should ensure these protections apply to banking agencies and hold them accountable for compliance.

Similar to the reporting obligations proposed by the FIRM Act, agencies should be required to protect the due process rights of regulated parties by reporting annually to Congress on their adherence to Executive Order 13892 and related orders. Moreover, under Executive Order 12866, agencies must explain in their rules and guidance why they chose to regulate, as required by law, and demonstrate that not regulating would create a significant problem. Put differently, EO 12866 indicates a preference for not regulating unless not regulating would cause harm. It must be more than mere inconvenience to the regulators. This would avoid the creation of more check-the-box exercises.

Moreover, given the President's recent assertion of Article II powers over independent agencies, there should be no doubt that these due process protections apply to federal banking agencies. Congress should make it clear that these standards apply to the federal banking agencies and that Congress will assess agency conduct against those standards.[4]

The Case for Eliminating the "M" in CAMELS

Research from the Bank Policy Institute shows no correlation between the "M" (Management) rating in the CAMELS system and a bank's financial condition. Rather, the "M" rating lacks statutory grounding, making it a product of regulatory evolution without congressional approval. Essentially, it functions as an unwritten rule that has come to mean "something examiners don't like," operating like a legislative rule without following proper procedures under the APA or CRA. That approach will not work long-term.

If a bank has adequate capital, liquidity, quality assets, and sound operations—metrics that are objectively measurable and are tied to safety and soundness—there is no reason to consider the quality of "Management," which is subjective and not based on any empirical or uniform standard. This should be left as the responsibility of the shareholders, who have every right to interject when they believe the bank is being poorly managed or taken in the wrong direction. If "Management" were truly affecting the bank, this would be evident in a decline in the other ratings. It is also important to note that a score of "3" or lower "M" rating can lead to severe, long-lasting consequences for a bank, including:

• Significant limits on non-bank activities
• Higher deposit insurance premiums
• Restrictions on access to FHLB funding
• Bans on expansion or M&A
• Negative impact on appointing directors or senior executives
• Difficulty in securing expedited processing for non-bank proposals

Moreover, banks are often unable to publicly contest a supervisory rating because such public disclosure would violate examination confidentiality. Such outcomes can stifle innovation or opportunities for growth. Given these consequences and the lack of objective grounding for the "M" rating, its elimination would streamline regulation and better align supervision with the interests of shareholders and the broader financial system. Thus, federal banking agencies should maintain their focus only on objective safety and soundness issues, not subjective standards that are ambiguous, unclear, and inconsistent.

Conclusion

The FIRM Act is an important and powerful step forward to safeguarding financial inclusion and creating a fairer and more just banking system. By focusing regulatory oversight on financial health and legal compliance, the FIRM Act will help ensure that banks make decisions based on objective criteria, not the subjective reputational judgments of their regulators. The legislation has already garnered a great deal of support, emphasizing the need for change in the banking system. And change already seems on the horizon with the OCC's issuance of Interpretive Letter 1183 confirming that crypto-asset custody, certain stablecoin activities, and participation in independent node verification networks such as distributed ledger are permissible for national banks and federal savings associations, which we covered in a previous post.

There are further legislative and policy initiatives needed to help unwind Operation Choke Point 2.0 and create a safer and more transparent banking environment, but this is a strong step in the right direction.

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Should you need additional analysis or guidance in connection with planning how to respond to these changes, the DWT financial services team is prepared to assist.