The Truth About Account Closures

Recent conversations around "debanking" are putting renewed focus on legal businesses that report difficulties accessing banking services. Alleviating this issue requires looking at both inefficient regulatory requirements and the opaque bank examination regime.

Banks in the United States play an important role in detecting and reporting suspected financial crimes. Banks dedicate enormous resources to prevent malicious actors from using the financial system for criminal enterprises, including drug trafficking and terrorist financing. But currently, some regulatory requirements and examiner checklists for preventing these activities are inefficient and largely ineffective. They create incentives for banks to file millions of Suspicious Activity Reports and, in some cases, designate customers as "high risk" even if their actual likelihood of criminal activity is low. Improving this framework can enable banks to focus on the highest-risk transactions, more accurately identify possible criminal activity and provide more services to law-abiding and creditworthy customers.

Background

Under the Bank Secrecy Act, banks have the obligation to build profiles of their customers, monitor their customers' activity and file Suspicious Activity Reports (SARs) in the event there is any suspicion of illicit activity. Under innumerable implementing regulations, policy statements and examination handbooks issued by the federal banking agencies, banks are heavily incentivized to file SARs because even an isolated and inadvertent miss can give examiners a reason to sanction a bank or call its entire risk management system into question. (The banking agencies do not trace the efficacy of SARs that are filed.) Conversely, banks are immune from liability for filing a SAR and will never be sanctioned for filing too many. Thus, 4.6 million SARs were filed last year.

Adding to the opacity of this regime, a SAR, and any information that would reveal the existence (or non-existence) of a SAR, are confidential and prohibited by law from disclosure. This means if a SAR is involved, banks are limited in the amount of information they can provide to the customer about the reasons for the closure.

Banks must also file Currency Transaction Reports (CTRs) for any cash transaction over $10,000. (That amount was set in 1970 and never revised; if adjusted for inflation, it would now be about $80,000.) Furthermore, many SARs filed are for "structuring," or a series of cash transactions that add up to $10,000. History shows that these structuring SARs are of little to no benefit, as they generally reflect honest activity, suspicious cash transactions are separately required to be reported as a SAR and real criminals know how to evade the restriction; however, they remain a major examination focus.

Another tactic of examiners is to require banks to designate certain accounts - by company, sector and/or country - as "high risk." Although there are good reasons to designate accounts as high-risk in some cases - for example, a recent FinCEN advisory describes red flags that could indicate a customer or counterparty may be involved in illicit activity fentanyl and synthetic opioids activities - an overly broad and punitive approach can significantly raise the costs to the bank and increase the risk of regulatory penalties, leading to reduced services even for law-abiding customers. First, a high-risk designation carries with it a heavy and ongoing compliance burden, basically to continually document that the account is not an illegal one. Furthermore, it means that any problem with that account is much more likely to generate draconian enforcement action. Failing to close an account or terminate a customer relationship with high illicit finance risk, even only with the benefit of hindsight, has led to penalties of hundreds of millions or even billions of dollars against banks in recent years.

While the banking agencies have said "no customer type presents a single level of uniform risk," there is no safe harbor preventing de-risking. Instead, examiners have increased their focus on how financial institutions handle higher-risk customers.

Debanking

Once multiple SARs have been filed, examiners generally expect the account to be closed. Failing to close an account or terminate a "high risk" customer relationship has driven significant criminal and regulatory actions against financial institutions for Bank Secrecy Act/Anti-Money Laundering violations. This strict regulatory stance on money laundering prevention means that banks face much higher risk if they miss an actual or even a suspected criminal activity than if they disappoint an individual who is actually a law-abiding customer by closing their account. Given the size of the penalties - which can also include being banned from organic growth or acquisitions - there is no margin that can be earned on some accounts to offset that risk.

The issue is currently focused on crypto, but it has been around for decades. Operation Choke Point used "high risk" designations affecting payday lenders, firearms stores, pawn shops and other industries. Earlier, the State Department had to intervene when dozens of embassies in Washington, D.C. lost their bank accounts. Those who care about global poverty have long complained that the threat of enforcement action has forced banks to exit Somalia and other countries.

Crypto companies are the latest group raising concerns about their access to banking services. And procedural requirements from the banking agencies demonstrate crypto-related activities have been subject to special treatment. Although there is no requirement in federal law that banks seek prior approval for new activities from the government, banks wishing to engage in crypto activities are now subject to notice requirements and something the agencies call "supervisory non-objection," an Orwellian phrase that effectively means prior approval. OCC guidance states, "[Crypto-related activities] are legally permissible for a bank to engage in, provided the bank can demonstrate, to the satisfaction of its supervisory office, that it has controls in place to conduct the activity in a safe and sound manner." Other agency guidance states, "Each agency has developed processes whereby banking organizations engage in robust supervisory discussions regarding proposed and existing crypto-asset-related activities." Illicit finance is one of many potential risks the agencies cite in their letters imposing heightened supervisory scrutiny on these activities.

While other agency guidance continues to say banks "are neither prohibited nor discouraged" from providing any legal banking services, in practice the secret examination regime gives regulators an effective veto over a bank's activities. Recent supervisory letters obtained by Coinbase and History Associates, Inc. show this phenomenon in action. The 23 supervisory letters are heavily redacted but they reveal examiners "requesting" that banks "pause" crypto-related activities, describe numerous conference calls and exchanges of information between banks and examiners, and include lengthy lists of questions regarding banks' planned crypto-related services. These letters provide a rare glimpse into how examiner pressure can discourage activities, even if they are legally permitted. Of course, even if a bank were to receive "non-objection," any crypto-related activities or other activities the examiners dislike could be designated high-risk and subject to oppressive oversight.

Solutions

AML

Policymakers can take stepsto enable banks to focus on the highest-risk transactions and streamline their anti-money laundering oversight.

A necessary but not sufficient solution is faithful implementation of the Anti-Money Laundering Act of 2020. That statute was passed specifically to refocus bank compliance on detecting illegal activity, and to encourage banks to use advanced AI and other techniques to locate terrorist financing and other series crimes. The Act's explicit direction is that financial institutions ensure "more attention and resources" are allocated towards "higher-risk customers and activities . . . rather than toward lower-risk customers and activities."

A 2024 proposal issued by FinCEN and the federal banking agencies effectively nullified both the spirit and text of the Act. It literally read the words "rather than toward lower-risk customers and activities" out of the statute. It failed to reorient the compliance regime to focus on true risk. It reiterated the check-the-box, multi-SAR approach to AML.

The next Administration has the opportunity to rewrite that rule, to the benefit of law-abiding businesses and the disappointment of the world's worst criminals.

The next Administration can also reform the requirements for SARs to stop mandatory filing of SARs on lower-risk transactions and to confirm that if an institution files multiple SARs on a single customer, there should be no expectation that the institution will exit the customer relationship on that basis alone.

More Broadly

The AML issue is part of a broader problem. Banks are authorized by statute to make loans and otherwise fund businesses and consumers. Capital and liquidity regulation ensures they do so safely. Bank examiners now feel empowered to tell individual banks how to run their business by shedding business lines or clients, as they have a strong incentive to find problems and prevent banks from taking risk. As a result, this has deprived creditworthy businesses and consumers of access to steady, inexpensive credit funded by deposits.

• Bank examiners can use the vague and amorphous concept of "reputational risk" to effectively push banks out of disfavored business lines. One occasion where such practices became public was Operation Choke Point, when it was revealed by Congressional investigations and media reports that examiners were pushing banks out of lending to politically unpopular businesses. More recently, the New York Department of Financial Services invoked reputational risk when it issued guidance to regulated entities urging them to reevaluate their business with gun promotion organizations. Last term, the Supreme Court unanimously held that the NRA plausibly alleged the NYDFS's actions violated their First Amendment rights. See NRA v. Vullo, 602 U.S. 175 (2024).
• The shift of lending to private credit followed agency "guidance" mandating that banks strictly limit lending to leveraged, mid-sized companies. Even when this guidance was found to be illegally promulgated under the Congressional Review Act, the agencies continued to enforce it.
• Examiners have pushed banks out of the mortgage servicing business, leveraged lending and synthetic risk transfers, which enable banks to expand lending to households via mortgages, auto loans, commercial and industrial (middle-market loans) and commercial real estate loans.
• Examiners have directed regional banks that are in full compliance with all liquidity rules to restrict lending and hold more government securities; they have directed regional banks that are in full compliance with all capital rules to raise capital.
• The FDIC has recently proposed, in conflict with state law and centuries of history, to institute "stakeholder" capitalism at the banks it oversees, intending to use the examination process to direct how banks serve their "stakeholders" - defined to include the FDIC itself.

There is a recipe for reform here, and it should be a top priority of incoming regulators.

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