The acting head of the Office of the Comptroller of the Currency sent a sharp message Jan. 17 that banks considered "too big to manage" could face being broken up into smaller pieces — but those decisions will not happen lightly.

Acting Comptroller of the Currency Michael Hsu said his agency will continue to focus on the timeliness of banks in acting to fix problems through its four-step escalation process. At the same time, the agency is also considering ways to make that process more transparent and predictable, and Hsu urged other regulators to do the same.

Bank regulators need "to develop credible, transparent mechanisms to compel divestitures and simplification at large banks when necessary," Hsu said. "At the OCC, we are considering steps to provide greater transparency and predictability into the escalation framework."

Escalation framework

Speaking at the Brookings Institution, Hsu expressed concern about large, complex banks where "control failures, risk management breakdowns, and negative surprises happen too frequently." In those cases, the size and complexity of the bank "is the core problem that needs to be solved, not the weaknesses of its systems and processes or the unwillingness or incompetence of its senior leaders," Hsu said.

Hsu laid out specifics of the escalation framework the OCC uses to demand change at those institutions.

Without noting any particular bank, Hsu said the OCC will first put a bank on notice and make clear what steps the financial institution must take to remediate problems, generally uncovered in the examination process. If the bank does not improve, the agency will move to public enforcement efforts, such as consent orders.

If problems persist and "negative surprises" continue to occur, the OCC could move to "growth restrictions" or even to divestitures, according to Hsu.

"The most effective and efficient way to successfully fix issues at a [too-big-to-manage] bank is to simplify it — by divesting businesses, curtailing operations, and reducing complexity," Hsu said.

However, the OCC does not make decisions lightly on when to restrict or break up a large bank.

"Given the stakes involved ... we need to approach such situations and actions with great care," Hsu said.

The OCC is considering steps to providing "greater transparency and predictability” into the escalation framework, he said. The agency wants to "support due process and fairness, and bolster the credibility of supervisory actions taken," Hsu noted.

Red flags

Hsu also spelled out situations that may hint to the OCC that a bank is "too-big-to-manage," including when the institution uses percentages to assess the impact of a problem on customers in a way that inaccurately measures that impact, or if the institution incorrectly assumes a problem is an isolated incident.

If regulatory examiners "consistently uncover more risks and problems" at the bank than the bank's internal risk and controls functions do, that would also be a red flag to the OCC. In some cases, the bank could become reliant on examiners to function as a so-called fourth line of defense, according to Hsu.

"This should be a flag and a sign that the bank is potentially becoming less manageable," he said.

The OCC will also raise an eyebrow to "a lack of agitation" among bank executives, which often "enables inertia and gives space for problems to fester, remediation timelines to extend, and partial efforts to be seen as good enough," Hsu said.

Mixed reaction

A panel discussion after the speech reflected mixed views on the framework Hsu laid out.

Douglas Elliott, a partner at Oliver Wyman who works on financial regulatory matters, said he "disagreed pretty strongly" with the framework, noting that breaking banks into smaller pieces might hurt more than it helps.

"There's at least the potential that by creating many more CEOs and C-suite members because you've got more organizations … the dilution and quality of those members could conceivably offset the advantages of having smaller, potentially simpler organizations," Elliott said. "It's not obvious they'd be all that much easier to manage."

Susan Ochs, CEO of Ochs Advisors LLC, thought Hsu's speech was "very interesting."

"I actually think a little bit more of a cudgel from the regulatory side could help bank management move into some of these better management decisions, thinking more about culture," Ochs said. "That actually could help them, and so I think this could be an interesting framework for them."