FDIC to Remove “Reputational Risk” Category from Bank Supervision, Shifting Focus to Traditional Risk Factors

The Federal Deposit Insurance Corporation (FDIC) is taking significant steps to overhaul how it supervises banks, moving away from the "reputational risk" category in its regulatory framework. The change, which was revealed in a March 24 letter to Rep. Dan Meuser, marks a pivotal shift in the way the agency approaches bank examinations.

In the letter, FDIC acting Chairman Travis Hill explained that "while a bank's reputation is critically important, most activities that could threaten a bank's reputation do so through traditional risk channels" like credit or market risks. Therefore, the FDIC will no longer use "reputational risk" as a standalone category in its supervisory processes. The letter emphasized that the FDIC had completed a review of its regulations and policy documents and would be eliminating references to reputational risk from its regulatory approach.

Hill’s comments indicate that the agency believes other risk categories, such as credit risk and market risk, already encompass the potential threats to a bank's reputation. Therefore, there is little need to treat reputational risk as a separate supervisory concern. Read more about the FDIC's policy shift here.

Reputational Risk in the Context of Digital Assets

The FDIC’s letter also touches on the issue of digital assets. Hill noted that the agency had generally been “closed for business” when it came to institutions seeking to engage with blockchain or distributed ledger technology. However, the letter hinted at a new direction in the FDIC’s digital asset policy. The agency plans to offer a clearer path for banks interested in engaging with the digital asset sector.

This move is significant as it comes in the wake of broader discussions about the debanking of certain industries, particularly the cryptocurrency sector. In 2023, many cryptocurrency and tech companies were denied banking services in the US, in what was seen as an unofficial operation known as Operation Chokepoint 2.0. This operation, which came after the collapse of crypto-friendly banks, led to the closure of more than 30 cryptocurrency and technology companies’ banking relationships.

Hill's comments are also a response to a letter from Rep. Dan Meuser and other lawmakers earlier this year. The letter called for clearer rules regarding digital assets and recommended steps to prevent debanking. The FDIC’s new approach aims to address these concerns while ensuring that banks are able to engage with digital assets in a compliant and secure manner.

Reputational Risk and Its Impact on Bank Operations

In financial regulations, reputational risk refers to the potential for a bank’s negative publicity to harm its business. This could occur through a loss of customers, costly lawsuits, or reduced revenue. Reputational risk has long been considered an intangible but significant factor in the banking world, affecting everything from customer trust to the overall health of financial institutions.

While the Federal Reserve defines reputational risk as the chance that negative publicity regarding a bank’s business practices could lead to operational setbacks, the FDIC’s decision to move away from using this risk category reflects the growing shift in the financial sector towards a more streamlined approach to supervision.

This move aligns with the Office of the Comptroller of the Currency (OCC), which similarly stopped conducting examinations based solely on reputational risk, focusing instead on traditional financial risks.

Looking Ahead: The Impact on Digital Assets and Banking

As the regulatory landscape evolves, the FDIC’s shift could open the door for greater collaboration between traditional financial institutions and the burgeoning digital asset space. While the agency has historically been conservative in its approach to blockchain and cryptocurrencies, this new direction signals an openness to engaging with the sector more effectively.

In the coming months, it will be crucial to monitor how these changes impact digital asset policies and whether other regulatory bodies follow suit in removing reputational risk as a barrier to banking services. This shift could help prevent future challenges in industries seen as "risky" to banks, particularly the cryptocurrency industry, which has faced significant hurdles in securing banking relationships.

For more details on the FDIC's stance on digital assets, read the full letter here.

As regulatory clarity grows, the relationship between traditional finance and digital assets may experience a shift toward greater cooperation and understanding, setting the stage for the next evolution in financial services.