The OCC’s Michael Hsu on the Big Risks Facing Banking Businesses Right Now

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1:28Hello and welcome to another episode of the All Thoughts podcast. I'm Tracy Alloway. And I'm Joe Weisenthal. So Joe, we've had a busy few months. Yeah, we really did. We were all over. We crisscrossed the country. We did all three coasts, East Coast, California, the third coast, Texas. We went to California twice in about three weeks, I think. But we have a nice little break now. Yes, I, for one, am grateful to not be living out of a suitcase for a while. But our last stop in the Whirlwind America tour was in Las Vegas. That was so fun. I loved going to Vegas. I really loved you. I love Vegas.

2:09It was so cool that I got the opportunity to join you in Las Vegas. Okay, listeners, this is where we're going to get into a little bit of an argument. You're going to hear Odlot's co-host air some dirty laundry. The day before, no, the day he was supposed to actually fly out to Las Vegas, Joe changed his mind. You decided Vegas isn't for you. So listeners, I love Vegas. It's one of my favorite cities in the country. I like playing poker. I love the strip. I love the lights. I love the water consumption in the desert. I was really excited. And then I got to the airport on this really nice fall day.

2:43He wasn't feeling it. No, it's not true. I got to the airport on this really nice fall day. And about 30 minutes after I got to the airport, my flight was pushed back about five hours. And I was only going to be in Vegas for 24 hours as it was. And I wasn't even sure that the flight was going to take off when they said, because actually it was the second delay at the time. And I did have family in town, which is also true. And Tracy was already out there. And Tracy is a very capable co-host, more than capable co-host. Sounds like a lot of excuse, Joe. And I said, please, Tracy, can you just do this?

3:19Can you just do me a solid and do this episode by herself and tracy without any complaint or frustration at the time i didn't complain i complained when i came back no making me feel bad about myself uh obliged let me just say the world's smallest microscope would not be able to locate my sympathy for this argument you know what no okay let's leave it there i just never okay listeners uh let me say though that you are in for a treat, as is Joe, because he wasn't there. So this is the first time he's going to hear this interview. But we spoke or I spoke with Michael Su, the acting comptroller of the currency.

3:58And we had a really interesting conversation. This was a live episode recorded on stage at Money 2020, which you might know as the big sort of fintech gathering. And we talked a lot about the intersection between banking and technology. And Joe, here's where it gets kind of odd lotsy, because Michael has been arguing for a while that a lot of what's happening in banking right now, and particularly in payments, kind of looks like a supply chain. So a lot of banks are outsourcing different functions like payments to third party vendors. And this presents a bunch of new and interesting problems and risks, and I guess also opportunities.

4:39these. It's so interesting to think about finance in this realm. And you can imagine how these things go in cycles, because you could imagine at some point, these functions were very simple, it was all in house, vertically, horizontally integrated, and so forth. And then like many other areas of the economy, companies realize, okay, wait, what if we have one specialty, other companies then specialize in this specific thing? I remember we did that episode about community banks and how they had to outsource a lot of their own functions about cybersecurity and so forth, because they don't have maybe the capacity of a J.P.

5:14Morgan. So it is interesting to think about the supply chain of money in that respect. Well, this is exactly it. So in one respect, it's a sort of natural evolution of the economy. Everyone becomes more specialized. Everyone becomes more efficient. The business model becomes more streamlined. But as Michael points out, there are these sort of new problems that are potentially thrown up by everyone outsourcing kind of critical functions in some respects. So without further ado, take a listen to this live episode with Michael Su recorded in Las Vegas, sans Joe, at Money 2020. Michael Su, acting controller of the OCC.

5:54Thank you so much for coming on OnLots. Tracy, thanks so much for having me. I love the show and it's a real honor to be here. Oh, I appreciate that. So I'm sort of in a reflective mood lately. And I used to be a banking correspondent. I covered a lot of fintech back when people were super excited about it. I feel like they're not as excited about it anymore. This is a really embarrassing first question. What does the OCC do? And how does it compare? I feel like there are so many different banking regulators. How much time do we have? Yeah, well, there's the FDIC. There's the Fed. There's the OCC.

6:26Who's doing what? How often do you step on each other's toes? We coordinate a lot. Let me put it that way. So the OCC regulates and supervises nationally chartered banks and federal savings associations. So just to put some numbers on that, it's about 1 ,100 banks. Wow. Okay. Now we've got over 4 ,000 banks in the banking system, but by assets, the largest banks tend to be nationally chartered. You're JPMorgan Chase's and your cities of the world. So by assets, the OCC supervises and regulates about two-thirds of the banking assets in the system. So you'll get a little bit of that 80-20 rule for nationally chartered banks.

7:06Banks can have state charters, and they can be members or not members of the Federal Reserve. So we have a complicated... Actually, your listeners might be interested in this, but maybe we'll spare them. No, our listeners love detail. So there's a different kind of landscape, but we coordinate quite a bit at the federal level on all the major rule makings because we want a level system. We want a level banking system. Now, I think what's really interesting about the OCC is historically, so we were founded in 1863 during the Civil War. And before the OCC, you had free banking. And this is relevant for stable coins.

7:44Because that system - But they all issued their own currency. Yes, I remember this. So you had the Bank of Tracy and you had the Bank of Mike and the Bank of Joe. And each bank would issue its own dollar. Different size, different color, but it would be a dollar. And so people were walking around with all these different notes. And in theory, they could go back to the Bank of Tracy and say, I want a dollar's worth of gold, right? Specy. And sometimes you had it and sometimes you didn't. And so there would be discount rates on these dollars. And so it was a mess. And you imagine like there's panics all the time.

8:17There's a lot of fraud and there were money men. People would walk, go around with bags full of money from town to town to exchange these dollars because, you know, if you're a farmer, you want to be able to do your business. So during the Civil War, Sam and Chase are like, hey, we've got to fund the war and we've got to bring the union together. So they've got, they passed a series of laws. They've got now a greenback, unified dollar, and they create national banks to basically both issue those and then take deposits and basically buy treasury bonds, which funds the war. That's crazy. So the OCC was around even before the Fed.

8:50Yes, yes, way before. So you have one up on them. So, well, and all we do is supervision. It's a, we are very supervisory focused agency. And so we've got a long deep history. And, you know, the stable coin debates, you know, this is less relevant now, but a lot of times folks are saying, well, why don't we want more? Don't we want stable coins? And it's like the stable coin landscape now looks a lot like free banking because each of these issuers is different. And they trade differently. I mean, if you go on and you look these things up, and it's not a long-term sustainable system. Well, since we're on the topic of stablecoins, as our Bloomberg Opinion columnist Matt Levine says often, it does seem like a lot of crypto and maybe some aspects of fintech are learning the lessons of the financial system development sort of in real time.

9:40And on the topic of stablecoins, you know, we did have a big collapse last year with Terra Luna. You at the OCC have always taken a sort of cautious approach to stablecoins. What was it that kind of worried you about their development? What was it that you saw that made you think, wait a second? And in some respects, it's kind of surprising because stable coins were supposed to be the safest aspect of the crypto system and then turned out to be very problematic. Although I guess you can say that about a lot of financial history, the safest assets often turn out to be the problematic ones. But what was it that made you take that cautious approach?

10:19So if we back up a little bit and just the rise of crypto. So I became acting comptroller in May of 2021. And that year alone, crypto was just on a rocket. That was a big year of growth for crypto in general and stable coins. And so there's a lot of hype, a lot of FOMO. And it felt familiar to me because it felt a lot like derivatives and structured finance circa 2004, 2006. Right. You pool all this stuff and then you trade it as one for one. And so there's, you know, Jillian Tett got this great book, Fool's Gold, and I recommend it to everybody because chapter one, innovation, chapter two, perversion, chapter three, crisis.

11:02And so this cycle happens over. The first innovations for credit default swaps were really, really good. They solved problems. It was amazing. It's great. And then people are just innovating for innovation's sake. And then you have the high priests. Who understands this? Oh, only the PhDs who understand nuclear physics can actually explain this stuff. And that creates an environment where it can just kind of eat itself. And so I had a feeling within crypto, maybe that's what's happening. And so, of course, I think we do what we do best in government. We dig in. What are the facts? Let's like crack the thing open, try to understand as best we can.

11:39And the more we looked, the more worrying signs of like, hmm, this is not all it's cracked up to be. And especially with stable coins, there was a big gap between the talk and the reality. And so that just sets a whole bunch of flags up. And so, yeah, you're trying to telegraph very clearly to banks. Like, look, if you're going to get into crypto, it's got to be safe, sound, and fair, do your homework, you make sure you have those controls in place. And so for the banks that were, you know, like I call them crypto curious, and there were a lot at the time, they lost interest, because I think they recognize, oh, that takes an awful lot of work.

12:14And then once the crypto winter happened, you know, a lot of that, there was a big pullback from that. Right. Well, the one other thing I want to ask is stable coins aside, you know, we did see a little bit of contagion from the crypto turmoil of 2022 into the banking system. So notably, we saw Silvergate collapse. And I guess we can debate how much of that was due to pure crypto or other dynamics with deposit outflows and things like that. But does it feel to you looking at the US banking landscape now in 2023 that there's enough of a barrier between between regulated banks and crypto? There's enough of a sort of insulation there?

12:53So I'm going to knock on, I'm not sure if this is wood. I'm going to knock on it. Our producer, Carmen, is going to kill you for making ambient noise during the podcast. The short answer is, I think so. And that's in part because across all the federal banking agencies, we've been very clear and unified about how we feel and what our expectations are about banks engaging in risky activities such as crypto. And we've listed those risks out. We've provided interagency guidance. Again, it's not to say that banks can't do it. But if a bank is going to do it, whatever it is, it's got to be safe, sound, and fair.

13:29And they have to prove that to us. We feel that that's very appropriate given what's taking place in the crypto space. Again, if you go back, I think the stats are about a billion dollars of fraud, two billion dollars of scams, and three billion dollars of hacks last year. Like, that's a risky space. That's not to say everybody's bad, because that's not true. There are good players in that space, but it's a risky space. And so we expect banks to do that work. And I think most banks, either they're doing that work or they're decided it's just not really worth it. So crypto is by no means a monolith.

14:02And even though you've taken a cautious approach to stablecoins, I get the sense that you're a little bit more interested in another aspect of crypto tokenization. You're holding a big tokenization conference, right? What's the draw there? So the OCC is hosting a tokenization symposium on February 8th. Mark your calendars. Open to the public. Our keynote is going to be Hyun Sung-shen from the BIS. I know you and Joe are like - And All Lots guest. One of our favorites. Yeah, yeah. And Hyun is fantastic because he's got a very broad perspective across both monetary policy, research, banking, and all things kind of crypto digital assets related.

14:42Because at the BIS, they've got the innovation hub. And there's a lot of intersection between his research and what they've been doing. In a word, there's been a growing divide between crypto and tokenization. And tokenization of real world assets and liabilities. Most crypto is not backed by anything. Bitcoin, Ether, etc. Or stable coins. Tokenization is a different game. Crypto is retail focused. And most of the interest in those coins is based on a hope for speculative gain. Tokenization is about solving a settlement problem. And this is really, for your listeners, now we're in the plumbing of the system.

15:22And for those who know, when you buy a share of stock, there's all this stuff that happens in the background. It involves multiple players. There's different handoffs. There's risk that gets transformed in different ways. It's complicated. And it creates frictions and it creates costs. So if there's a way to make that settlement process better, why not? And I think that's the promise of tokenization is that some of those risks and frictions can be addressed by basically taking messaging and settlement and combining that. Can you explain that a little bit further? Because when I think tokenization, I presume these are centralized databases.

16:01And then I think, well, what's the difference between a tokenized central database versus an Excel spreadsheet? Right. That's password protected. Yes. Like, what is the innovation here? Right. So this is a very important point. Blockchain. Note, I didn't say blockchain. No, you didn't. Okay. And I think that's a very important distinction, right? I think there has been a little bit of a, how should I, what's the best way to put it? It's almost like a Rorschach test. You know, you say blockchain and some folks say, oh, that's the next big thing, whether they understand it or not. Like, oh, it's super efficient and fast.

16:34Right. It's not super efficient or fast. I mean, I remember the years when we were going to put everything on the blockchain, like groceries or like balsamic vinegar was going to be traceable on the blockchain to make sure it came from a specific region and things like that. Right. And so the design of public blockchains was there were certain reasons for doing it. If you go back to the Satoshi Nakamoto white paper, that paper is pretty fascinating. It's a really interesting paper, and it makes the case for why you should do something that way. But to your point, Tracy, if the problem you're trying to solve is settlement frictions, you don't need that.

17:13And in fact, that probably just slows things down and gums things up. There are better ways to do that. Now, what's the innovation? That's your question. What's the innovation? It's basically taking messaging and settlement and combining it. that's different. Because right now, when you, again, we'll use the example, when you buy a share of stock, you're sending a message to buy a share of Tesla or something. And then that message goes. And then a bunch of other things have to happen before that thing actually settles. Your money gets transferred, you get a share of stock, and that's held somewhere.

17:43And you have, everyone's fully aware that that has happened. With tokenization, you actually collapse a lot of those steps into a single thing. Oh, I see. So multiple processes can exist as sort of like one thing that can then move through the system and be verified. Exactly. And, you know, again, for the banking nerds and the payment nerds out there, this is exciting. Now, it's hard to tell this story to a retail because it's hard to see that difference. But those costs and those frictions add up. And there's quite a bit of time and effort that gets put into identifying, addressing, assessing, managing those risks and frictions.

18:22And so, you know, that in the, for the regulators in the central banks that have been kind of, you know, interested in this space, a lot of the, the more of the excitement going forward is really in this kind of tokenization space rather than in kind of the retail space, which I think is been colored by a lot of the recent, you know, the crypto events.

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19:39So, have you heard the story about the prescription plan with savings automatically built in? It's where a family of any size can feel confident the cost of their medication won't hold them back. Go to cmk.co slash stories to learn how CVS Caremark helps members save just by being members. That's cmk.co slash s-t-o-r-i-e-s. Well, since we're on the topic of financial innovation and we are essentially at a fintech conference, we're at Money 2020, I want to ask you about a recent publication from the OCC. It's the Interagency, it has a very catchy name, the Interagency Guidance on Third-Party Relationships.

20:23Is that just basically a way of saying that you're worried about fintech partnerships with the banks? So the guidance is broader than just that, but you're onto something. So let me just zoom out for a second. That guidance is geared towards banks' relationships with any vendors, Any third parties. Okay. So payments as well and things like that. Payments, but a bunch of others as well. And so the story I like to tell is, way back in the beginning, all of banking was done by banks. And so you can imagine there's like a box, and you can label it banks and banking. It was the same box. They did everything by themselves.

20:58And then over time, they had to rely on others to do certain things. And probably the clearest example is with the core processors, a lot of banks rely on the core processors to do certain processing. Right. accounting, reconciliations, et cetera. And so that's, now there's a dependency. And so as a regulator, you say, how do I ensure that everything that that bank does is safe, sound, and fair? Oh, I need to make sure that what they've done with that third party is up to snuff, right? If it's slipshod, if it's done sloppily, things can break. And then the bank would say, oh, that wasn't my fault.

21:32And they'll blame it on someone else. But at the end of the day, the bank itself is not going to be safe. We don't have a safe and sound system. So we want to make sure that that standard kind of carries through. It's almost like an extension of the bank, if you will. Okay, that's 101. Now we fast forward to today. Now it's way more complicated because not only do you have lots of different kinds of vendors, like a lot of banks are now saying, hey, why stop with cores? We can do this with a lot of, because our comparative advantage is different than a lot of the technology that's out there. There's a whole bunch of different use cases in terms of vendors.

22:04Now the tables are being turned. Now you've got some fintechs that are going to customers and say, we will be the interface with you to take a deposit, make a loan, etc. But we need a bank to actually do that. And so then they go to the bank. So in a sense, the bank is the provider. That's why it's banking as a service. The bank is providing that service, but the dependency is flipped around. Yeah. It's almost like, you know, we used to talk about the disintermediation of banks. and someone brought this up in our discord recently. Apparently I wrote an article, which I'd forgotten, but when there was all that excitement about peer-to-peer lending or direct lending, Wells Fargo apparently like put out a notice to its employees saying, please do not invest in peer-to-peer lending because they're a direct competitor to us, right?

22:54The whole idea was cut out the banks and people could make loans to each other. But now it's almost like disaggregation. We're disaggregating the banks. We're sort of like taking pieces away or like there are new players, new companies that are tapping the banks for specific pieces. It's all very confusing. Well, it's confusing, but there's a logic to it. And so the analogy I like to draw is if you go back to pre-2008, capital markets disintermediated banking. It was really the lending and the deposit taking, right? Money funds took deposit taking and securitization took lending. By the way, this is how you get a financial journalist's attention when you say, here's a pre-2008 analogy.

23:33I'm all ears. I'm like, yes, tell me. So if you drew a picture, and one of my favorite pictures of this, Zoltan Pozar, who is another Odd Thoughts favorite. Another Odd Thoughts favorite. He drew this map. His famous map that he had pinned on the wall of the New York Fed. I mean, a bunch of folks had this map pinned. It was a gigantic map. And, you know, again, for the nerds on the podcast, it was basically T-accounts. Assets, liabilities, equity. But for different points of the system. And it did what any good financial, follow the money. Right. You just follow the money. Right. How it's moving through the banking system and the shadow banking system at that time.

24:12And so Zoltan and then Adam Ashcraft was a co-author on the shadow banking paper, which basically said what banks used to do as lenders has now been broken up into six pieces or multiple pieces. And each piece is being done by a different group. So origination. Remember New Century and Option 1? They would do originations for mortgages. Warehouse lending. Someone else would do warehouse lending. Distribution. Someone else would do. And you'd look at that and say, well, does that make sense? Well, there's like a specialty there. Okay. And maybe they're particularly good at that. And there's economies of scale.

24:43Yeah, they would argue efficiencies, right? Efficiencies. And so you'd say that that logic in and of itself on a micro scale made sense. It's only when you zoomed out and you looked at the whole thing that you said, uh-oh, does this hold? And I think the real insight from the POSAR Ashcraft work was all the Fed facilities matched up to each of those points. So it's almost like the discount window was recreated for what had been disintermediated, which is quite intuitive, actually. So it gets back to this idea I have, which I think others have talked about. It's like you've got the conservation of matter.