Inside Treasury's Push to Reset Bank Regulation

Now, A.I. does offer, I think, an opportunity to accelerate growth, but we've got antiquated regulation like model risk guidance that limited the ability of banks to adopt. And we also had significant supervisory regulatory impediments to banks being able to participate with fund the trillions in investment necessary to really capitalize on the promise of A.I. This wasn't working. Coming into this administration. That's Jonathan McHaranon, who went to recently served as Treasury undersecretary for domestic finance and my guest today on banking with interest. I'm Rob Blackwell, Chief Content Officer at Interfine and a former banking journalist for 20 years. One of the defining features of bank regulation during the Second Trump administration has been the role played by the Treasury Department. Other than leaving the Fed, FDIC and OCC to move largely on their own, Treasury has been actively coordinating what Secretary Scott Besson has called a fundamental regulatory reset, touching everything from capital and supervision to liquidity and any money laundering rules. During his tenure at Treasury, Jonathan was at the center of that effort. He says that regulators have historically spent too much time trying to eliminate risk rather than making sure banks could manage it, and that the cumulative result has been less credit, fewer community banks, and more financial activity migrating outside the banking system. We also talk about what he learned as an FDIC board member during the failures of Silicon Valley banks, signature and first republic, what changes he would recommend in the wake of those failures, and how A.I. could fundamentally reshape banking. And finally, we discuss arguably the toughest challenge of all. After three administrations marked by dramatic swings in bank policy, can the changes made by Treasury this time around actually last? Jonathan officially served as Undersecretary for Domestic Finance since October of last year, and he was a Senior Treasury Advisor before that starting in February. He previously served on the board of the FDIC as an Independent Director from January of 2023 until 2025. Prior to that, he was a Senior Council for Policy at the Federal Housing Finance Agency, previously worked for Senators Pat Toomey and Bob Corker on the Senate Banking Committee. Jonathan, welcome to the show. Rob, it's great to be with you. So let's dive in. This Treasury Department has been in the driver's seat when it comes to bank regulation in a way that I personally haven't seen since the financial crisis. Can you take me through why Treasury felt it was the right move here to sort of more directly coordinate the bank regulators? Yeah, so as you know, Rob, Treasury's role here is not entirely new. There was obviously Treasury's involvement in the response to the 2008 financial crisis. Treasury's involvement in response to the threat crisis in the '90s. Secretary Chase and establishment of National Bank System during the Civil War and even going further back Secretary Hamilton and the First Bank of the United States. Treasury has historically played a central role in financial regulatory questions when those questions become questions of national economic policy. More than 15 years after the financial crisis, you look around and take stock and take some things to jump out. Since 2010, we've lost 3,600 community banks that's more than 45 percent of those banks. The new charters they used to be going into the crisis more than 100 a year, how are down to six, sometimes even fewer. That was going into this administration. Mortgage lending, left the banking system, doing large part, I think, to excessive credit risk capital requirements on mortgage, increasingly that's also true at corporate lending with the rise of private credit. Large banks now allocate about 25 percent of their balance sheet to save assets that's up from 10 percent before the crisis, and economic growth is slow, that's undermined our economic security and our ability to meet our obligations to the old and the sick. LAI does offer, I think, an opportunity to accelerate growth, but we've got antiquated regulation like model risk guidance that limited the ability of banks to adopt. And we also had significant supervisory regulatory impediments to banks being able to participate, fund the trillions in investment necessary to really capitalize on the promise of AI. This wasn't working. Coming into this administration, we needed a course correction. If the regulatory framework is not fit for purpose today, it certainly was not fit for purpose for the financial system of the future when you're going to have potentially AI agents, other innovations fundamentally change the market structure. So in times like this, it's treasuries mandate to get things back on track. Treasuries roll is not the direct regulators to try to replace their expertise. Treasuries roll is simply to forget common sense perspective, coordinate across the regulators, a shared understanding of where the cumulative framework is striking an appropriate balance across safety and soundness and finish stability on the one hand and the impacts on the real economy on the other hand, whether in terms of growth, loss growth, the viability of community bank model, or what's felt on Main Street. And then to the extent that balance is off, Treasuries roll is really just a drive in their agency consensus, settle turf battles, overcome policy inertia, maintain the urgency of reform. Discipline process is especially important because we've got more than a handful of financial services regulators. We've got to get it all on the same page. So I think that's why Treasuries roll is the right move. We urgently need a fundamental reset on financial regulation, both for today and also to make way for the financial system of the future. We're going to talk a little bit more about what the reset means before we do, which I want to dive deeper a little bit into your bio, because you had a sort of unique experience in Sheila Barr was famously at Treasury before she was at the FDIC. You were at FDIC as a director on the board and then went to Treasuries. So how did that inform your view at Treasury? When the bank fails, especially when a large bank fails, it makes the newspaper, makes the front pages. People tend to notice, people get upset, people demand action. That's on the flip side, not really the case when regulation has choked off credit to some young family that's trying to get them mortgage to buy a house, small business, small farm, trying to get alone to grow. That doesn't make the headlines, right? Probably that family, that business, that farm didn't even realize that there was regulation to play the role in that credit, that loan not being made. So I think there's this natural tendency at the regulators to regulate by reflex, respond to what's in the headlines by piling on one regulation on top of another without a larger sense of the cumulative cost and benefits to society of that regulation. And ultimately, what the result is is a risk push, even responsible risk-taking out of the banking system. But banks exist to take and manage risks. That's the very essence of banking. Is risk management, not risk elimination. And so what I think I learned is that regulators have this structural incentive to underweight the diffuse cost to society of excessive regulation, whether that's lost growth and impact on the viability community bank model or on mainstream. Regulators and incentives are not always well aligned with the balanced approach. So in other words, in my time at the FDIC, I think I got a sense of how we ended up where we are and also potentially a path out. You made a reference to resetting financial regulation, that's something obviously Secretary Besson talked about, you talked about it, what exactly needs to reset and how's that going? Yeah, let's just go there. So at a high level, it's about balanced objectives and discipline process. But ticking through the issues here on supervision, the goal is to focus the examiners on material financial risk. On capital, the objective is to align credit risk, market risk, capital requirements to latest and greatest evidence on risk, while simplifying the framework. Liquidity, we need to return the lender of last resort to its appropriate role. The intended role is the insurance of your liquidity risk, AML, need to focus on outcomes over process and then really across these issues with the continued viability of the community bank model in mind, we need to really double down, recommit to tailoring, regulation, supervision to the business model, so the regulated entities. You can see proposals out on all these, I think, and regulators moving quickly to finalize some, some RDA final. Can you talk me through a little bit more of the focus on the material financial risk? You've seen some blowback, some criticism, particularly from the Democrats who fear that by focusing on that, perhaps you're not focusing on other areas, they're going to sneak up and blow up a bank one day. It's not a vague, I think it's astounding, right, that we do not have a definition in rule of unsafe or unsound. I mean, this is a key concept that shows up over and over again in the course of supervision and enforcement. Yet it's undefined in rule. Now, there's a case law out there that, by the way, uses terms like abnormal risk, concentrated prudent practice, certainly has already a materiality qualifier built in. But like Secretary Besen said, you've got to keep the main thing. And as we saw with the events March 2023, when examiners are looking at everything, then nothing's a priority. So we really need to focus on that, which can pose a risk to the solvency of the bank. That doesn't mean that it has to pose imminent risk today. There's a likelihood judgment here, and there's a causal change that's possible, but you really need, as an examiner, to tie the criticism, tie the enforcement action back to something that could plausibly affect the solvency of the institution. Like an SVB case interest rate risk, for example. That's right. There was one rating going into 2022, and then gets downgraded to a two towards the end of the year. Yeah, two still being pretty naive for what the hell they were doing. That's right. I'm blowing up the whole organization. So you just ticked through a long list, and we're going to talk about some more, but can we talk about the Basel proposal? Because I know that's been a focus. Capital has been one of the things that Secretary was flagging early on. So is that set in the right balance? I've seen some pushback from the big banks saying, listen, it's better than the last one, but we still have some issues with it. Where would you give it a grade? Yeah. I think it's in the right direction here. A couple of points on this. One, it's important to remember that Basel line game was supposed to be a modernization effort. I think we know that the capital requirements for some exposures are too high, especially in the banking book mortgage, for instance, and I think we know that the capital requirements for other exposures are actually too low. This was an effort to calibrate the exposure specific capital charges to the latest and greatest evidence of the risk. This is not just road across the board when capital down. It's important to get that right because you have too low, you obviously have safety and sound this risk. You have too high. You push that intermediation out of the banking system. You can actually increase risk of financial stability outside the system and also undermine the bank's ability to perform their economic role. So I think on that score, this proposal takes a big step towards aligning the exposure specific requirements with the best evidence. It's also, I think this modernization effort has remarkably become also a simplification project. Under the last administration, the July 23 proposed lies under called the dual stack structure where banks are going to calculate their capital requirements under the new Basel stock And then all. also under the antiquated existing standard eye stack. Interestingly, more than two thirds of the banks that would have been subject to that September reposal actually would have found themselves bound by the antiquated stack the existing standard eye stack. So that really neutered modernization effect if it's not actually the binding set of constraints. It's also incredibly complicated to have two stacks out there. So let's deploy. I spoke out on this in July 2023 when I was at the FDIC on thrilled to see that as part of the proposal ship to what we call the single stack. And also I think very important are the implications for community banks that are outside the scope of the proposal. When I was at the FDIC, yeah, this kind of natural reaction, both within the regulators and among the smaller banks, say, well, we're outside the scope of this proposal, we don't need to worry about it. One of the things I kept saying is no, no, no, no, you may be outside the scope. What you need to worry about here is we're going to reduce credit risk capital requirements, mortgage, other exposures that are critical to your business model, that's going to further what you had in competitive disadvantage relative to the largest banks. So what they did with this proposal is gone ahead and just reduced the capital requirements on mortgage a few other exposures under the existing stack that will still apply to the banks that are out of scope. Importantly, given the community banks, the smaller banks outside the scope, the opportunity to opt in to the modernized stack that ensures competitive parity, I think. So you pull back this really reflects, I think, it's a good example of the administration's balanced approach to regulations, modernization effort, it's a simplification effort. It also does a long way to preserving the viability of the community bank model. Is this the end of the end game? Because we've obviously, I believe this is the third Basel proposal I've seen. One didn't make it out of the FDIC because you and others had issues with it. So is this it? I'll leave that to the regulators, but I think they've said themselves that you hope to finalize this year. So we're going to talk about agentech AI because it's obviously one of these existential worries, but more broadly on AI in general, Treasury intervened this spring to temporarily stop the release of a new Clawed AI model named Mythos. Can you talk about why that was necessary? How concerned are you more broadly about AI's ability to crack cyber safeguards at banks? And particularly because we seem to be seeing more news about Rue AI agents doing things that weren't even intended by the people that were programming them. Yeah, so Mythos certainly represents a step function increase in capability. It is a really astounding tool for both identifying vulnerabilities in software and also patching, remediating those vulnerabilities really fast and doesn't always require a lot of human involvement. So this is a big change in the market structure here. And there is the gradual rollout of that capability to give some time for critical effort for structure to harden, to patch, to remediate, to identify deficiencies. I think this is something we should all be obviously very focused on. AI applications for cyber security are obviously very real. I suspect this issue in AI more generally will be one of the more defining issues of the next few years. Are we talking enough about it? I mean, obviously Treasury was talking about it, but we're watching someone resign from one of the big AI companies and say that greater than 10% chance it's going to kill us all. So are we focused enough on it? I'm certainly not in the doomer camp. But I do think the implications are profound. And I do think that as we all begin to better understand the technology, we see how it's adopted by the industry. The policy response develops to that. My sense is it's very likely that many of the issues we are dealing with now, capital liquidity supervision will feel quaint in context. And do we have any idea? Is that going to be legislation regulation? Just getting everyone together on the same page. We have any clue what that'll look like or just too early to say. You can see those debates happening now in the newspapers and also just stepping onto AML reform because I know that's one of the big issues. And we had one Zorate former Treasury official in charge of AML reform back in the day on earlier this year. How is that progressing? And is that something that you think is actually going to take hold? So when I talked with community banks when I was at the FDIC or when I was a Senate staffer, AML always tended to be one of the top issues. I mean, this is a huge portion of their very limited compliance staff time. And so yes, this has been a big priority for the administration for Treasury. And I think there's been good progress on this obviously. And Sin released some frequently asked questions on structuring SARS, the no file decision, continuing activity SARS. That was a big deal in itself. But I think even bigger deal, even more remarkable progress was in this AML program rule issued by the agencies. That rule, that proposal, provides significant clarity around what the expectations really are. It provides a safe harbor that prevents enforcement liability for foot faults. And I think the OCCF, the IC rule is remarkable in that it gives Vincent some consultation rule that kind of a notice a heads up an opportunity to provide views on a significant AML or enforcement matter. The problem we're solving for here is we've got examiners really focused on kind of check the box processes around AML less focused on the outcomes. Does the AML program really further the AML national priorities does it effectively mitigate the illicit finance risks at the bank and shifting examiners to a more outcome based approach to our outcome based focus. It's really a culture change for examiners, especially at the bank and agencies. And driving that culture change really requires a change in incentives, cars more accountability, more transparency. And I think having the potential for Vincent to just get us not a video, just an opportunity to take a look at the potential enforcement of supervisory matter and provide a view will remind the examiners, somebody's going to take a second look and it might be a critical second look. That in and of itself, I think causes examiners to really think for themselves does what I've identified here, really, really in some material way to the outcomes that we're focused on here. Now an important wrinkle here on this Vincent consultation is obviously Vincent. It's going to have a hard time looking at every single MRA supervisory matter, enforcement matter. It's moving on AML. And so what the OCC and FDIC rule it does contemplate is it mends the rules governing confidential supervisory information to allow banks to go directly to Vincent. But like you can think of it as a whistleblower kind of concept. I think that's really important. Maybe under appreciate it, but really important. Overall, you feel like again that problem has been, there's been more of a focus on the examiners side of checking boxes, unless using one's judgment to say, how important is this? Focus more on the letter of the law than the spirit of the law. Writing up banks for no filed terminations. A class example of this process focused that you see outside of AML as well, particularly in the AML context. Turning the battleship obviously requires time. Administration has four years, they move particularly quickly in terms of getting itself on the same page again, treasury, helping with that coordination function too. How well do you think it will stick? Yeah, this will depend a lot on the personalities of the future, right? But I will say the rationale for a Vincent consultation. Again, it's just a heads up. It's just an opportunity to provide a view. It's not a veto over the action. It's compelling, right? Vincent sets the national AML priorities. Vincent's the domain expert in this space. Vincent's got the access to the classified information. Vincent's the one that has a better sense on whether a particular bank is furthering the national security priorities or the AML priorities. Just imagine a world in which the bank examiners were enforcing, for instance, the tax code. Right. And instead of the IRS, that's bonkers. So I think the rationale for having a Vincent consultations very compelling. That said, if it doesn't persuade future folks, then cannelly doesn't deserve to stand the test of time. I think that's a compelling rationale for a pretty common sense change. You've given expansive speech on post 2008 liquidity rules and how they tied into the failure of Silicon Valley bank, which I do want to talk about, because you were at the FDIC when that all went down. But when we talk about liquidity for a moment, what needs to change and why? So yeah, that was a secretary-best in speech. I was very privileged to have the honor of giving that speech when he was pulled away at the last minute. So what's the problem? The administration treasury is solving for with the liquidity rules. I think we are reminded with SBB events March 23. We really kind of knew before this that a big stock of liquid assets is not on its own a liquidity strategy. We've got at least two problems. One is we saw during COVID, banks tend to hoard their liquid assets, spreads the stress through the system. And two, to the extent banks do convert their liquid assets to cash, monetize the liquid assets, that has the effect really of shuffling reserve balances around the system in a way that also tends to spread the stress propaneated liquidity stress throughout the system. And what you really want, I think, is instead for banks to go to the discount window, go to the Fed and get through the discount window, cash reserve balances, in a way that actually increases the aggregate reserve balances in the system. You know, only the Fed can, I don't know, F9 or whatever button they push to create new reserve balances. You want the banks to go to the window during a stress. Now, this is, I think, a very different view in the view that prevailed at the time liquidity rules were being fashioned there. Primary focus I think among many of the architects was that the discount window, a moral hazard problem, fostered excessive risk taking. We saw with March 23, you really need discount window readiness. You really need to address stigma. Really, we need to have the lender of last resort performance with intended role is insure against severe liquidity stress. And we haven't really solved the problem of stigma. I think it's still very much there. And I don't know, I don't know, despite efforts to really get at that issue, is just still a segment attached to it. And I think you'd start to see articles if folks started using it. Yeah, although I think what treasury has in mind, there's no single bullet here to address stigma, but it goes a long way in that direction. And I think what needs to happen here is we need to amend the LCR, the resolution liquidity rules, the other rules of liquidity risk management regime to give credit for essentially content reserve balances. In other words, bank prepositions loans, collateral at the discount window. There should be some reflection of that in either the numerator, denominator of the LCR. Now, it's important that credit be capped. Banks should still self-insured against their own idiosyncratic liquidity risk. We don't want banks funding themselves entirely in the short-term funding markets. But you do want to have the banks incentivized to pledge at the window, right? And you want to try to attack stigma by having them have a conversation within the C-suite around why they're pledging. And you want to encourage the Fed. And the banks actually build out the readiness for the window. If you just made a mistake coming out of the crisis, and essentially situating large banks as the insurers of your liquidity system, not just for the bank, but for the whole financial system. That's the role it's really supposed to be played by the lender of last resort. If these changes go into effect, or if you could have applied them retroactively to SVB with SVB has been as bad, what do you think would have happened there? Obviously, SVB not subject to the LCR. But if you have, I think, within the system, a very different understanding of the discount window, both system at the banks, but also at the examiners, you know, at the supervisors. As that stress starts to spread, you can see banks going to the Fed, either it reserve balances increase, that does help mitigate the proclamation of the stress. - Can you take me through, since you were on the board of the FDIC at the time, how did that play out behind the scenes? And what do you think the public generally missed from that time period? - It was a-- - Not fun. - It was not a funny experience. I thought a lot about it both the time and since. Unfortunately, constrained by the statutory protections on confidential supervision information, how much I can go into that. I do hope that the regulators will continue to foster some transparency around what is going on there. I think there's a lot to be told there. One thing I can't talk about consistent with what's already in the public domain, is I think that the events around March 2023 really expose there's a gap between what's supposed to happen during the resolution of a bank, especially a large bank, what actually happens. So what's supposed to happen? The FDIC pointed receiver of the bank conducts a process as required by statute to consider, quote, all possible methods for resolving the failed bank. And then the FDIC selects from those all possible methods, the method that poses the least cost to deposit insurance fund. In some cases, what that will mean, is that the FDIC sells the assets of the failed bank, pays out the proceeds of that asset sale pursuant to the deposit waterfall. And what that means is that uninsured depositors often take a loss, they take a haircut. Now in practice, uninsured depositors really take a loss. Now that could be the right outcome, even under the least cost test, whenever preserving a bank's franchise value, selling the bank as a whole, that the value add there actually exceeds what the uninsured depositors would have borne in the deposit payout. As a term, the acquiring bank wants to pick up all the deposits uninsured and insured. And the way that works, especially, when the uninsured balance is relatively small amount, the way the math works is less is borne by the uninsured. So it needs to be less of a premium to acquire the entire deposit franchise. That tends to work. But that's not what happened in March of '23. So obviously with SVV and signature, the FDIC invoked the Assistemic Risk Exception, why they call it the exception, it's the exception to the least cost test. So FDIC was not fettered by the least cost test could pay out on all the uninsured depositors. Now a first republic is much more complicated. There there was no systemic risk exception. And the FDIC confronted a real dilemma. If it moved forward with the deposit payout, and again, the concentration of uninsured deposits there is going to be losses for the uninsured. So what I advocated at the time, some of it was in the press, was that the FDIC needed to open the door to allow non-banked bitters to bid on first republic's assets at the same time, that's important at the same time. And on substantially, the same terms is available to the bank bitters. Why is that important to me? Well, a few things. One, again, there's a statutory mandate at the FDIC to consider, quote, all possible methods. Two, adding non-banked bitters into the auction process, again, at the same time, increases competitive tension. FDIC can get a better value on the assets, lower cost to the dip. And then related to that, I mean, a third distinct point is non-banks are often going to be the capital efficient home for the failed bank assets. Especially in the case like with first republic on mortgages, the regulatory capital requirements are far in excess of what a non-bank would require in terms of economic capital. So the non-banks are going to be a more competitive position to bid on those assets. The problem is, if the FDIC had gone that way, allowed non-banks to bid at the same time, once substantially same terms, you really increased the likelihood that you get a deposit payout, a haircut on uninsured depositors. Now, the FDIC at the time would have said, we did allow non-banks in. This is public domain out there, but non-banks had the partner with the bank that was going to take the deposit franchise, and non-banks did not get the same very generous financing terms and lost share terms that were extended to the banks. And again, there's this imbovalence at the FDIC. There's this even bias against imposing losses and uninsured depositors that really led, I think, to an auction process that did not consider all possible methods. Now, I get it. I certainly understand the imbovalence around imposing losses, hair cutting, uninsured depositors, especially when you have a lot of them at a large bank. The systemic risk, the stability risk were there. Many would say money claims should be money good. I get it. We should acknowledge that Congress dealt with this issue coming out of thrift crisis. That's how the lease cost test was added. We need to be explicit when that imbovalence pushes us in a different direction, and in fact, Congress provided a systemic risk exception for that outcome. That was not the path taken by the FDIC in part because I was a no on a systemic risk exception for First Republic. And so you see this tension play out in a way that I think has some very significant applications for the market structure and for just fidelity to the statute. - So if I'm understanding you right, we have a magic one and do what you ever want, that you're okay with keeping the lease cost resolution in the test, but you want non banks to be able to come in there and if they can't take the deposits, if they're just picking up the assets, but they can't take the deposits, then the FDIC pays a payout to the insured depositors, which is why they do it when there's no acquiring bank. And then the uninsured depositors take a hit. That's just the way it is. If that's the cheaper option, that should be the cheaper option. - Again, that's what the statute requires. There's a policy debate and there's a legal debate. The statute's quite clear on this. Again, Congress tackled this after the thrift crisis where this happened over and over again. This bias towards protecting insured depositors became a real thing. - Yeah, and I find it fascinating. You're speaking to someone who else is a deposit insurance nerd self-described because it does have implications and people don't tend to think about it. If you could go back in time and do SVB again, would you still vote to invoke the systemic risk accepting? If you clearly there weren't problems later. - Yep, so it's something I've thought a lot about and I'm just on what side of the bed I wake up. Not the time front and center of my mind was especially with SVB, that was a very unique business. - Yes. - The venture business. 94% uninsured and then saying nobody else came across it. - Mid on the assets and on lending is like integrated into the valley, to the tech world. And that is an incredibly important part of our economy. That matter to me, maybe it shouldn't have. That intermediation function was important to continue. The other thing is, I think it's kind of hard to get the intuition behind the lease cost test, but a lot of people say, why didn't you sell SVB in signature right away when they failed? The mechanics of lease cost has actually precluded a deal. When 90% of the deposits are uninsured, that means that the FDIC is going to take a relatively small loss in a deposit payout. And that relatively small loss caps the financial support that the FDIC can provide and acquire to take the whole bank. So until lease cost test was essentially accepted through the systemic risk exception, the whole bank acquisition was not possible to sell the assets that we can couldn't sell the bank. And my thinking at the time was that nothing would reinstate market confidence like a successful deal. And I thought the systemic risk exception was necessary to get a deal done. And I think it's also important context to remember that weekend we actually had SVB signature and it was expected that first republic was going to fail on Sunday as well. That's public domain as well. - Yep, absolutely. - That did not happen for various regions. I'm not sure I really understand. But we had three, you know, second, third, fourth largest bank failures in history. 750 billion dollars in assets all happen over a weekend. That's a profound shock to the system, even if any single bank maybe on its own is a much more dubious case for systemic risk exception. Bottom line, this is a meandering answer to get there. What I wish I had done with the benefit of hindsight, whereas I'm not sure I had all the facts. I'm hoping that the transparency that we're looking for in the future will out some of that. - And the Fed is doing a report on that as we speak. - I think they're more focused on the supervisory side and there's a lot to talk about there that's even in the public domain. But on the resolution side, I hope there's more transparency there as well. There's a lot of debate that weekend. Is SVB different from signature? I think there may be a case where you have a systemic risk exception on SVB, but not on signature. - A hundred billion dollar bank. I was looking at TFDID's closures the other day. FDID I think is actually gonna make money on signature's resolution. - Yeah. - Was there another path forward with signature? But I'd been at the FDID I see all of, I think five or six weeks when I got there, now you're still learning that thing. You don't have the same information that within the agency that you might like. 'Cause I have a true and a full accounting of the facts, so. - And to be sympathetic, it's tough. When everybody's coming to you and saying, "If you don't vote for this, the entire system's gonna melt down." That's a difficult position, especially when you just got there to be in for anybody. - And how confident you have to be in your view that there will not be that severe event, that severe economic impact. I think I was fairly confident that the world was not gonna end, that we did not have the systemic risk exception. But you have to be very confident, right? You have to have 90%, 95% confidence in your view given the magnitude of the consequences of being wrong. - I wanna tie this all back to the regulatory reset. What lessons did you take from SVB? And what does that have to do with your push while at Treasury to do this regulatory reset and the ongoing push from Secretary of State? - So we talked up front about the impacts of the headlines, the newspapers on how they drive agency decision-making. I think front and center, the foremost lesson learned really is around liquidity and the importance of returning the lender of last resort to its intended role. - But I think a few of you, relatively important small related points one like I said already the way the FDIC resolve signature SVB first group public has profound implications for the viability community bank model. This bias towards avoiding haircuts on uninsured depositors is strongest for the larger banks. You know you saw later small big failure where we've had two of them unsure depositors did actually take classes. Now there there was fraud involved and so it makes it very hard to do a whole bank deal that the map just doesn't work. The market notices that the market perception gets reinforced. If you're an uninsured depositor at a large bank you're money good. You don't have that for the community banks that is a significant competitive disadvantage for the community banks. Related to that I think this has some implications for the design of the deposit insurance framework. What I took from that not all uninsured deposits are the same within the various taxonomy of uninsured deposits. Some of them if subject to a haircut pose a greater likelihood of risk to financial stability. We should distinguish between the types of uninsured depositors when calibrating the deposit design. The deposit insurance design and in particular payment related deposits money claims but there's an argument there he'd be money good. So I think that's something we really need to fully wrestle through and that's something that Treasury has spoken in favor of enhancements to deposit franchise in particular with respect to transactional balances to payment accounts. Not interest bearing deposits. That's right money claims. And the interesting wrinkle there is you hear this pushback around the implications for market discipline and excessive risk taking moral hazard. But if we better calibrated deposit insurance to those stability risk you actually could have the nice upshot that it increases the ability the likelihood removes that institutional bias at the FDIC against haircutting on insured depositors. If the uninsured depositors that are taking the loss are less likely to pose that stability risk. So it actually properly done calibrated in the right way. I think it actually foster that market discipline by really focusing the losses on particular taxonomy can bear those loss. By changing the behavior of the FDIC then is more willing to make haircuts on undisturbed depositors because they're not worried about the stability of the system as much. One of your other focuses I mean it relates to this which is deposit competition and your fear that banks may no longer be able to rely on cheap sticky deposits because Fintech digital asset competition and we could have all the conversation about stablecoin and potentially that's disintermediating. Can you take me more through that argument and where you think that comes out? Thanks. Earn a spread on their deposit fund. They take those deposits and sticky deposits and invest them in loans other productive assets and those deposits are sticky in part because the search costs the switching costs is simple inertia really makes it irrational values of the depositors time. Most depositors at least the shop constantly in junk bank to bank just for a few basis points here and there. But I think we need to start pondering the implications of innovation potentially AI agents other innovations that can do this shopping for depositors even move the balances around. You can imagine a world where an AI agent through APIs other data and take develops a very sophisticated understanding of you the depositors transaction history. Yep. How their transactions are going over the next few days and develop a very nuanced accurate projection of where the free deposit balances are going to be over the course of the week and then as an agent able to sweep the excess balance to a money market fund. They've been other banks deposits maybe even the treasuries that takes on added significance I think that functionality if we have a world in which money market funds deposits are tokenized and these kinds of sweeps can happen 24/7 atomically. Now there's already products sweeps such that it's just to do something like this with the change here the innovation I think we all should be thinking through is having an agent do this without much human attention. I just tell Siri put my money where it's getting the best rate until I needed on the first of the month to pay my bills. Right. Right. And then it does it automatically for me and I even care where it is. And it uses your location, your Gmail. I mean, this functionality already exists with the APIs to develop a very nuanced understanding of where your deposits are going to be over the week. The structure of the banking system is defined in part by economies of scale, economies of scope transaction costs like switching costs, search costs, negotiation monitoring costs, enforcement costs that create frictions that define and part the bank model. Right. Now, banks are a lot more than that, especially if you communicate you have the relationship with your borrowers. You have trust you provide a lot of services in addition, but the frictions are part of the business model. Yep. And these innovations that we have now are smoothing away those frictions. Not going to remove all of them. It's going to create new ones. It's going to remove some of the economies of scale and scopes. That's very fundamentally changing the drivers of the market structure. We got to keep up with regulators. In other words, there's a certain amount of inertia builds into the system that you are not going to open accounts five different places because it's a pain to do so. But if your Siri can just do it for you and you've already authorized all the information so we can do it and then not bother you about it. Are you human in the loop? It comes back and says, do you want to do this? And you just click, yes, that's a whole different ball. And you don't need every deposit to do that. You just need some portion to opt into this regime. And then you've got a very different competitive dynamic of the deposit market or in a 30-year market or who knows what you have. But again, the point here is innovation is changing the frictions that define the banking system in ways that I think are going to potentially go slowly and then suddenly the regulatory framework has got to keep up. Yeah, and we haven't even talked about what happens when Siri decides to pull money out of the bank. If it decides, it's reading the financial system and imposing that moral hazard that maybe people did not at S.V.B. until plus 2.8. Maybe someone's pulling it and what happens when we have an eugenic AI run because half of people are using the same AI. I don't know, but I agree with you. Somebody needs to be getting hold on that before it happens. This is part, I think, what rationalizes the regulatory reset. The regulatory framework is not fit for purpose in today's economy. We went through all that at the beginning. And it's certainly not fit for this financial system of the future. You have a more than a handful of financial services regulator that all got to get on the same page and move quickly. They'll have turf. They'll have different views. Treasury's coordination is important in times like this when these questions of financial regulatory policy become defining questions in national economic policy. Can I ask you about the clarity act since obviously banks are spending a lot of time at the moment being very worried about at particular provisions because they feel like if stablecoins are allowed to pay yield in some form or fashion that they're going to cause disintermediation. So how does that fit in with what you're talking about? Because obviously I know the White House has been pushing and clarity act pretty strongly. So like risk, like regulation that I think should be the true north whenever you're adapting regulation to innovation, we can debate what's a like risk. And that's the debate that's unfolding now in Congress. I do think that it's important that we embrace programmable payment instruments, right? This programmability that's built into the stablecoin rails, I think is an important innovation. I'm optimistic that banks will eventually come around to tokenize deposits as repetitive response. And I'm actually quite optimistic that tokenize deposits as a competitive response while some very significant competitive advantages relative to other payment instruments. But ultimately that's up to the markets, it's up to the policy response to that. When here is like risk, it's like regulation. Are you bullish on tokenized deposits? So I think that depends a lot on how the bots want to get paid. My suspicion, my hunch would be that in famous last words, but my hunch is that the defining driver of programmable payments will be agentic AI that wants to move money 24/7 on a programmable rail and an atomic level. But it's not just a question of what the bots want, then it'll be a question of first the adoption rate among businesses among consumers of that technology. And importantly the policy response. When I mentioned potential competitive advantages for tokenized deposits, as is quite speculative, but there's been considerable press, especially if you fall on my backspeed on the hugging face incident and the rogue agents there. Rogue agents that want to play in the real world are going to need to make payments in the real world. And just query whether you could see a policy response to this that seeks to use your customers KYC or other gate keeping to the payment rails to try to mitigate some of the risks posed by rogue agents. And the question will become what should the competing payment rails is better able to provide that gatekeeping functionality both on the initial issuance and in the subsequent legs of the transactions. And tokenized deposits as a bearer instrument present a very different model for KYC that could potentially have competitive advantages there. The point here though is we're I think very much early earnings. I'm cautiously optimistic. We're optimistic, at least, and I think the baseline expectation is the promise of the tokenized deposits. Touch on this a little bit earlier and I've talked about it on the show before, which is this idea that there are dramatic swings between administrations on bank regulation and banks themselves feel like they're getting regulatory whiplash. Is there a way to make a reset stick? And what's to prevent a reset later from the other side, which are unduz everything that's been done? Reset of the reset. Reset of the reset. Yeah, yeah, permanent reset. My view here is the regulators should not try to make the reforms durable by force will debate is just part of the process debate and even some policy reversals over the course of different administrations is really essential to the legitimacy of the framework that said good policy isn't partisan and the administration's reforms will be durable if the rationales for those reforms are persuasive. So I think it's pretty simple. The regulators have just got to make the case if the regulators cannot make a compelling case that reforms just simply do not deserve to endure. I'm confident much at Treasury's regulatory reset will stand the test of time and I think the result of that will be a safe and sad system. The finances growth protects the viability of the community bank model. Credibly handles bank fillers. It makes well for the financial system of the future. It feels to me like you're making an argument for somewhat consensus-driven changes. In other words, you need to get a buy-in from different stakeholders in order to make it stick. What I'm trying to make the case for is we should expect some of them flow here. This is a country with a lot of different views. We settle those views ideally through argumentation to words. We should expect more of the same of that to continue after this. This isn't the final world. I know means is the right set going to get everything right. No one's got them monopoly on the truth. If you can't make the case, if you can't persuade and your reforms don't deserve to endure. So I want to thank you for your time and insights and coming in. Jonathan, this has been a great conversation. I really appreciate it. Thank you. Today is the day. If all goes according to plan, the Senate is scheduled to hold a key procedural vote on the crypto market structure bill later this afternoon. There was a flurry of news in the past 24 hours around the bill. The Republicans have released a new draft meant to quell democratic concerns around ethical issues tied to government officials owning crypto and allowing the Treasury Secretary to write rules to restrict stablecoin yield if stablecoin succeed in disintermediating banks. Bank groups have blasted the latter provision arguing that it gives the Treasury Secretary vague powers only after harms are even done. And as of this moment, it's unclear if the ethical concerns are going to be laid to rest. The Washington Sun's Jeff Stein reported that the Trump family appears to be lining up a sale of their crypto holdings worth a possible 20 billion dollars. The Trump family's abrupt recent entry into the crypto industry is one of the reason modern Democrats may ultimately vote against this bill. And that's all for me this week. Thank you. With interest is written by me, Rob Blackwell, and produced by Sam Navarro. Our theme song was written and produced by Stella Tracks courtesy upon five. The information views and opinions expressed during the banking with interest podcasts belonging solely to myself and my guests and do not represent those of interfi LLC, its directors, management, or employees. Any ideas and strategies contained within the podcast are for informational purposes only and do not constantly go to investment advice. If you like what you hear, please leave a rating or review on the podcast platform of your choice. Banking with interest is available on Apple podcast, Spotify, Google, and Amazon. New episodes to view each week. Stay safe, stay healthy, and we'll see you next week. [Music]