Crash Test Ratings for Banks: Move Your Money Somewhere Safe

04/03/2010 05:12 am 05:12:01 | Updated May 25, 2011

President Obama's renewed zeal for reining in risky banking practices may face a great deal of resistance and delay on Capitol Hill once it translates into proposed legislation. At the same time, consumers want to know now where it is safe to move their money. But neither the Administration nor the public need wait for new legislation to pass in a Congress no longer in the hands of a filibuster-proof Democratic majority. A new approach could generate that knowledge -- one that would include a voluntary code of conduct for banks, together with bank safety ratings -- all produced by regulators or industry watchdogs. Since we already do it for cars through the crash test ratings system, why not do it for banks as well?

As consumers use automobile crash test ratings when shopping for cars, bank customers could "vote with their feet" and make informed decisions about where to place their money. Moving one's money would be easy, and it is likely that bank practices would follow that money. More importantly, perhaps, such a system, if created by bank regulators, could be adopted without congressional approval; and no legislation would be necessary if private, non-profit groups took on the task of generating such ratings without regulator support.

Such a program is not without precedent. In the depths of the Great Depression, the Roosevelt Administration promoted the adoption of voluntary codes of conduct for hundreds of industries in an effort to spur consumption. These codes were designed to instill consumer faith in companies complying with the codes so that consumers would buy those companies' products. Businesses that complied with the codes could display the National Recovery Administration's "Blue Eagle" decal. The Blue Eagle became a marketing tool to lure customers to those companies "doing their part" for the recovery effort. Unfortunately, the codes turned out to be not all that voluntary and the system was struck down by the Supreme Court as a result. Could a similar--albeit constitutional-- effort promote trustworthy behavior in the financial system?

At present, the U.S. economy faces a crisis of confidence not unlike that which plagued recovery efforts in the early 1930s. Central to this crisis is a lack of faith in financial institutions. A recent poll reveals that almost 80% of the American public does not trust the financial system generally, and nearly three times as many Americans trust community banks and credit unions as they do bailed out banks.

In an effort to restore faith in the financial system, the Obama Administration is moving on many fronts to strengthen the regulatory infrastructure of that system. Yet reams of new legislation are not going to give consumers the information they need to assess which banks are trustworthy and which are not. This is especially true if that legislation is window-dressing, watered down by the financial industry's powerful lobbyists. What's more, the average consumer is not going to have an opinion on the optimal legislative response to the financial crisis: for example, whether the Commodity Futures Modernization Act needs to be repealed or Glass-Steagall's protections need to be revived. What is needed, then, is an easily accessible way for consumers to gauge the trustworthiness of financial institutions. If consumers had an easy way to assess whether banks were engaged in trustworthy behavior, and a significant number of consumers moved their money to those trustworthy banks, it is likely that banks would fall into line and engage in less risky practices.

To this end, regulators could issue a voluntary code of conduct for banks. Where banks complied with that code, they could advertise that compliance to consumers. Just as consumers might look for "the union label" or the Good Housekeeping "seal of approval," regulators could authorize banks complying with the guidelines to deploy a symbol like the Blue Eagle (a Blue Phoenix, let's say). Regulators could also issue a ratings scale--like the crash test ratings generated for cars, trucks and SUVs by the National Highway Traffic Safety Administration--where a bank would receive progressively higher marks based on the number of benchmarks it met. Such benchmarks could be developed by regulators in consultation with industry representatives, including community bank officials and credit union officers, together with industry watchdogs. These benchmarks would serve to gauge the safety of financial institutions, the extent to which they engage in risky practices, and their ability to weather economic distress.

With a national public information campaign that emphasized the significance of the Blue Phoenix and a star rating system that would go with it, it is likely that the market would generate significant support for firms that followed the codes of conduct.

Another attractive feature of such a program is that it would not need Congressional approval. Bank regulators could introduce such a voluntary system through regulation, which would not need the endorsement of a fractured Congress. And if such a system was truly voluntary, there would be no constitutional impediment to its adoption.

If the Obama Administration does not have the time, energy or commitment to create such a program, there is nothing stopping groups like the Center for Responsible Lending, Americans for Financial Reform and the National Community Reinvestment Coalition from building on the work of Institutional Risk Analytics and devising an easily accessible system for assessing and grading risky bank practices.

This grading system could be used by individual consumers and institutional investors alike. Indeed, if larger investors, like union pension funds, university endowments, socially responsible mutual funds and states and cities with tax revenue funds to invest started to seek compliance with the codes, it is likely that financial institutions would fall over each other to adopt them. In another context, once large purchasers of apparel, like universities (acting under pressure from students and alumni), started to demand that clothing manufacturers follow voluntary anti-sweatshop guidelines, such codes began to take root, ultimately improving the working conditions of millions of workers across the globe. Taking a page from the anti-Apartheid playbook of the 1980s, a domestic divestment movement could emerge on campuses, in town council meetings and in union halls.

But just as in the labor setting, where voluntary codes are no cure-all, such voluntary programs are no substitute for hard-and-fast rules, or a strong regulatory infrastructure. Indeed, such voluntary codes of conduct would not serve as a substitute for vigorous enforcement of anti-discrimination laws, anti-trust laws, anti-fraud laws and criminal prohibitions, or for legislation reining in credit default swaps and other aspects of the shadow banking system. Rather, this voluntary regime would broach some of the more contentious issues, like executive compensation, where the correct role of regulation is subject to heated debate.

By making a range of conduct voluntary (but verifiable), where compliance will generate strong market share, it is likely that sustainable and sensible practices will become the norm, and not the exception. Whether the Obama Administration promoted such a system through regulation, or private groups developed them without government intervention, such efforts would sidestep a Congress that is looking less and less able to pass progressive legislation, no matter how popular it may be.

Crash tests for banks just make sense where unrestrained bank practices threaten the health of the financial system. We do not need to place our money in banks unable to survive another crisis. This is certainly the case where present practices, unchecked, simply recreate the conditions that brought about the last crash and will likely fuel the next.