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Legislation now circulating in the U.S. Senate would explicitly bar federal banking agencies from using “reputational risk” as a component of their supervision, examinations and assessments of financial institutions, and require them to remove the term from official guidance.

By scrapping reputational risk, the Financial Integrity and Regulation Management Act, or FIRM Act, would remove what some view as the key obstacle blocking state-chartered banks that serve virtual asset service platforms, or VASPs, from opening “master accounts” with the Federal Reserve, and thereby handling payments independently of other, federally supervised banks.

“The use of reputational risk to determine a[n] … institution’s supervisory rating is … an improper use of supervisory authority,” Senate Banking Committee Chairman Tim Scott (R-SC), said Thursday when introducing the bill. “Federal banking agencies use reputational risk to prevent … depository institutions from providing financial services to industries that the agencies disfavor.”

Reputational risk refers to the possibility of banks damaging their public brand, and ultimately their revenue and financial stability, by serving allegedly unsavory, albeit legitimate, clients.

More than a decade ago, Republican lawmakers accused regulators of using the concept to pressure banks into cutting ties with third parties that process payments for payday lenders, pawnshops and other purportedly high-risk vendors as part of “Operation Choke Point.”

The current difficulty VASPs face in securing access to financial services and the Federal Reserve’s separate consideration of reputational risk when reviewing applications for master accounts amount to what Republicans now describe as “Choke Point 2.0.”

Applications from state-chartered banks that lack federal depository insurance and operate without federal prudential supervision undergo the strictest level of review, especially if those institutions engage in high-risk “novel activities.”

Federal Reserve Chair Jerome Powell discussed the possibility of scrapping reputational risk from those policies in a congressional hearing last month.

Powell referred to internal policies that the 12 U.S. reserve banks use when reviewing applications, not the publicly available guidance that the agency adopted in 2022.

The Office of the Comptroller of the Currency on Friday separately withdrew a requirement for nationally regulated banks to obtain “supervisory non-objection” from the agency and show that they have adequate safeguards for engaging with cryptocurrency before doing so.

“The OCC expects banks to have the same strong risk-management controls in place to support novel bank activities as they do for traditional ones,” Acting Comptroller of the Currency Rodney Hood said.

The American Bankers Association and a coalition of 26 state financial officers have expressed support for the FIRM Act.

Contact Charlie Passut at cpassut@acams.org