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The Royal Bank, Canada's largest bank, says that it won’t lend to clients that get more than 60% of their revenue from thermal coal or coal-fired power generation. Should a bank be able to avoid providing services to businesses just because they don't engage in the sorts of activities the bank, or its depositors, approve of? 

Put differently, should the Royal Bank be able to avoid "dirty" loans so that it can offer its depositors the semblance a Fair Trade, or green, bank account?

Critics would say that the Royal Bank shouldn't be allowed to avoid banking coal-fire dependent companies because it operates within a “regime of privilege.” That is, the Royal Bank benefits from a system of government regulation, central bank lender of last resort benefits, Federal deposit insurance, and direct access to core public payments systems. Given how deeply it is fused with public infrastructure, the Royal Bank is sort of like a utility, and like any utility it has a public duty to consider all customers, even coal energy guzzlers.

A related argument is that because banks must obtain a charter in order to operate, and this is difficult, there are not enough banks competing with each other. And thus it would be unfair for Royal Bank to avoid doing business with coal-fired power generators; financial banishment could doom these businesses to failure.

I draw the above arguments from a recent paper by Brian Knight and Trace Mitchell. Hopefully I have accurately captured their views. Given their specialness, banks should not be permitted to act as "de facto regulators," say the authors.

Now for the counterargument. People should be free to enter whatever contracts they see fit, including avoiding ones they find distasteful or against their beliefs. This freedom shouldn't be available to some people but not others. For instance, say that Sarah and Tom are both worried about global warming and sustainability. Tom is a skilled cook and decides to set up a sustainable restaurant that serves only ethically sourced ingredients. Sarah, for her part, is trained in finance and wants to set up a sustainable bank. Her source material for creating 100% green bank deposits is ethical loans to green businesses.

A law disallowing banks from choosing their customers means that Tom can self-actuate his beliefs by only dealing with green food suppliers, but Sarah cannot do the same by only lending to green borrowers. That hardly seem fair.

So there are two conflicting ideals at play here: the right to receive core services vs the freedom of association.

In the U.S., the Office of the Comptroller of the Currency (OCC), a key U.S. bank regulator, is choosing a side in this conflict. In an effort to stop banks from “politically driven discrimination,” the OCC is proposing a rule that would prevent bankers from using anything other than regular credit and operational criteria for evaluating a company seeking financial services. Were the OCC's "no discrimination rule" to be applied in Canada, it would require Royal Bank to lend to companies hooked on coal-fire energy.

In proposing this rule, the OCC has adopted the same rational as Knight & Mitchell. In an op-ed for the Wall Street Journal, OCC head Brian Brooks and Chief Economist Charles Calomiris argue that government chartering and direct access to the Federal Reserve obligate banks to provide services to all companies.

I recently wrote about this "no discrimination" rule for Coindesk. In that article I took the pro-Royal Bank side, arguing in favour of fair trade bank accounts. The 21st century consumer wants to know more about the provenance of the things they buy. We don’t just want tuna, we want dolphin-friendly tuna. We don’t want our T-shirts to be made in sweatshops with Xinjiang-grown cotton. We want ethical T-shirts. So why shouldn't we get clean bank accounts?

I want to explore this tension a bit more.

If we are going to apply a no discrimination rule to any segment of the banking and payments market, I think it should be placed on the card networks, Visa and MasterCard. The card networks have the power to exercise far more de facto regulation over the economy than any bank. If a bank disconnects a business, that'll certainly a hassle for the debanked business. But at least there are dozens of other banks in Canada to turn to, and thousands in the U.S. Even if no bank is willing to step forward, there is a whole host of non-bank financial institutions that can provide a business with financing or payments services.

Not so if the two card networks disconnect a retailer. Since there is no good alternative to Visa and MasterCard (especially online), a banned business could be in very real jeopardy. For instance, the card companies currently allow gun and porn purchases across their networks. But were they to ban gun and porn sales because they deem them unsavoury, Visa and MasterCard would be doing incredible damage to both industries, far more than if two large banks were to cease providing services to gun retailers or porn sites.

For a demonstration of this power, look at Pornhub's recent reaction to the threat of being deplatformed by Visa and MasterCard. After being accused of hosting child porn, Pornhub completely redesigned its platform to try and keep the two card networks on side (it failed.) 

By the way, I wrote about this incident for the Sound Money Project. Porn is legal, but child porn is illegal. Any financial institution that knowingly allows illegal transactions to cross its platform could be accused of money laundering. So Pornhub's deplatforming wasn't a case of the card networks acting as de facto regulators of content. Rather, they were doing what the actual regulators, i.e. the law, dictate. (That doesn't mean we shouldn't be worried that card networks can engage in de facto regulation. It just means that in this case, they didn't exercise that power).

So to reiterate, card networks have more power than banks. But unlike banks, card networks don't operate within a “regime of privilege” as described by Knight & Mitchell or in Brooks & Calomiris's op-ed. They don't have lender of last resort benefits, Federal deposit insurance, or direct access to core public payments systems. Nor do they have to get to get a bank charter. 

Visa and MasterCard are powerful because they are networks. Once everyone is connected to a network, there is very little reason for any one to leave to a competing network since only the incumbent can offer a large number of connections. (A bank is not a network, it is a member of a network.) 

And so Visa and MasterCard evade—unjustifiably so, in my opinion—all of the criteria for being targeted by the OCC's no discrimination rule. Instead, it is less powerful banks that would be handicapped by it on the basis of their proximity to government infrastructure and their obligation to get a charter.

Which gets me to my final point. The OCC and Knight & Mitchell have proposed that the criteria for triggering a no discrimination rule should be the existence of a "regime of privilege" and chartering. But doesn't a wide swath of the economy operate within a "regime of privilege" and chartering? 

A restaurant, for instance, must get a restaurant license before opening its doors. It also needs to secure building, ventilation, and signage permits. It is encumbered by zoning requirements and needs to secure a license to sell alcohol. Restaurants benefit from a government-funded system of food inspection. The ingredients that a restaurateur purchases has passed through some sort of a food safety regulatory process.

In sum, I do agree that we may need some sort of no discrimination rule for financial institutions. I'm just not sure that the OCC and Knight & Mitchell have found the right criteria for applying this rule. Let's choose whatever criteria get us to a situation that the card network Visa and MasterCard are the prime candidates for a "no discrimination" rule, not banks (or restaurants).

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