Questions around financial regulation changes

Question: What’s black and white, twenty-eight times longer than War and Peace, and, as of February 2nd, up against the ropes?

Answer: The Dodd-Frank Wall Street Reform and Consumer Protection Act

With a few strokes of the pen, Donald Trump not only added his signature to an executive order and a presidential memorandum, but also placed question marks after two of the biggest pieces of financial regulation of the past twenty years: Dodd-Frank and the Department of Labor’s (DoL) fiduciary rule.

The president’s executive order doesn’t mention Dodd-Frank directly, though it clearly sets out to dismantle the massive regulatory regime put into place after the 2008 financial crisis. Trump’s memorandum may put a delay on the DoL’s scheduled April roll-out.*

It’s still early, but the questions are already swirling.

What’s next?

There are probably no immediate impacts with the executive order on Dodd-Frank. Any big changes will need to be done through Congress. Even with a Republican majority, there will need to be debate and discussion as to what stays and what goes in the tens of thousands of pages that make up the act. For a while now, House Financial Services Committee chair, Jeb Hensarling, has been touting his Financial CHOICE Act as the replacement for a scrapped Dodd-Frank, and this is likely one of the models that Republicans will forth as the current legislation is dismantled.

On the DoL fiduciary rule, there’s nothing needed from Congress, so it’s future is really determined by the political will to remove or adjust it.

What parts of Dodd-Frank are most vulnerable?

I would watch the Volcker Rule as a fairly easy target for revision. Intended to restrict banks from proprietary trading, and other forms of behavior deemed to “risky,” the Volcker Rule (named after former Fed chair Paul Volcker) has been a source of contention since it was enacted. The parts of the rule that deter market making and hinder liquidity would be the obvious choice for regulators to target. A recent paper from the Federal Reserve showed that the Volcker Rule had fairly negative consequences on the bond market during periods of financial stress. So, there will be some proof points for anyone wanting to attack this portion of Dodd-Frank.

The Consumer Financial Protection Bureau could also get some scrutiny. They could subject the CFPB, which is currently funded through the Federal Reserve, to congressional appropriations and reduce their funding. Similarly, the Financial Stability Oversight Council might see some changes in funding. This body designates non-bank strategically important financial institutions (SIFI). Lastly, I would expect that Congress would want to reduce burdens on small and regional banks, and could alter the minimum requirements for SIFI qualification.

Is this good or bad?

It’s too early to tell. For all of the fighting around Dodd-Frank, it’s one of the primary reasons the U.S. banking sector was able to right itself so quickly after the 2008 financial crisis. European banks, which didn’t have such comprehensive controls put into place, took far longer to recover. So dismissing the regulation without recognizing the good it’s done is akin to throwing the baby out with the bathwater.

Even with the unlikely prospect of a total repeal, the largest banks and financial institutions would still have to comply with regulations outside the United States. So, changes to Dodd-Frank may benefit smaller regional banks more so than global organizations. The U.S. banking system is already pretty competitive; U.S. banks are much stronger than their European counterparts and lending standards are relatively looser than on the Continent.

Keep in mind that financial regulations like Dodd-Frank were put into place for a reason: banks and financial services companies need to have strong balance sheets to stay healthy and weather financial storms. If regulations are loosened too much for the really large banks, then in a crisis, their safety and soundness will come into question as they did in 2008.

For the DoL rule, any changes may only slightly change the outcome. A lot of big firms are already saying that they’ll act as if the DoL regulation is in place. As with Dodd-Frank, a massive amount of effort has already gone into complying with the rule. More importantly, customers demand lower fees and transparency, something that’s not likely to fade even if the regulation itself does.

*Earlier versions of this post noted a 90-day delay. The post has been updated to reflect current information.

 

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