What the 2,300-page Dodd-Frank reform legislation means for America's financial system will play out in large part during the next months and years in 150 or so yet-to-be-written regulations.
These new or modified regulations will produce winners and losers as well as some surprising outcomes that are not obvious from a first reading of the legislation. Rule-writing will march forward in earnest for the next 12 months or so, yet regulatory refinements and interpretations will not settle down for years.
Of equal importance to the legislation's effect, in addition to these regulations, is the supervisory process — how the supervisors will interpret and apply legislative and regulatory mandates to the relevant financial institutions.
The enforcement and effectiveness of the thousands of pages of regulations emanating from this legislation will depend upon the people and policies of the agencies themselves. On this important matter the legislation is quieter than one would expect, particularly given the magnitude of the financial crisis and the extent to which supervisory practice before, during and after it shaped the crisis, its impact and its outcome.
The legislation gives little guidance to supervisors and supplies no mechanisms to improve the quality of supervision. On crucial matters of enforcement policy, examiner education, the breadth and depth of examinations, new products and charter approvals, the existing agencies are largely left on their own. So what should we expect?
For the next several years I would anticipate that the regulators will brew a stew of caution with respect to new activities, products and charters. More frequent and tougher examinations and enforcement, and more frequent and demanding supervisory orders will become the norm.
I would also anticipate some unevenness in the application of these regulations. This is bound to happen with a mass of new regulations added to an already massive rule book. A supervisor may enforce one rule more rigorously than another, or more forcefully than another supervisor would. The focus of examinations and enforcement actions will continually evolve, often reflecting market events and individual agency prerogatives.
Another factor to bear in mind is that the agencies themselves are in flux, with discrete responsibilities to be redistributed in the year following enactment, particularly with respect to the abolition of the Office of Thrift Supervision.
For financial institutions, staying on top of this process — understanding the supervisor's particular focus — will be critical. For example, just think of the pain many institutions could have avoided earlier in this decade had they recognized that anti-money-laundering would become a central supervisory focus. Monitoring and appreciating agencies' proposed rules, final rules, guidance and speeches will be more necessary than ever.
As the process of devising regulations gets under way, I would add one further guiding thought: A goal of effective regulation should be to foster healthy, growing and profitable companies that can continue to serve their communities. During the public comment phase, it is important that bankers make this case thoughtfully, respectfully and constructively, showing evidence of which regulatory approaches work and which do not.
In sum, for the next several years, the stability and success of the financial system will depend not only upon how well financial institutions understand and help shape the upcoming Dodd-Frank regulations but also on how well they understand and interact with the supervisory process.