Nearly six years after passage of the Dodd-Frank, it is amazing how little has been achieved in figuring out the correct balance in financial regulation — one that keeps institutions in check without undermining their ability to do business.
A good example of what is still unresolved is the Financial Stability Oversight Council. With the recent rescission of GE Capital's "systematically important financial institution" status, and with MetLife's legal victory over its SIFI designation, the FSOC right now can count only two firms — AIG and Prudential — as squarely in the SIFI category. (The MetLife decision awaits an appellate court's review.)
No doubt that the FSOC does not believe that two SIFI designations solve the systemic-stability issues that Title I of Dodd-Frank intended to address. So whether in this administration or the next, the FSOC will likely refine its approach and goals, which already includes attempts to impose greater prudential regulation on nonbanks such as asset managers and investment funds.
Banks and other large nonbank financial companies are also yet to feel the ultimate deployment of some of Dodd-Frank's authorities provided to the Federal Deposit Insurance Corp. and the Federal Reserve. Those new powers include, among other things, the authority to break up large banks and nonbanks that fail to file a credible living will, and to place large financial companies into FDIC receivership, circumventing traditional federal bankruptcy rules.
While there may be a sense that this is all just a huge fight between the titans of the financial world and the gods of prudential regulation, history suggests that there is much more at stake. The regulation of large financial companies eventually becomes the regulation of all financial companies to some extent or another, either through the imposition of new regulatory standards or the evolution of best practices. At issue, therefore, is the future regulation of all financial intermediaries: banks, insurance companies, asset managers and fintech firms. And all of them — large and small — should be part of the debate.
In the case of the oversight council's designation of SIFIs — which triggers enhanced Fed supervision — we are witnessing the first concerted attempt in 35 years to prudentially regulate companies that do not have federally insured deposits. This is thanks to Dodd-Frank, the efforts of the FSOC (largely fueled by the Treasury Department) and the international efforts of the G-20's Financial Stability Board.
Strong regulation of financial institutions is critical. That is a fundamental immutable principle that has guided financial regulatory policies in this country for 150 years. And the form and nature of regulation is continuing to evolve, as it should, to match the economic conditions and innovations on the ground.
Those who believe the designation of nonbanks for Fed regulation is a critical component in achieving systemic stability probably believe that two FSOC designations won't do the trick. But, while it is easy to argue that every financial crisis proves the need for more regulation, the issue has always been and still is about the right kind of regulation. Over extended periods, poorly thought-out regulation can contribute to a financial crisis just as easily as smart regulation can avert one.
Let's hope that the increasing extension of banklike prudential regulation to nonbanks has been better thought out than prior policies that facilitated past crises. There is a universal sense, however, in the financial services industry that each business day that is dominated by compliance can often divert time and energy from actually running the company. The number of compliance specialists at some large institutions exceeds the total number of employees at regional institutions. Of a greater concern, however, is the imposition by Congress over the last 40 years of a punch-list mentality on the regulators that can distract examiners from the core mission of determining safety and soundness. There is a cost to compliance, but there is a greater cost to faulty and unfocused regulation.
Achieving the right balance between a federal government that affirmatively alters the profile of markets to presumably prevent a crisis, and a government that seeks to monitor risks and be prepared to respond to financial crises is a difficult and challenging one for Congress and regulators. There are obviously many variations on these themes that can be chosen. But the point is that since Dodd-Frank put these issues on the table, every financial institution, large and small, must participate in the debate since it will determine the climate in which they must draw their operating breaths.
In post-crisis times, Congress passes new laws and regulators implement them. The implementers try to intuit the intent of the Congress and often add their own gloss. Companies that push back and challenge regulatory agencies are a vital part of achieving the correct regulatory balance. Similarly, commenting on proposed regulations is fundamental to the development of an administrative record that a court may ultimately review. All of these moving parts are critical to the ongoing yin and yang of regulation that keeps it balanced and allows the economy to work efficiently.
Thomas P. Vartanian is the chairman of the financial institutions practice at Dechert LLP, an international law firm, and a former regulatory official at two different federal banking agencies.