Banks should be cautious about celebrating big regulatory rollbacks

Graeme Sloan/Bloomberg

After going undefeated and winning the Miami Dade County Catholic league basketball championship, I advised my team to celebrate but not showboat, because payback is painful.

The banking industry, currently holding most of the regulatory cards in the Trump deregulatory revolution, may be overplaying its hand by asking for and getting some of the most extreme wish-list reforms in decades.

The problem is that when, not if, the bank regulatory pendulum swings back in either Congress and/or the administration, the U-turn will be sharper than ever, possibly with some revenge regulations.

The risk isn't just regulatory reversal, it's regulatory retaliation. Bank regulatory karma?

The banking industry typically witnesses the greatest re-regulatory efforts after major crises or bank failures. Times have changed, and our very divisive 50-50 political climate means that Democratic control of the House, Senate and/or administration will witness an unprecedented 180-degree turnaround, including some retaliatory regulations.

A single flip of one of these three power sources, as early as next year's midterms, would be disruptive, a double whammy would be overwhelming, but a full political hat trick by 2028 would be transformational. No one knows this better than Trump and his advisors, who are hurriedly pushing through the most extreme deregulatory efforts I've seen in over 50 years of banking.

The bank regulatory pendulum shifts normally include safety and soundness issues such as tightening or loosening capital, liquidity or asset quality requirements; creating new or watering down existing compliance and consumer protection regulations; enhancing or restricting competition via branch, merger or nonbank entry rules; broadening or narrowing the government safety net via changes in deposit insurance, emergency access to government liquidity and critical "too big to fail" decisions; and even changes in the regulatory structure like the elimination or creation of new federal regulatory agencies.

The DOGE-inspired deregulation effort was inspired in part by Trump's "10 to 1" executive order, eliminating ten regulations for every new one. Revenge regulations might mean adding ten new regulations for every one Trump eliminated. One need only look at recent Democratic proposals like the "Stop TRUMP in Crypto Act" as a harbinger of things to come.

One of the first pro-industry changes under Trump was the FDIC's elimination of problem bank asset data that has been disclosed since 1990. Their excuse was that a huge jump could lead to a bank run at an easily identifiable bank. However, this did not happen when such assets skyrocketed by $120 billion in 2021's fourth quarter and remained elevated for the following three quarters.

The timing of Trump's removal of reputational risk assessment could not be worse with the expanding alphabet of potential reputational risk sources such as AI, BaaS, crypto and, of course, debanking, the original focus of this effort. Reputation risk exists for both banks and their customers alike. If Elon Musk owned the "Tesla Bank," can you imagine the reputational bank run risk during his chainsaw DOGE days?

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One of the most radical Trump deregulation proposals is the removal of the management component of CAMELS ratings. Clearly the most subjective ratings factor, it is also one of the most important to assess potential risk at a bank with a managerial compliance or safety and soundness cultural defect. One of the first "c's of credit" in loan underwriting is evaluating a borrower's character, so why shouldn't regulators do the same thing when evaluating a bank?

As extreme as Trump's deregulatory changes are, the regulatory whiplash under a partial or full Democratic Congress and/or administration, especially one with an anti-Trump vendetta, could be redefining.

Realizing this is a political cycle rather than a permanent reality, bankers should consider the following strategies to help hedge against the risk of a retaliatory re-regulation regime.

First, the industry should let Trump own this extreme deregulation effort rather than being a vocal advocate and piling on. With little to lose in his second term, Trump has the cards to play with, but the industry has much to lose in an anti-bank political environment. Let Trump overplay his hand, not the industry. Above all, banks must remain visibly apolitical.

Second, banks who have ever thought about M&A, and this means most community banks, should take advantage of this merger-friendly environment. Regulations can be reversed but mergers can't.

Third, Community Reinvestment Act and fair lending regulations may appear relaxed now, but banks must remain vigilant and continually improve their compliance infrastructure by investing in upgraded RegTech systems and maintaining staffing, perhaps engaging fired or retired examiners. The Department of Justice's discrimination investigators use a five-year lookback, so when they visit a bank in 2029 under a possible Democratic administration, the excuse that a Trump deregulation dog ate my homework won't work.

Fourth, considering potential regulatory exposure, the industry should consider scaling up its lobbying efforts relative to other highly regulated industries. The banking industry spent $64 million on 480 lobbyists in the 2024 election cycle, which was relatively low compared to defense ($149 million on 950) and health care ($83 million on 1,845). I never visit the Everglades swamp without an experienced guide, and bankers should not visit the D.C. swamp without one either, although those paycheck-principled, influence-peddling guides are called lobbyists.

Fifth, the industry has a new and powerful tool in its regulatory response kit. Regulatory justice litigation is no longer theoretical but, rather, a proven strategic tactic. It was successfully used for the first time against the three prudential regulators' misguided CRA final rule. Instead of relying on existing trade groups with diverse memberships, the industry should consider forming a dedicated litigation-focused trade group. Such a "Bank Regulatory Justice Association," would provide an effective last line of defense in a punitive regulatory climate.

Banking has always and will continue to be the world's most regulated industry, but bank regulations have become poisoned with politics. The industry should embrace the current deregulation cycle with balanced judgment and common-sense moderation, while strategically preparing for the inevitable revenge regulatory payback.