Financial Regulators Send Mixed Messages, and Consumers Pay the Price

Regulatory policies need to be both rational and consistent in order to work efficiently. Conflicting regulatory requirements lead to paralysis, and irrational regulatory requirements lead to waste and unnecessary costs. These issues in turn lead to higher costs for the economy as a whole and a loss of confidence in the fairness of our regulatory system.

No regulator is perfect, and no regulatory framework will always result in the best and most logical rules. However, in the rush to issue hundreds of new rules under the Dodd-Frank Act, the Basel Accord and other policy initiatives, an avalanche of new and often inconsistent regulatory requirements have forced upon the financial services industry.

The Consumer Financial Protection Bureau, for example, has issued regulations designed to ensure that mortgages are not issued to consumers who lack the ability to repay the loan. Banks complied by tightening lending standards. Now government officials are blaming these same banks for providing insufficient credit to homebuyers. Some senior officials, including Federal Reserve chair Janet Yellen, have publicly stated that banks are holding back the housing recovery by refusing to make mortgage loans to riskier borrowers.

The mortgage servicing business has also been subject to confused regulatory objectives. In the past, many banking institutions serviced mortgages, and these banks made expensive investments in the computer systems and personnel training necessary for this specialized field. Then the banking agencies issued regulations that imposed punitive capital requirements on mortgage servicing assets under Basel III. As a result, banking companies divested their mortgage servicing businesses. Less-regulated companies have become the primary mortgage servicing providers.

Now federal agencies are concerned that mortgage servicing functions are being transferred to so-called shadow banking firms that do not have to follow the same capital rules and risk-management requirements as banks. But this was the obvious result of subjecting this asset to stiff capital requirements.

The recently adopted Basel III liquidity rule provides another example of contradictory regulation. The rule is intended to enhance safety and soundness by requiring banking companies to hold high-quality liquid assets to meet the cash needs of a 30-day run during stressed economic conditions. High-quality liquid assets are limited to such items as U.S. Treasury bonds and debt instruments issued by European Union countries and other foreign nations, as well as limited amounts of certain high-quality securities.

The regulatory message is clear: Banks should hold more Treasury and foreign sovereign debt. The policy ignores the fact that these instruments have significant risks, including interest rate risk and, in the case of foreign debt, credit risk. So these measures will not necessarily result in safer banks. They will, however, result in less funding for housing, small business loans, and consumer loans. The reason is simple: the total amount of loans and assets that a bank can hold is limited. The more Treasury and foreign debt the bank is required to hold, the less capacity the bank has to make loans to private businesses or to consumers.

Ironically, just as a policy requiring banks to load up on government securities is being implemented, a regulatory proposal from the Federal Housing Finance Agency seeks to cut off access to Federal Home Loan Bank advances for financial companies that do not maintain a sufficient portfolio of housing assets. Thus, for liquidity purposes, one arm of the government is telling banking companies that mortgage assets do not count as liquid assets and that they should hold government securities. Meanwhile, another arm is telling financial companies that unless they maintain a mortgage portfolio they will be cut off from the liquidity that is offered by the FHLB system.

In another area, the State Department and the United States Agency for International Development have issued multiple studies and reports extolling the benefits of remittance payments sent by U.S. residents back to their home countries. There is no question that these remittance payments provide a very significant source of capital to developing countries, thereby enhancing stability and growth. On the other hand, the government clampdown on anti-money laundering and anti-fraud compliance has made it more difficult and costly for licensed financial institutions to provide these services. As a result, banks are rethinking whether they want to be in the remittance business at all, and the underground and unregulated remittance providers that actually pose far greater risk are more than eager to provide an alternative to the regulated sector.

These are just a few examples of a broader problem facing the financial industry. The problem comes down to the fact that there is not one overriding goal or agency capable of reconciling the competing objectives of various new regulations. Without such coordination, regulatory policy will continue to be inconsistent, and the cost will be paid by the American public.

Raymond Natter is a partner in the Washington, D.C., law firm of Barnett Sivon & Natter, P.C. He specializes in representing financial institutions before the U.S. Congress and federal regulatory agencies. The views expressed in this article are solely those of the author.