If Senate Banking Committee chairman Richard Shelby was hoping to ignite the passions of financial regulation experts across the political spectrum with his proposed regulatory relief bill, he's certainly succeeded.
Shelby's draft legislation has the potential to help or hurt financial reform. If it winds up provoking serious discussion on the eve of Dodd-Frank's fifth anniversary about what in the financial reform act is working and what needs improvement, we need to welcome that debate. The Dodd-Frank law was crafted while we were in the midst of a significant financial crisis; we were unable to fully digest the causes of the crisis at the time and agreed-upon necessary solutions. Politicians then went on to the next hot item, leaving 15 different regulators to write the implementation rules whilst grappling with insufficient human and technology resources and facing a barrage of deep-pocketed lobbyists.
However, Shelby's proposal could turn out to be a Trojan horse smuggling gifts to large banks, as Dennis Kelleher, head of the public interest group Better Markets, argues. If this is the case, the Alabama senator and his supporters be they Democrats or Republicans would do an immense disservice to American taxpayers who could wind up bearing the cost of future bailouts.
Within Shelby's comprehensive draft legislation, I am particularly concerned about his desire to move the $50 billion asset threshold at which banks are considered systemically important to $500 billion. This could severely impede the ability of the Federal Reserve, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency to impose enhanced prudential standards on large banks in order to keep them from failing. Remember that the largest bank failure in the U.S. was that of Washington Mutual which had about $300 billion assets at the time. Although JPMorgan Chase bought the bank, the outcome can hardly be seen as a success story. "This strategy of having a stronger bank buy up a weaker one is not sustainable," explains Jennifer Taub, professor at Vermont Law School.
Many diverse banks fall into the $50 billion to $500 billion range. Their stability is key to the U.S. financial sector and the economy. Changing the systemically important bank benchmark to $500 billion would mean that banks that are domestically or regionally important including American Express, Capital One, Charles Schwab, Citizens Bank, PNC, Regions Financial Corp., and U.S. Bancorp could be excluded from essential bank regulations such as enhanced capital requirements, leverage and liquidity rules, capital adequacy assessment reviews, stress tests or living will requirements.
Moreover, foreign bank operations in the U.S. such as BBVA Compass, BMO, Deutsche Bank Trust Corp., HSBC North America, MUFG Americas, Santander Holdings USA and TD Trust could also be excluded. Given the laundry list of significant infractions accumulated by Deutsche and HSBC in areas such as manipulating market rate benchmarks, violating anti-money-laundering and terrorism financing rules and aiding clients in tax evasion, these two institutions in particular should be under enhanced supervision not less.
However, Shelby's proposal is still a long way from becoming law, not to mention regulation. In the current toxic political environment, in which politicians take inaction to a new art form, Shelby will face a challenge gaining bipartisan support for his proposal. Mark Calabria, director of financial regulation studies at the Cato Institute and former senior staff member of the Senate Banking Committee, told me that he believes Democratic Sen. Sherrod Brown "is on the fence and leaning toward 'no,' but I do not think he wants to be on the losing side if many Democrats were to vote for Shelby's proposal."
Indeed, given that Brown, along with Republican senator David Vitter, proposed in 2013 that banks face far greater capital requirements than currently imposed under Basel III standards, I find it difficult to believe that Brown would endorse a bill that in any way eased bank regulations for big banks.
It is very likely that Shelby would need to lower the proposed SIFI threshold closer to the $150-$200 billion range in order to gain sufficient support. However, even that threshold could leave banks like Alabama-based Regions Financial Corp. and quite a few foreign bank operations exposed to weaker bank regulations.
Shelby's draft legislation should adjust the factors that it recommends the Financial Stability Oversight Council consider in designating SIFIs. Right now, Shelby proposes that the FSOC take into account financial institutions' size, interconnectedness, substitutability, cross-border activities and complexity. Shelby should consider including the level of bank opacity in their repurchasing agreements, sponsoring of securitizations, and derivatives transactions as another important element of the risk banks pose to the entire financial system.
In addition, I urge Shelby to consider the level of financial benefits that large banks receive because of the market's belief that the government would bail them out as another important element in the SIFI designation.
A few other changes would also greatly improve Shelby's draft legislation. Shelby could leave a tremendous legacy by facing down big-bank lobbies and forcing large, interconnected banks to have a culture of ethics set by a board of directors, requiring big banks to be better capitalized than they are now, and demanding that they be transparent about the risks they take. If Shelby is in a gift-giving mood as Dodd-Frank's fifth birthday approaches, he should ease Basel capital requirements for the roughly 6,000 community banks in the U.S. that still believe in the essence of banking: lending to the real economy. I would happily come to his office and help with the gift wrapping.