Editor's Note: This post originally appeared, in slightly different form, here.
President Trump’s executive order last month on “core principles” for financial regulation is succinct and instructive. Interpreting it is more complex especially when attempting to reconcile it with what Trump or his Cabinet members have said about regulation in general and financial regulation in particular.
Let's go over the main policy points.
"Empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth."
I support empowering customers. We, in fintech land, stress how vital it is for financial institutions to be customer centric as opposed to product or transaction centric. This policy goal implies that customers be given the right information at the right time to make the right decisions from a cost-benefit point of view. It also means that financial institutions or fintech startups adopt a transparent business and revenue model while selling to customers.
This does not necessarily mean overbearing regulatory oversight. It certainly means smart regulatory oversight and strong customer/consumer advocacy and protection. It remains to be seen whether a repeal of the Department of Labor fiduciary rule or the outright elimination of the Consumer Financial Protection Bureau — as some regulatory critics have pushed for — would be congruent with this policy goal.
“Prevent taxpayer-funded bailouts" and “foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry.”
I am in violent agreement with the intended goal here. We witnessed the destructive effects of the previous bailout that saw taxpayer money rescue major banks as opposed to shareholders bearing the cost of the mistakes made by the banks they were invested in. If current regulation fosters or encourages taxpayer-funded bailouts or moral hazard, it should be eliminated.
In so doing, and in order to create vibrant financial markets that foster economic growth, which I presume needs to be resilient and sustainable as opposed to exuberant and unsustainable, the inevitable conclusion is that financial institutions will have to be subjected to high or higher capital requirements. Indeed, no taxpayer money and less systemic risk necessarily translate into more skin in the game for financial institutions. In other words, less regulation is good, smart regulation is better but stringent capital requirements and standards is best.
“Enable American companies to be competitive with foreign firms in domestic and foreign markets" and "advance American interests in international financial regulatory negotiations and meetings."
These two policy goals leave much to interpretation. Are we meant to understand that we shall see the U.S. engaging in regulatory competition while decoupling from international banking regulation or that the U.S. will collaborate with other jurisdictions to ensure a level playing field?
The global financial services industry is so networked and complex that an “America First” approach to regulation is difficult to fathom. Further, regulatory competition is fraught with danger and may lead to a "race to the bottom.” Finally, the U.S. has already had as much latitude as it wanted in adopting international banking standards such as the Basel accords. In the eyes of many industry participants, a unilateral go-it-alone policy toward international markets may have negative and unintended consequences.
“Make regulation efficient, effective, and appropriately tailored.”
This is by far my favorite policy goal based on what it promises potentially. Regulators also need to change. In the U.K, the Financial Conduct Authority's sandbox initiatives have shown that a regulatory body can derive much value in engaging with startups, new technologies and new business models as early as conveniently possible. Regulators need to develop novel ways to conduct their own businesses and upgrade their own capabilities. Bottom-up approaches such as testing environments or initiatives around regtech collaboration are the way forward.
If this policy goal nudges U.S. financial regulators to think outside of the box and help them regulate along the lines of what can be possible as opposed to what is not permissible, the U.S. regulatory landscape will have been greatly enhanced.
"Restore public accountability within Federal financial regulatory agencies and rationalize the Federal financial regulatory framework."
My next favorite policy goal. Let's face it, the U.S. financial regulatory landscape is a mess: OCC, FDIC, Fed, CFPB, FSOC, CFTC, FHFA, FTC, NCUA, SEC, HUD, Treasury and Fincen, not to mention 50 state regulators for banking, insurance, money transfers, debt collection and securities.
All of these independent yet interrelated agencies were built for the industrial age. Overlaps, redundancies and gaps plague the system and create inefficiencies as well as uncertainties, let alone unnecessary costs for market participants, startups and new entrants. Incumbents, ironically, have historically used this regulatory maze for their benefit as a defensive moat. A major rethink is needed.
From this perspective, the intended goal of the OCC, with its fintech charter, is very interesting — although due to the aforementioned balkanization, the new charter policy is doomed to encounter major turbulence. I do understand the federal-versus-state issues specific to the U.S. Constitution, but still some rationalizing of the balkanized U.S. regulatory system needs to occur.
The public accountability part of this policy goal is laudable too. However, the danger will lie with the potential erosion of regulatory independence should public accountability lead to undue political dependence and interference.
Now, what I find particularly interesting when reviewing the executive order is how jarringly different it is in tone compared to sound bites coming from the Trump administration. Granted, the order may have been worded in a way that allows for latitude and blandness.
For example, in a meeting with business lenders, President Trump said, “We expect to be cutting a lot out of Dodd-Frank, because frankly, I have so many people, friends of mine that had nice businesses, they can’t borrow money,” and, “They just can’t get any money because the banks just won’t let them borrow it because of the rules and regulations in Dodd-Frank.”
Are U.S. banks not lending because of too many rules, too much regulation? Are they not lending across the board or only to specific borrowers — subprime as opposed to prime, for example? Is the economy so muzzled by the lack of supply or has it been a lack of demand? To be fair, smaller banks may be hit harder by regulation than larger banks. Is it the case that smaller banks are not lending while larger banks are?
Based on FDIC data, overall lending was on a downward slope from its peak of exuberance in 2007-8 through 2012, but then rebounded for smaller financial institutions from 2012 to 2016 and stabilized for larger financial institutions during the same period. I guess there are several ways of interpreting this. First, the rebound could have been stronger, and if true we are still faced with the supply/demand conundrum. Second, financial institutions have been lending again, and actually smaller ones more so than larger ones, which tends to invalidate the "too much red tape is killing lending" argument. Do we really want more exuberant lending to the tune of close to 95% of deposits as the ratio stood in 2007, especially for larger financial institutions?
This next sound bite is not from Trump himself, but from Gary Cohn, the director of Trump’s National Economic Council. He said:
“We need to get capital available to small and medium size businesses and for entrepreneurs. Today banks do not lend money to companies. Banks are forced to hoard money because they are forced to hoard capital and they can’t take any risks. We need to get banks back in the lending business, that’s our number one objective.”
The wording is clearer here: banks are hoarding too much capital and we should allow them to take more risks and lend more by reserving less capital. If that is the case, then the objective may not be to rationalize and simplify regulation per se, but to relax capital requirements and standards. Should this goal benefit large banks or Wall Street, in particular? How will Main Street benefit? Should this goal be achieved by predominantly helping community banks and regional banks, then the path toward benefiting Main Street becomes clearer.
Incidentally, any regulatory path that fosters innovation and competition benefits Main Street — my subtle nudge for the fintech ecosystem.
While there is much to like in this executive order, how it will be carried out by the executive and the legislative branches, and how it will be viewed by the judicial branch, is what really matters in the end.