Bank regulatory relief under the Trump administration

May 2018 | SPOTLIGHT | BANKING & FINANCE

Financier Worldwide Magazine

May 2018 Issue

Although not a mainstream political topic, critics of the Dodd-Frank Act have aggressively advocated for regulatory relief following the election of President Trump and his assumption of administrative control over the federal banking agencies. Commencing with the appointment of an acting director of the Consumer Financial Protection Bureau (CFPB) and the senior executive positions at the Federal Reserve Board, critics of the current scope of banking oversight have been avidly awaiting the loosening of regulation in favour of American banks.

Fourteen months into the new Administration, however, significant regulatory reforms have not occurred, despite recurring promises by newly appointed banking agency management, and an analysis of the reasons for this will be explored in this article. Specifically, the reason for regulatory inaction might be viewed from statutory, administrative agency and process perspectives. In addition, this article will suggest probable initiatives that might be considered in the coming year.

Historically in the US, whenever comprehensive banking legislation has been adopted, additional legislation has often been required to correct errors made in the comprehensive legislation. Stated simply, mistakes are always made. This has been particularly true of the innumerable provisions of the Dodd-Frank Act, which granted wide-ranging regulatory authority to federal banking regulators from ‘too big to fail’ to the creation of the CFPB.

Because of the fear of defenders of the CFPB that a follow-up corrections bill would be used by a Republican-controlled Congress to eviscerate the authority of the CFPB, in the last seven years CFPB supporters have staunchly refused to allow remedial legislation to proceed. In defending that position, defenders of the Dodd-Frank Act and the CFPB have pointed to the legislative initiative put forward by the chairman of the House Financial Services Committee, Jeb Hensarling, whose proposed legislation, the CHOICE Act, addresses virtually every aspect of the Dodd-Frank Act in a punitive and partisan manner, particularly the CFPB.

In a rare display of bipartisan cooperation, on 14 March, the Senate adopted the

Economic Growth, Regulatory Relief, and Consumer Protection Act, which was painstakingly negotiated by the chairman of the Senate Banking Committee, Republican Senator Crapo, with his Democratic counterparts. Of particular note is that, except for one major amendment to the Dodd-Frank Act, the Act makes very minor amendments to the banking structure adopted by the Dodd-Frank Act, and contains the types of error-corrective provisions that likely should have been adopted four or five years ago by consensus. Of note here is that the Act deliberately does not address the structure or operations of the CFPB, which has allowed Democratic centrists to vote in favour of the Act. In fact, the vast majority of the regulatory relief provisions in the Act, however, are aimed at statutory reforms needed by community banks, which constitute more than 95 percent of the banks chartered in the US.

The one notable exception to this focus on regulatory relief aimed at community banks adopted by the Act is to increase asset levels for a systemically important financial institution (SIFI) from a floor of $50bn to $100bn immediately, and from $100bn to $250bn in the 18 months following enactment. The argument supporting this amendment is that the too big to fail threshold that was originally set at $50bn was too low, and subjected non-complex banking institutions to enhanced regulatory requirements that are unnecessary for such financial institutions. This provision would remove enhanced regulation rules for 25 of the 35 largest US banks. As a concession to the banking agencies, the Federal Reserve would retain the right to continue regulating a bank between $100bn and $250bn as a SIFI if the bank was deemed to be operating in a systemically risky, complex manner.

The next step in the legislative process will be a Conference Committee comprised of House and Senate conferences, which will probably adopt most of the provisions of the Act in order to preserve the number of votes in the Senate necessary for final passage, because in the US Senate a 60-vote majority is required to overcome a filibuster by the minority party.

Assuming that the Act, or a slightly modified version, is ultimately adopted this year, implementing the modifications will require administrative agency action, which is time-consuming and potentially complex.

Adopting legislative reform is but one major hurdle faced by the Trump administration in its announced goal of adopting regulatory reforms for the banking system, and also relates to two factors that will impede prompt regulatory reform in the near future. The first is the role of the bank regulatory agencies and the second is the administrative process by which regulatory reforms must proceed.

With regard to the nature of the federal regulatory bank agency process, historically, it has been relatively balanced in its approach between Republican and Democratic administrations because of the overriding mandate that the federal banking agencies oversee the safety and soundness of the US banking system. Although a cynic might point out that there is hesitancy on the part of any federal regulator to be blamed for the underpinnings of another banking crisis by deregulating banks, the experience of the banking crisis in 2006 is a clear warning of the risks involved in a deregulation agenda.

Moreover, practically every banking regulator of every political persuasion agrees that numerous regulatory enhancements authorised by the Dodd-Frank Act were effective and have enabled the federal banking agencies to examine and regulate SIFIs on a go-forward basis, including stress testing, liquidity requirements and living wills. Although there may have been overreach in the application of enhanced prudential standards to smaller, non-complex institutions, the increased compliance costs associated with these regulatory requirements has resulted in a safer, and understandable, US banking system.

Beyond the agreement that the Dodd-Frank Act’s regulatory reforms were generally effective, the federal administrative process substantially impedes the adoption of swift regulatory action by Trump-appointed banking agency personnel. Specifically, the federal Administrative Procedure Act (APA) imposes a time-consuming process whereby public comment is required to be received for proposed changes in regulations, which can only be implemented after months of analysis and possible negotiation among agencies jointly sharing the authority to issue a regulation. For example, the so-called ‘Volcker Rule’ is a joint agency regulation, with the federal agencies having decidedly different views about its effectiveness and even its raison d’être. As acknowledged by many agency staff who have participated in joint agency rulemaking, it is difficult to adopt a joint agency regulation but almost impossible to amend a joint agency rule once adopted.

Compounding the difficulty in adopting regulatory relief because of the limits imposed by the APA are the hurdles that can be presented by the staff of the various banking agencies and by the limits placed by the language of the Dodd-Frank Act itself. In the case of career agency staff, the concept of safety and soundness is a fundamental operating dogma, and internal objection to changes that are perceived to be contrary to that operating principle may be opposed within the bureaucracy – the CFPB perhaps being the clearest example.

With regard to the limits placed on regulatory reforms by the Dodd-Frank Act, that statute was micro-managed in numerous areas, and presents interpretative difficulties to a reform-minded agency to negate regulatory provisions imposed not by regulatory fiat, but by specific statutory imperatives. And as noted, any attempt to modify the Dodd-Frank Act requirements in a manner that would be found objectionable by Senate Democrats will doom even the modest amendments that might occur this year.

Notwithstanding these obstacles impeding accelerated bank regulatory reform, there are agency initiatives that provide hope of increased regulatory flexibility. For example, on 12 June 2017, the US Treasury issued a report, ‘A Financial System That Creates Economic Opportunities’, which was issued pursuant to the Trump administration’s Executive Order 13772 on Core Principles for Regulating the United States Financial System. That report identified literally dozens of actions that could immediately be considered by the federal banking agencies to achieve regulatory relief, many of which are currently under consideration at the bank agency level. However, many of those proposals are arguably non-partisan in nature, but still require vetting through the administrative process. Time will tell how the Treasury’s proposals will achieve measurable results.

In conclusion, the US bank regulatory process is ponderous and slow moving. It is suggested that this is actually salutary, in that detailed analysis of proposed changes is more desirable than facilitating regulatory reforms that result in unintended increased risk to the US banking system.

While not a millstone of the gods, the banking agency reform process grinds exceptionally fine.

Joseph T. Lynyak III is a partner at Dorsey & Whitney. He can be contacted on +1 (202) 442 3515 or by email: lynyak.joseph@dorsey.com.

Joseph T. Lynyak III

Dorsey & Whitney