Last Thursday, President Trump signed the Economic Growth, Regulatory Relief, and Consumer Protection Act that tweaks, but hardly repeals or even reforms the Dodd-Frank Act that Congress enacted in 2010 in response to the last financial crisis that peaked in 2008.
This legislation complements major changes taking place at the bank regulatory agencies, including Senate confirmation last Thursday of Jelena McWilliams as the new chairperson of the Federal Deposit Insurance Corporation.
{mosads}Earlier this year, Joseph Otting was confirmed as comptroller of the currency, the regulator of national banks; Jerome Powell was promoted to chairman of the Board of Governors of the Federal Reserve; and Randal Quarles was confirmed as the Fed’s vice chairman for supervision.
These officials will lead the implementation of the new legislation as well as continue the process of reducing the regulatory burden imposed by what remains of Dodd-Frank, as well as earlier banking legislation still on the books.
The new legislation, coupled with the other regulatory initiatives, should enable the banking industry, especially community banks, to better serve the economy. But risks abound, which could have a longer-term negative impact on the economy and therefore on the banking industry.
Community banks will benefit from the new legislation in several ways. Modifying the definition of a qualified mortgage will make it easier and less risky legally for banks with less than $10 billion in assets to make home loans and hold those mortgages on their own balance sheets. That will be especially beneficial for banks serving smaller communities and rural areas.
Capital requirements are being simplified for community banks to reduce the regulatory cost and burden of complying with the Basel III capital requirements that are much more suited for very large and internationally active banks.
Numerous other provisions in this legislation will simplify community bank regulation without increasing the risk of widespread failures or systemic risk.
While the largest banks are not seen as big winners under this legislation, they are hardly losers.
The bill, by immediately lifting the definition of a “systemically important financial institution” from $50 billion to $100 billion and eventually to as high as $250 billion, opens the door to further consolidation within the banking industry. That consolidation should create market opportunities for new and existing community banks.
One of the most significant regulatory changes taking place, aided in part by the new legislation, is a rolling back of the so-called Volcker Rule, a Dodd-Frank provision named after its principal advocate, former Federal Reserve Chairman Paul Volcker.
The Volcker Rule essentially banned proprietary trading by banks in which they engage in buying and selling of securities for their own account versus on behalf of customers. There never was any justification for the Volcker Rule, as proprietary trading did not cause banks to fail or magnify the effects of the last financial crisis.
The new law exempts banks with less than $10 billion of assets and trading assets and liabilities of less than 5 percent of their total assets from the Volcker Rule. This exemption will enable community banks to engage in such trading when it makes sense to do so without incurring significant regulatory costs and risks.
On a parallel track, regulators will soon release regulatory modifications, which some call Volcker Rule 2.0, to ease the day-to-day burden on larger banks of complying with the rule. Hopefully these modifications will increase the ability of banks to be more active as market makers in relatively illiquid securities, such as municipal bonds.
All of these changes are taking place in the context of a sustained and reasonably robust recovery from the financial crisis. Next month marks the ninth year of the economic expansion, tying it as the second-longest on record.
Just as there are no perpetual-motion machines, eventually the current expansion will cease. Rising interest rates, growing credit-quality problems, inflated real-estate values, financial distress elsewhere in the world (Argentina, Brazil, Italy, etc.), punitive tariffs and trade wars, among other factors, could dump the United States into its next recession.
Hopefully, that economic downturn will be short and relatively mild, as has been the case with several of the post-World War II recessions, and the banking industry will survive largely unscathed.
Bankers had better hope that will be the case, because if the United States suffers a severe recession, the political backlash against the banking industry, even if unjustified, could be as harsh and punitive as it was following the 2008 crisis.
Given that bankers get blamed far more than is justified whenever the economy tanks, they need to be especially prudent in exercising these recent and forthcoming regulatory relaxations.
Just as important, they need to be vocal in warning of practices that currently magnify banking risk, such as excessively loose credit standards (perhaps already too loose), unwise acquisitions and growth and excessively risky interest-rate bets.
It will be most interesting to see, over the next three or five years, how the just-past banking legislation and the regulatory relaxations of the Trump era play out. Hopefully, the results will be very positive for the U.S. economy and beyond.
Bert Ely is the principal of Ely & Company, Inc., where he monitors conditions in the banking industry, monetary policy, the payments system, and the growing federalization of credit risk. Prior articles by Ely on banking issues and cryptocurrencies can be found here. Follow Bert on Twitter: @BertEly