Regulating America’s banks

The Treasury publishes proposals to cut red tape

The Dodd-Frank act gave regulators discretion to do more. And, under Donald Trump, to do less
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TEN days after he became America’s 45th president in January, Donald Trump vowed to “do a big number on Dodd-Frank”, the elephantine law that recast financial regulation after the crisis of 2007-08. Soon after, he asked his treasury secretary, Steven Mnuchin, to measure all America’s rules (not just Dodd-Frank) against seven broad principles, including the prevention of bail-outs by the taxpayer and making regulation more efficient.

On June 12th Mr Mnuchin gave the first part of his answer, in a 147-page report on banks.

Later instalments will cover capital markets, insurance and asset management, and non-bank institutions and financial technology. Banks of all sizes will be cheered by its proposals to ease regulation, make “stress tests” of their resilience less onerous and tame the Consumer Financial Protection Bureau (CFPB), a watchdog born of the Dodd-Frank act. To allay the confusion caused by America’s many regulators, Mr Mnuchin wants to give co-ordinating power to the Financial Stability Oversight Council, comprising the heads of all the agencies and chaired by himself.

The report’s underlying thesis—shared by Mr Trump and many bankers—is that excessive regulation has held back lending, which has in turn constrained economic growth. Since the crisis, the report notes, lending has risen by 25%, far less than in other recent recoveries, and GDP growth has been sluggish.

In some areas red tape surely has choked lending—notably residential mortgages, where recklessness led to catastrophe a decade ago. But the report pays scant attention to the possibility that slow growth may instead cause weak demand for credit. “I don’t think the economy is credit-constrained,” says Kim Schoenholtz of New York University’s Stern School of Business. In the latest monthly survey by the National Federation of Independent Business, a lobby group for small firms, a mere 3% of companies said that their borrowing needs were not being met; 31% said that they had all they required and half that they did not want a loan at all. Lack of skilled labour was a far bigger concern.

No matter. Small banks are cock-a-hoop at Mr Mnuchin’s proposals. “We’re popping champagne corks,” says Camden Fine, president of the Independent Community Bankers of America (ICBA).

Local community banks with less than $10bn in assets account for 5,400 of America’s 5,900 lenders.

Though they have only 13% of the system’s assets, they make 43% of small loans to business.

“Nearly every ICBA policy was adopted,” Mr Fine says.

Thus Mr Mnuchin suggests making it easier for mortgages to qualify for purchase by the government-backed entities that dominate the secondary market and for protection against lawsuits from borrowers. He also wants to delay an increase in reporting requirements for home loans and to exempt community banks from risk-based international capital standards, known as Basel 3: high risk-weights for mortgage-servicing assets and commercial-property loans have caused some small banks to quit those businesses.

Higher up the scale, Mr Mnuchin wants to raise the threshold above which banks must carry out Dodd-Frank’s required stress tests from $10bn of assets to $50bn or more, and to scrap some tests altogether. The lower limit for the most exacting prudential standards and the Federal Reserve’s separate capital-adequacy reviews, now $50bn and covering more than 30 banks, from the titanic JPMorgan Chase, with $2.5trn, to Zions Bancorp, a lender in 11 western states with just $65bn, should also be raised, “to be better tailored to the complexity of bank holding companies”. The report does not say by how much.

Big banks have long grumbled about the Fed’s annual capital-adequacy reviews, which assess how much equity would be burned in a hypothetical crisis and which they consider their most painful constraint. They complain that the scenarios are unrealistic and that the Fed keeps its models under wraps. (The Fed fears that, if it revealed the models, banks would arrange their balance-sheets to game the test.) Mr Mnuchin says the Fed should rethink its assumptions, be more open with its models and consider carrying out reviews every two years. He also wants “living wills”—banks’ plans for an orderly demise, should disaster strike—to be submitted only biennially.

A less demanding review may allow big banks to have less equity on their balance-sheets. So might the exclusion of cash and Treasury securities from calculations of the Basel 3 supplementary leverage ratio, of equity to assets. Such high-quality liquid assets make up 24% of big banks’ total, five times as much as before the crisis. “Changing how capital is measured can have a major impact,” says Aaron Klein of the Brookings Institution, a think-tank in Washington, DC.

Some proposals will need the approval of Congress. These include changes to stress-test and capital-review thresholds and an overhaul of the Community Reinvestment Act of 1977, which scrutinises banks’ provision of credit and other services in poor areas and to poor people. With a nod to Republicans in the House of Representatives, the report says Congress should “consider” exempting “well capitalised” banks from all other capital rules, stress tests and the Volcker rule, which bans banks from proprietary trading and from investing in hedge funds and private-equity funds. This is the centrepiece of a deregulatory bill already approved by the House. It has little chance in the Senate, where it needs Democratic support.

However most—62—of Mr Mnuchin’s 97 proposals do not rely on Congress but on regulators chosen by Mr Trump. He has one in place, has nominated two more and by 2018 will have chosen several others. Bankers used to moan that Dodd-Frank had greatly extended regulators’ discretion.

The wheel is about to turn.

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