Congress is about to revisit the financial protections put in place after the 2008 crisis. Some would call what’s proposed a gutting of the Dodd-Frank reforms. It’s hardly that, but it’s troubling nonetheless.
President Donald Trump entered office promising to ease the regulatory burden on the financial industry. After various iterations, congressional Republicans have settled on a bill that they think will deliver. Known as the Economic Growth, Regulatory Relief, and Consumer Protection Act, it’s expected to come to a vote in the Senate soon.
This bill wouldn’t dismantle oversight of the country’s largest banks or eliminate consumer protections, unlike some of its predecessors. And in fact it has some good ideas.
For instance, it would free smaller community banks from some parts of the Dodd-Frank Act—including strict mortgage rules that have needlessly complicated the kind of “know your customer” lending at which they excel. Delinquencies on such loans, held on the banks’ balance sheets, didn’t exceed 1.5 percent even in the worst years of the crisis. Rolling back these rules would improve the flow of credit without undue risk.
Unfortunately, though, there’s more to the bill than regulatory relief for community banks. Other provisions chip away at the bedrock of financial resilience—the equity capital that allows banks to absorb losses and keep on lending in bad times. In particular, the measure would adjust the leverage ratio in a way that would let clearing banks (among the most systemically important U.S. institutions) hold more assets in relation to their capital. It would also raise the asset threshold above which banks are subject to annual Federal Reserve stress tests, to $250 billion from $50 billion.
Making stress tests less onerous might make sense if the banks concerned could safely be allowed to fail or had enough capital to make added scrutiny unnecessary. As yet, they can’t and they don’t. During the 2008 crisis, the government spent more than $45 billion bailing out the mid-sized banks that the bill targets for relief: Officials deemed them too big to fail. And in last year’s stress tests, several only just met their required (and none too demanding) capital standards. As long as such institutions choose to operate at the edge of financial safety, added vigilance is needed.
Scrutiny should certainly be commensurate to a bank’s systemic importance—and the $50 billion stress-test threshold in Dodd-Frank does seem too low. Fed officials have suggested that the cutoff could safely be raised to $100 billion, and research backs that up. In general, though, the Fed already tailors its approach, reserving its most stringent requirements for the largest and most interconnected institutions.
Congress is right to want to ease the regulatory burden on banks—but financial resilience should be the prerequisite. Getting this balance wrong could prove very costly the next time a crisis hits.