No Reservations

BANKING REGULATIONS: Bark is proving to be worse than bite

THE RUSH IS ON to make sure banking regulation prevents future financial crises of the scale seen in 2008/2009. But some plans have been watered down, while banks are fighting tooth and nail against more regulation.

For banks in the United States, a key piece of legislation – the Dodd-Frank Act – has been passed. The website Qfinance reports the Act is ambitious. It provides for a new Financial Stability Oversight Council, a “resolution authority” for failing banks and financial institutions, and a new Consumer Financial Protection Bureau. It also imposes tougher capital, leverage and liquidity requirements.

However, a major shortcoming of the Act is that, despite its size, it’s short on detail. It only provides a rough framework for the future regulatory structure. Treasury department officials now have to begin writing the regulations that will give the framework for enforcing the law. Bloomberg reports that’s a process that could take a year.

Bloomberg reported: “For the banking industry, the battle now shifts to the regulators, where an alphabet soup of federal agencies have been tasked with crafting the new rules mandated by Congress. At the Commodity Futures Trading Commission, chairman Gary Gensler has convened 30 teams to construct a new regulatory system for the US$615 trillion over-the-counter derivatives market. Derivatives are financial instruments based on the value of another security or benchmark. Some instruments, including contracts that insured mortgage-backed bonds, have been blamed for fuelling a financial crisis that led to the worst recession since the Great Depression.”

Bloomberg quoted an official as saying the full impact of the Act will only be known once the regulatory agencies have issued hundreds of regulations and “possibly thousands of interpretations”. That’s one of the reasons why many people believe the Dodd-Frank Act won’t prevent future banking crises.

The website Qfinance says the Act has drawn the sharpest criticism for what was left out. “In particular, critics believe it will do little to prevent the next crisis, since it skirts around the ‘too big to fail’ issue (it fails to impose size limits on any financial institution), sidesteps reform of America’s dysfunctional secondary mortgage players Freddie Mac and Fannie Mae and fails to reinstate Glass-Steagall’s separation of ‘utility’ and ‘casino’ banking.”

That means US President Barack Obama’s announcement earlier this year that retail banks and investment banks will be separated hasn’t materialised. The Glass-Steagall Act was passed in 1933, separating retail (“utility”) banking from investment (“casino”) banking at the time.

The much trumpeted action against being “too big to fail” is also not happening. As the months have dragged on, the US’s appetite for radical action against the banks has diminished, although once the regulations are written, US banks may still find themselves at a disadvantage internationally.

The US action comes over and above international action by the Basel committee on financial regulation. The main idea behind the Basel plan
is for banks to keep more capital and liquidity than they have in the past so there’s a cushion in times of crisis. However, after an outcry by
banks, the committee softened some of its
suggested rules on capital and liquidity while introducing new restrictions on how much lenders can borrow as part of an effort to rein in their risk-taking.

Banks have been fighting those regulations ferociously. Bloomberg reports Deutsche Bank and Bank of America warned a rush to regulate may force them to cut lending, jeopardising the economic recovery. The Institute for International Finance (a bankers’ club) argues growth will be cut and jobs lost if the proposals are put into practice.