Banking Needs a New Regulatory Structure

There has been a great deal of commentary on the number and complexity of new bank regulations. This is a huge problem, but in the long run, the biggest problem may be the number of regulators and the complexity of the regulatory structure.

Companies and industries often face a structure in which a federal agency regulates their basic business, although few, if any, face the detailed regulation banks face from their "primary" regulators. Companies may also be subject to Securities and Exchange Commission jurisdiction, if they are publicly traded, and to Justice Department scrutiny. Some state and local regulations also apply.

For banks, it is very different. A growing multitude of agencies is involved in the regulation of each institution. Furthermore, an agreement with one agency or group of agencies does not mean an issue is resolved. Other agencies can, and do, go after banks on the same issues. In some cases, this results in piling on. Increasingly in the future, it will result in conflicting demands and regulatory uncertainty. There is also the large cost of paying for all these agencies (often by banks) and of complying with all their overlapping rules and demands.

It should be obvious that no one in his or her right mind would design the bank regulatory system we have today. No third-world country's bureaucracy is so byzantine. For primary regulators, we have the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp. and state regulators. Every banking institution is subject to regulation by two of these, and many by three or even four. In addition, there is the growing and very powerful Consumer Financial Protection Bureau.

But the litany of acronyms goes much further. For many banks, parts of their basic business are regulated by the SEC, the Commodity Futures Trading Commission, the Financial Crimes Enforcement Network, the Department of Housing and Urban Development, the Federal Housing Finance Agency, the Labor Department and more. In addition, we have two new agencies gearing up: the Financial Stability Oversight Council, the multi-humped camel truly designed by a committee, and the Office of Financial Research, which has broad authority to demand information from a bank. Added to this witches' brew must be the Justice Department, state regulators, aggressive state attorneys general and local authorities.

There is no clear line of demarcation between the authorities of these regulators. For example, the primary regulators will call a consumer issue a safety and soundness issue because of "reputational" and "legal" risk, and investigate a bank on the same issue the CFPB is investigating. Right now, this usually results in a regulatory double team. In the future, given turf wars, it will result in conflicting demands.

Take the example of a mortgage loan. Some part of the process could be subject to regulation, oversight or enforcement by one or more federal bank regulators, a state bank regulator (if state-chartered), the CFPB, HUD, FHFA, the Justice Department, state AGs and local governments. There are also numerous opportunities for private rights of action. As clearly demonstrated in recent cases, a bank can be subject to an aggressive enforcement action by the banking agencies; then be subject to separate actions on the same activity by Justice, state AGs, local governments and private parties.

Another example is the Volcker Rule. Five agencies were assigned to try to reach a common regulation. It took them well over two years to finalize the rule, and within days, further interpretation was needed. Future interpretations may take a sign-off by all five.

Regulatory structure is not a transitional issue. The costs, redundancy, piling on, conflicts, delays and uncertainty will slowly crush the banking industry, and particularly community banks. Thousands of community banks will disappear within the next decade. But this is not just a concern for bankers. No modern economy has been successful without a strong banking industry, and the current regulatory structure is simply incompatible with a strong banking industry. There will be a huge long-term impact in significantly higher cost for banking services and for credit.

Those who advocate for more regulation should also support change. Some currently like having all these agencies involved; in effect, they want to maximize the forums for going after banks. While in the near term that may make sense from these groups' perspective, all should strive for the best regulation.

In any management scheme, clear lines of responsibility are critical to success. The same is true in regulation. One of the reasons there was regulatory failure with respect to mortgages was the lack of clear responsibility. There is often no clear line of authority in the existing structure.

Today the multiplicity of regulators may be leading to tougher regulation and enforcement, but that may not always be the case. Over time, this multiplicity may result in ineffective regulation and enforcement, as the regulators turn increasingly to turf battles. The delays and internal battles over the Volcker rule should be an early warning of what is to come.

The current structure is so bad, and carries so much historic baggage, that it would be best to use a zero-based approach. What are the regulatory goals we are trying to achieve and what is the best structure to achieve them? The goals would include a strong, competitive banking system; safety and soundness; consumer protection; fighting money laundering and other illicit activities; and an elimination of too-big-too-fail. I would add supporting a dual federal-state system.

There is no possibility of near-term reform of the current regulatory structure. A new structure will take many years to enact, but the discussion should begin now. As with any reform, the first step is to develop a consensus that reform is needed. The current regulatory structure is unworkable. It will slowly crush the banking system, undermine economic growth, and result in poor, bureaucratic regulation.

Edward L. Yingling is a partner in the Washington office of Covington & Burling LLP. He was previously president and CEO of the American Bankers Association.