The cornucopia of proposals in the Financial Choice Act — recently passed by the House — to roll back crisis-era regulations is being touted as vital for community banks. To hear the bill’s author, Rep. Jeb Hensarling, R-Texas, tell it, community banks are in an existential crisis due to onerous Dodd-Frank regulations.
But this rhetoric is divorced from two key realities: First, most of the provisions in the Choice Act do not apply to the vast majority of community banks; the legislation’s main beneficiaries are elite megabanks. Second, the challenges faced by community banks largely predate and are unrelated to the post-crisis regulatory regime.
The bill passed by House Republicans, which includes some of the same relief approaches called for in the Treasury Department’s regulatory report unveiled Monday, is a 600-page juggernaut that would run roughshod over consumers, Main Street businesses and small banks in favor of Wall Street.
In seeking to repeal significant aspects of Dodd-Frank, the Choice Act would: nullify key shareholder rights for all but the largest investors in public companies; undermine the neutrality and effectiveness of the Consumer Financial Protection Bureau, an agency that has provided a whopping $11.7 billion in restitution to exploited consumers in six short years; eliminate the Federal Deposit Insurance Corp.’s “orderly liquidation authority” — intended to help the FDIC manage the next banking crisis — in favor of having bankruptcy courts handle the cleanup of large failures; and invalidate the Volcker Rule, thereby recreating pre-2008 Wall Street incentives for depository institutions to engage in rampant speculation using customer deposits and Federal Reserve largess.
That these changes are being sold as rescuing struggling community banks is galling.
For one thing, the connection between Dodd-Frank and the demise of community banking has been greatly exaggerated.
According to an FDIC study, the core profitability of community banks has returned to pre-2008 levels despite the fact that the current economic recovery is the most sluggish since World War II. U.S. commercial-bank lending is enjoying a 70-year high, and has risen consistently since 2010. Indeed, community bank profits are actually up relative to big banks.
While the creation of new community banks has been scarce — and existing small banks are being engulfed by larger ones — these trends have been ongoing for the past four decades due to oligopolistic conditions in the banking sector. Broad macroeconomic trends, not regulations, are the primary determinant of commercial bank profitability. Community banks have more to fear from increased unemployment and a sluggish economy. What’s more, those headwinds could intensify under the Choice Act, which would revive the pre-crisis conditions that led to the Great Recession in the first place.
The fact is that much of the regulation targeted by the Choice Act is plainly inapplicable to community banks. For instance, Dodd-Frank largely exempts small banks from stress tests, systemic capital surcharges and living wills. The FDIC has designated well over 5,000 banks as “community banks.” Of these, a mere six are subject to Dodd-Frank stress tests that apply to banks with over $10 billion in consolidated assets. And not a single one is subject to heightened stress testing applicable to banks with over $50 billion in consolidated assets. And yet the repeal of these protections against systemic risk is being trumpeted in community banks’ name.
Another target of the Choice Act, the Volcker Rule, prohibits proprietary trading, which is an activity that community banks mostly eschew. As of the end of 2016, 98.5% of total derivatives by notional value were held at the top 10 banks, and virtually all (99.66%) were held by the top 25 banks. And on its own terms, the Volcker Rule contains relaxed reporting requirements for banks with under $50 billion in consolidated assets. The repeal of the Volcker Rule would eradicate a vital structural barrier to risk proliferation, which would rejuvenate bank speculation in credit derivatives, the same instruments that torpedoed Lehman Brothers and cost the American economy over $22 trillion.
Under the Choice Act, banks can avail of an “off-ramp” from a host of regulations, simply by maintaining a 10% leverage ratio of capital to assets. While this simple alternative may sound appealing, there is no consensus that a 10% capital ratio would be sufficient to avert another crisis. While some economists believe that a 10% ratio is adequate, others believe that 20-30% may be more appropriate. Even if 10% were the right number, the valuation of capital and assets can be difficult, and that difficulty is compounded during the turbulence of market crises, when capital is most needed yet hardest to price. What good is the Choice Act’s 10% leverage ratio if the ratio is only a reliable metric during stable market conditions?
Though imperfect, Dodd-Frank’s provisions on systemic risk follow a comprehensive regulatory approach that provides banking regulators with a variety of tools to help avoid the next major crisis. The Choice Act deprives them of these vital tools, in favor of an overly mechanical, one-size-fits-none approach. Every financial professional knows that you don’t put all of your eggs in one basket. A hedged, multifactorial approach is safer. Why would we apply different standards to bank supervision?
While community banks may benefit from minor technical fixes to certain Dodd-Frank statutes and their implementing regulations, the Choice Act is not the solution — it’s a red herring. As in the past, Wall Street-friendly legislators are using the cause of community banks to line the pockets of the biggest banks, to the detriment of everyone else.
