Three Takeaways from the Treasury Report on Regulating Banks and Credit Unions

The Department of the Treasury released a much anticipated report last week reviewing whether current regulations for banks and credit unions fit into seven core principles outlined in an executive order earlier this year by President Trump. Overall, the report is a positive contribution to the debate on financial regulatory reform and includes a number of recommendations that could garner bipartisan support.

Reviewing and tailoring regulation, along with streamlining the U.S. financial regulatory structure, will make financial regulation more effective and efficient.

Report recommendations and our take

• • • The report recommends that regulation should be tailored “based on the size and complexity of a financial organization’s business model and take into account risk and impact” and calls for “a holistic analysis of the cumulative impact of the regulatory environment.” 
      The Treasury is correct to focus on better tailoring regulation for financial firms, since it will help shift regulatory focus to where it is most needed and ease burdens on firms that are less risky and systemically important. This is why BPC has recommended adjusting and giving regulators more flexibility in making exceptions to thresholds, and tailoring the regulation of systemically important nonbanks.The report recommends that regulation should be tailored “based on the size and complexity of a financial organization’s business model and take into account risk and impact” and calls for “a holistic analysis of the cumulative impact of the regulatory environment.”

      BPC also agrees that a review of post-crisis financial regulation is necessary and should be conducted on a regular basis. There is evidence of unintended consequences from post-crisis reforms that should be addressed on the following:

      • curtailment of certain financial activities
      • lack of coordination and unnecessary duplication and conflict in rules
      • multiple binding constraints on the business decisions of financial firms
      • continuing gaps in regulation

      For instance, post-crisis reforms wisely required higher capital levels from banks, but the Supplementary Leverage Ratio applies these requirements even to essentially risk-free assets, which creates incentives to hold riskier assets. Other regulations may have helped make the financial system safer, but may also have negatively affected lending and market liquidity. Reviewing regulations can help find better ways to keep the financial system safe, while mitigating unintended consequences.

    • Treasury recommends taking action to “reduce fragmentation, overlap, and duplication in the U.S. regulatory structure.”

      We agree with the report’s call for Congress to streamline the fragmented U.S. regulatory structure (BPC’s plan is here). The U.S. financial regulatory structure has evolved over time with new agencies being created after most major crises. This has resulted in fragmentation, overlap, and duplication in our regulatory structure; a problem that was not sufficiently addressed in Dodd-Frank.

      Treasury’s recommendation for agencies jointly examining banks is excellent because it would reduce duplication for regulators and financial firms and improve interagency communication. BPC also supports Treasury’s recommendation for Congress to give the Financial Stability Oversight Council the authority to coordinate regulators and appoint lead regulators when multiple agencies have overlapping jurisdiction. This authority would have been helpful in a case such as the Volcker Rule, which five different agencies struggled to develop and promulgate.

    • Treasury recommends making the Consumer Financial Protection Bureau and Office of Financial Research less independent by “funding the CFPB through the annual appropriations process” and having “the OFR become a functional part of Treasury.”

      The main area where we disagree with the report is on the independence of financial regulatory agencies, which has proved so valuable in past crises. The CFPB was created to focus consumer protection in a single agency while the OFR was designed in part to identify systemic risks to the financial system. Both agencies are outside of the congressional appropriation process to insulate them from short-term political pressures, but are still accountable to Congress in several other ways.

      The report’s recommendation to make the CFPB’s funding subject to congressional appropriation would subject the Bureau to potentially large gyrations in its funding after each election cycle, thus weakening the CFPB’s ability to protect consumers. Congress should take a different tack for enhancing CFPB accountability by creating a separate, independent inspector general for the agency, which has already been proposed by several members of Congress.

      Similarly, the OFR should be made more independent, not less. Political realities make it difficult for Treasury or the Federal Reserve, to publicly “sound the alarm” on emerging sources of systemic risk. An independent OFR has the ability to perform this important role.

  The Treasury report is a step in the right direction and advances the debate on financial regulatory reform. 

  The Treasury report is a step in the right direction and advances the debate on financial regulatory reform. Reviewing and tailoring regulation, along with streamlining the U.S. financial regulatory structure, will make financial regulation more effective and efficient. All of this can and should be done while maintaining and enhancing regulatory independence.