WASHINGTON – The Treasury Department released its highly-anticipated report on revamping financial industry regulations late Monday, including many expected recommendations while also offering up some surprises.
In some respects, the report echoes a bill passed by the House last week, including a leverage ratio “off-ramp” from many post-crisis rules, a significant paring back of the Federal Reserve’s stress testing program and a reconsideration of many of the international standards the U.S. follows.
“This report comes after a four-month process of trying to move from campaign rhetoric to policymaking, and it reflects a first try at doing that,” said David Portilla, a partner at Debevoise Plimpton and a former Treasury official. “It’s a little bit different from Choice Act, but does seem to dovetail with the Choice Act.”
But the report also has some surprises. It calls for the U.S. to implement the remaining aspects of the Basel III standards, including capital floors, calls for Congress to expand the authority of the Financial Stability Oversight Board and seeks additional flexibility for Community Financial Depository Institutions – a class of community bank whose grant budgets the administration sought to zero out in the 2018 federal budget.
It also toys with new ideas while not fully fleshing them out, including a “coordinated examination force” for community banks and suggesting a “restructuring” of regulators without detailing exactly what would be entailed.
Treasury Secretary Steven Mnuchin said in a statement accompanying the report that the report was designed to maximize consumer choice and spur growth that will help all Americans.
“Properly structuring regulation of the U.S. financial system is critical to achieve the administration’s goal of sustained economic growth and to create opportunities for all Americans to benefit from a stronger economy,” Mnuchin said. “We are focused on encouraging a market environment where consumers have more choices, access to capital and safe loan products – while ensuring taxpayer-funded bailouts are truly a thing of the past.”
But the administration’s critics have already panned the proposal as a giveaway to the banking industry. Sen. Sherrod Brown, D-Ohio, who serves as top Democrat on the Senate Banking Committee, blasted the report, citing the disproportionate representation of banks and banking organizations among those consulted as evidence that it does not have the average American’s needs at heart. Brown said Treasury consulted with 244 banking groups, compared with 14 consumer advocates.
“When Wall Street greed goes unchecked, American taxpayers and working families pay the price,” Brown said. “Too many hardworking Americans still haven’t fully recovered from the financial crisis, and Washington should be focused on protecting them by holding Wall Street accountable, not doing its bidding.”
But Richard Hunt, president of the Consumer Bankers Association, said Treasury probed deep during interviews with bankers and did not simply accept industry recommendations.
“They pushed back on many of the things we were saying,” Hunt said. “It was good, substantive dialogue and push back.”
Following is an in-depth guide to Treasury’s recommendations:
Better coordination, regulatory restructuring
Among the most surprising recommendations was a call to boost FSOC’s power. Industry observers had concluded that FSOC was all but finished when President Trump was elected, concluding that the new administration would view it as regulatory overreach.
But the Treasury plan envisions FSOC playing a bigger role in coordination and supervision. That includes a suggestion to give “it the authority to appoint a lead regulator on any issue on which multiple agencies may have conflicting and overlapping regulatory jurisdiction.”
Such a change could significantly increase the power of the Treasury Department, which chairs FSOC, by allowing it to help choose a single regulator to write complex rules that usually require multiple agencies.
“This new authority would allow the FSOC to play a larger role in the coordination and direction of regulatory and supervisory policies,” the report said.
Portilla said that recommendation probably represents an ideological concession that, for all the gnashing of teeth related to the interagency council’s excessive power, the FSOC is the one and only forum where the administration wields direct influence and authority over the various independent financial regulators. That would appeal to any administration seeking to advance its agenda, he said.
“The administration can use the FSOC’s powers of persuasion, use that bully pulpit,” Portilla said. “I think that illustrates the fact that the FSOC is the one forum for the administration – separate and apart from the independent regulatory agencies – to have some type of influence on how the process moves forward.”
Hunt said it made sense for some entity to help with overlapping regulators, though he was not yet convinced it should be FSOC.
“I’m glad they thought they needed a mechanism for who should go to a bank,” he said. “It’s ridiculous how many examiners from the various agencies that are in our banks examining the same issue.”
The report also touches on regulatory restructuring, saying that Congress should “take action to reduce fragmentation, overlap and duplication” in the regulatory structure, including consolidating regulators with similar missions. But it doesn’t spell out what exactly should be done.
“There is a strong implication in the report supporting some sort of regulatory agencies restructuring,” said Cam Fine, president of the Independent Community Bankers of America, who was supportive of several suggestions in the report. “It will be interesting to see how that plays out. Administration after administration has made a run at regulatory restructure (as has Congress from time to time) with only very limited success.”
The report also calls on agencies to better coordinate supervision and exam activities, including considering “coordinating enforcement actions such that only one regulator leads enforcement related to a single incident or set of facts.”
Kevin Petrasic, partner at White Case, said the idea of regulatory consolidation has been considered for years, with one of the most serious recent considerations put forward in 2015 by former Federal Reserve chair Paul Volcker. But those ideas have tended not to gain traction, not least because the fractured nature of the U.S. bank regulatory system has benefits as well as drawbacks.
“Certainly one of the pros is having more uniformity and consistency, one of the cons of course is you have a certain degree of tension between regulators that can be a good thing and a bad thing,” he said. “You don’t always have tremendous expediency with respect to policy development, but it does give time for thoughtful reflection and debate among the regulators.”
Community banks and credit unions
The plan also specifically tackled how to help community banks and credit unions, recommending a variety of steps. While most have been suggested in the past, one intriguing possibility was the creation of a “consolidated examination force.”
The report did not offer details on how such a force would be put together, but bankers have long complained about overlapping exams from multiple regulators, though supervisors have said repeatedly they do their best to coordinate.
Other recommendations included: exempting community banks with less than $10 billion of assets from the Volcker Rule, Basel III requirements and possibly Dodd-Frank’s Collins amendment, which established a minimum capital floor for all institutions; doubling the Small Bank Holding Company Policy Statement asset threshold to $2 billion; and streamlining call reports and other reporting requirements.
Treasury also said that it “may be appropriate” for community development financial institutions and minority depository institutions to be granted “additional flexibility in utilizing subordinated debt or capital, particularly capital that is borrowed by the holding company and injected into the bank.”
The report broke out some specific recommendations for credit unions as well, including raising the scope for stress-testing requirements for federally-insured credit unions to $50 billion in assets, a five-fold increase. It also called for the repeal of a final rule requiring credit unions with more than $100 million of assets to satisfy a risk-weighted capital framework. Instead, credit unions should have a simple leverage test, Treasury said.
Regulatory off ramp, stress tests and asset thresholds
Like the bill passed by the House last week, Treasury’s report envisions a regulatory “off-ramp” from all capital and liquidity requirements, as well as the Volcker Rule, for institutions that agree to hold a “sufficiently high” level of capital. The report specifically references the 10% non-risk-weighted leverage ratio outlined in the House bill, but Treasury appears open to alternative approaches.
Such a move would benefit smaller banks, which often have leverage ratios that exceed that level, while not helping larger institutions, which would find a 10% leverage ratio too onerous.
The report also calls for raising capital thresholds – a central metric for various requirements in Dodd-Frank – in order to reduce the number of banks subject to those requirements.
The report specifically calls for the $10 billion asset threshold for the Dodd-Frank Act Stress Test to be raised to $50 billion, and for the threshold for systemically important financial institutions subject to the Comprehensive Capital Assessment and Review to be raised from $50 billion to “be better tailored to the complexity of bank holding companies.”
The report says the Liquidity Coverage Ratio and Single Counterparty Credit Limit asset thresholds should also be more limited to only the largest and most complex banks, while the Supplementary Leverage Ratio should not consider cash, Treasuries or initial margin on cleared swaps as part of the denominator. The proposal also calls on High Quality Liquid Assets should be expanded to include high-quality municipal bonds and adjust the assumptions about cash flow in a crisis to be less conservative.
The stress testing changes are in many ways similar to the proposals outlined in the Choice Act. The bill would eliminate the qualitative aspects of CCAR as a basis for objection, fold the countercyclical capital buffer into the stress testing program, and subject the Fed’s stress testing models to an open notice-and-comment period.
Restructuring of the Office of Financial Research
While the report broadly calls for regulatory restructuring, it mostly avoids drilling into many specifics – with one exception.
The plan calls for folding the Office of Financial Research, created by Dodd-Frank as an independent agency, into the Treasury Department. The director of the OFR would be appointed by the Treasury secretary and subject to removal at will, while the budget would be under Treasury’s control.
Consumer Financial Protection Bureau
As expected, the Treasury report includes suggestions for revamping the Consumer Financial Protection Bureau, but largely hews close to the existing GOP policy recommendations.
The report says that either the CFPB director should be removable at will by the president or restructured into an independent commission. It also calls for subjecting the CFPB to the congressional appropriations process. Both ideas are long-standing Republican requests dating back to before the passage of Dodd-Frank.
Moreover, the Treasury report calls for reforming the CFPB so that “regulated entities have adequate notice of CFPB interpretations of law before subjecting them to enforcement actions, and curbing abuses in investigations and enforcement actions.”
The administration faces an uphill battle for any of its CFPB recommendations. While changing the structure to a board is theoretically possible, Senate Democrats are wary of any proposed changes, fearing that Republicans simply want to gut the agency as much as possible. As a result, they have been reluctant to support any changes.
At least eight Senate Democrats would have to support any changes to the CFPB in the current Congress.
Interestingly for a Republican administration, the Treasury report does specifically support financial inclusion efforts, supporting “bringing more consumers into the banking system and out of less regulated markets.”
“Treasury has reviewed and made recommendations to improve, and reduce the costs of, lending flows from the banking system across a range of product types, including residential mortgages, leveraged lending, and small business lending,” the report said. “A significant amount of regulatory overlap of activities-based regulation exists across consumer and commercial lending that should be addressed through inter-agency review and coordination. This overlap puts a particularly high burden on mid-sized and community banking organizations.”