Trump Will End Bank Rules. No He Won’t. A Guide for the Puzzled
U.S. bank stocks have jumped 14 percent since the election of Donald Trump, partly on hopes he will dismantle regulation. Here’s how the new president might change rules that have made the financial system safer since the 2008 crisis, from most likely to least.
Many politicians and regulators agreed before the election that post-crisis rules unfairly burdened small banks. While most regulation targeted too-big-to-fail firms, tighter standards also applied to regional and community lenders. Democrats probably will support Republicans in exempting small banks from some requirements. The Federal Reserve is already in the process of making annual stress tests easier for them.
The Financial Choice Act, a bill presented in June by Jeb Hensarling, Republican chairman of the House Committee on Financial Services, proposed freeing banks from new regulations if they maintain a simple leverage ratio of 10 percent. That means the value of a bank’s assets could decline by 10 percent and the firm would still be solvent because shareholders would shoulder the losses. Unlike other measures of bank safety, the leverage ratio doesn’t allow for adjustments based on the perceived riskiness of holdings.
Many Democrats could support this provision for small banks, though not for the largest ones, according to Karen Shaw Petrou, co-founder of Washington-based Federal Financial Analytics. Because most smaller banks already meet that 10 percent minimum or could reach it with relative ease, that would in effect exempt them from hundreds of new rules.
Another target is the Financial Stability Oversight Council and its power to designate nonbank financial firms such as insurance giant American International Group Inc. as systemically important. While regulators haven’t figured out what to do with such firms, they’re planning to impose some enhanced safety measures. FSOC was created by the 2010 Dodd-Frank Act, which most Republicans would like to repeal. Even if they can’t muster the 60 Senate votes needed to overturn the law, the council is chaired by the Treasury secretary, whom Trump will appoint.
Some analysts expect the government to drop its appeal of a court decision rescinding the designation of insurance firm MetLife Inc. as systemically important after Trump takes office. Efforts to reduce risk in shadow banks — hedge funds, mortgage firms, auto lenders and other financial institutions that extend credit to companies or consumers — will probably peter out as Trump replaces key people at regulatory agencies.
Hensarling’s Choice Act would eliminate FSOC’s too-big-to-fail designation powers. Paul Atkins, who’s advising Trump on regulatory appointments, opposed oversight of hedge funds when he was a member of the Securities and Exchange Commission.
While smaller banks may escape stress-testing altogether, the biggest lenders also might see some easing. The annual tests look at how much firms would lose in a hypothetical crisis and whether they have adequate buffers to protect them. Banks have complained about the lack of transparency as to how losses are calculated in the tests, a view echoed in a recent Government Accountability Office report commissioned by Hensarling. The Texas congressman’s chief counsel is writing policy papers for regulatory agencies for the Trump transition team. More transparency could make it easier for big banks to pass.
Trump has to navigate between the anti-regulatory fervor of his traditional Republican base and the anti-bank sentiment that resonates with voters. On the Republican wish list is repeal of Title II of Dodd-Frank, which gives the Federal Deposit Insurance Corp. power to wind down big banks. Opponents say it codifies too big to fail by giving regulators the option of bailing out banks under the guise of resolution. The FDIC can tap Fed funds to keep a bank in operation during this transition, which many Republicans see as a bailout.
They prefer Title I, which would put a failing firm directly into bankruptcy, in which case it would get no government funds other than FDIC protection on deposits. Banks have been pushing for a rewrite of bankruptcy laws to make that option more viable and less dangerous for the rest of the financial system. Critics say bankruptcy doesn’t work for banks because financial assets need uninterrupted funding to prevent fire sales.
“It’s sad that so many of my fellow Republicans see it as a bailout provision when it is in fact an anti-bailout provision,” says Sheila Bair, a former FDIC chairman. “It’s actually a bankruptcy process run by the FDIC instead of the court. At the end, the shareholders and creditors bear all the costs, not the government.”
Title II could be eliminated by attaching a motion to a Senate budget-reconciliation bill, which can be passed with just 51 votes. There will be at least 51 Republican senators next year.
Bank executives have complained more about Title I than Title II because of the difficulty they’ve faced coming up with blueprints spelling out how they’d be wound down in bankruptcy. But they aren’t worried about Title II going away as they’ve done a lot of work complying with Title I requirements and expect some bankruptcy-law change will accompany the removal of the FDIC’s resolution powers.
One puzzle is whether capital rules adopted after 2008 will be softened under Trump. The stricter standards came from the Basel Committee on Banking Supervision, made up of regulators from around the world. The revised rules almost tripled the ratio of bank capital to assets — the more that lending is funded by shareholders’ equity rather than borrowed funds, the lower the chances of a bank failing when an economic downturn causes losses.
The Fed is at the forefront of translating and implementing Basel rules in the U.S. Dan Tarullo, the Fed governor who has led the effort, could be replaced by a Trump appointee. With other appointments, Trump could tip the balance on the Fed board and at other agencies toward a more bank-friendly approach. In theory, regulators could then roll back capital requirements to Basel minimums — 3 percent currently for the leverage ratio — from the higher standard set by the Fed.
Signals coming from Hensarling and other Trump advisers don’t support that. Hensarling’s Choice Act demands a 10 percent leverage ratio. The current corresponding requirement is 5 percent for the biggest six banks, whose ratios averaged below 7 percent at the end of September. That means JPMorgan Chase & Co., Goldman Sachs Group Inc. and their peers would have to raise billions of dollars in equity to reach the Hensarling threshold.
“I don’t know anybody, haven’t seen anybody of either party, saying let’s really unlock the biggest banks to go out and do whatever they want to do,” says Neel Kashkari, president of the Federal Reserve Bank of Minneapolis and a former Treasury official under George W. Bush. “A lot of the divide in the country, the anxiety, stems from the financial crisis.” Kashkari this month called for even higher capital requirements than Hensarling.
Hensarling and other Trump advisers have attacked the Volcker Rule, named after former Fed Chairman Paul Volcker. The rule prohibits banks from making market bets and limits trading activity to serving clients’ needs. Bond-trading revenue at the five biggest U.S. investment banks in the first nine months of this year was about half of what it was in 2010. Although other factors such as persistent low interest rates contributed to that decline, banks tend to blame the Volcker Rule.
Even now, the complexity of the rule makes it difficult to enforce the separation of market bets from assisting clients in their trading. That was exemplified by Goldman Sachs concluding it was in compliance with the rule after one of its traders made $250 million for the firm last year. The part of the Volcker Rule banks would like to see go away is the strict limit on their investments in hedge funds or private equity firms. That section is written into the Dodd-Frank Act and can’t be changed without Congressional approval or softened by regulators.
Democrats in Congress will oppose rolling back the rule, which would require 60 votes in the Senate. Volcker, widely revered as a hero for bringing down runaway inflation in the early 1980s, would also defend the rule publicly. Trump has spoken highly of Volcker and said he’s OK with the rule as long as Volcker is happy with it.