By Lon S. Cohen
The banking industry has been hard at work this year telling its story to state and federal lawmakers, repeatedly making the point that the vast majority of banks didn’t engage in the activities that caused the economic crisis, and that regulation efforts should focus on the non-banking institutions seen as the cause of the problems.
Meanwhile, in recent months, we’ve seen a modest rebound in the investment markets. Economic forecasters predict the recession will last at least through this year.
That’s very likely contributing to a national ambivalence about what financial regulatory reform can and should accomplish. The repeal of Glass-Steagall in 1999 was a response to the banking industry’s call for rules changes that would make them more competitive with non-banks. Will we take lessons we’ve learned from history in rewriting the rules again? What will regulation look like this time around?
The Obama administration’s outline for a consolidated regulatory environment for the banking industry has seen concessions and switches, but it still amounts to more government regulation.
The administration says that regulatory agencies suffer from overlapping authority. The president has implied that the very concept of protecting individual banks is outdated, because it ignores the systemic risk factor underlying the web of relationships between large financial institutions.
President Barack Obama is inclined to give the job of bank overseer to the Federal Reserve. While the Fed may have been just as blind to the systemic risk threatening the economy as everyone else, the president feels that the Fed performed better than most other agencies during the crisis and that it deserves the job.
“There’s got to be somebody who is responsible not just for monitoring the health of individual institutions, but somebody who’s monitoring the systemic risks of the system as a whole,” he said during a White House press conference in June. He added that his administration believes that “the Fed has the most technical expertise and the best track record in terms of doing that.”
The administration’s central idea is to have one office, possibly the Fed, act as ringleader, overseeing systemic risk and the activities of smaller agencies. Additionally, a Financial Services Oversight Council may be established to monitor the agency, make suggestions and report back to Congress. The council, chaired by the Treasury secretary, would act as arbitrator if there is infighting between the agencies.
Bankers have their own ideas
Bankers and the organizations that represent them have some suggestions about the shape of the regulatory body to which they’d be beholden in the new scheme of things.
Mark Tryniski, president and CEO of Community Bank System, thinks it was not a splintered regulatory environment, but rather the shadow banking system of subprime and wholesale lenders, conduit mortgage lenders and credit default swaps that was responsible for the failure to predict the current economic crisis. He thinks agencies need to shine a regulatory light on those shadow-banking markets, and that a bigger, consolidated overseer will not do a better job of regulating them.
He argues that proposed changes may weaken the banking system by eliminating some key assets and imposing more limitations. The banking industry is already highly regulated, and adding more rules can only lead to stifling and restricting of innovation, which has been the strength of the U.S. banking system overall. And while the regulators themselves may have missed the opportunity to prevent this crisis, the market is self-correcting now, if slowly and painfully, for both banks and consumers.
“Through a form of ‘natural selection,’ the failure of non-regulated institutions pushes business to regulated banks,” said Tryniski. “The marketplace is doing its job.”
What went wrong (this time)
The systemic risk of banks deemed “too big to fail” was never reined in by any federal regulatory agency currently in existence or any officer in charge of watching over the U.S. banking system.
“Reforms are needed,” Tryniski said. “And it’s appropriate to revisit the system to see how we can improve it. It’s absolutely essential to look at the systemic risk issue. We can’t have institutions that are too big to fail.”
At Herald National Bank, President and CEO David Bagatelle said that he supports consolidating agencies because it would give consistency to oversight in the industry, something that has been sorely missing. “It would be particularly helpful for banks that operate in multiple states,” he said.
“I think the myriad of regulators may have been part of the problem, but not the problem itself,” Bagatelle said. “There were many other factors – the list as we know it is long – including some of the regulations themselves.”
But Robert Hockett, Associate Professor of Financial Law and Economics at Cornell University, said that there is inherent weakness in the way the agencies are structured and there is a need to close the gaps in order to do the very things that bankers are suggesting. Because there were several fractured groups, communication broke down between them and may have prevented a better solution from being considered. Among other things, the super regulator would be watching bubbles and making sure they don’t grow too large too fast and pose too much risk to the system.
“I think we should probably celebrate more than we fear about more regulatory consolidation,” he said.
Group diversity: a good thing
Hockett also sees disagreements between the Fed, the Federal Deposit Insurance Corporation (FDIC) and those who run the Trouble Assets Relief Program (TARP) as a contributing factor to public confusion. While it seems that in recent years the Fed and the Treasury have been of the same mind, they sometimes stand in opposition to FDIC.
The healthy competition that works so well on the open market can cripple governance. Regulatory turf wars are harmful to the system and produced the very fissures that allowed key elements to fall through the cracks. Their main disadvantage is the inefficiency of their tracking and coordination, Hockett said, “particularly when some of them disagree with one another.”
Hockett thinks the FDIC is a good choice as the systemic risk regulator. The FDIC has been in a position to become a de facto regulator for many years, considering it reaches across the divide between federal- and state-chartered banks. While not all banks already come under the influence of the Fed, all come under the jurisdiction of the FDIC in some way, because most banks are a part of the department’s system to protect depositors’ assets.
“If they aim to attract and keep custo-mers, banks will join the Federal Deposit Insurance System,” said Hockett. “And that affords the FDIC enormous leverage in imposing regulatory requirements upon them.”
David Bagatelle says he really has no preference of choice in regulators , though he does feel that “the agency that does take on the role of lead regulator needs to be consistent in their oversight across all organization types,” he said. “Be they national charters, state charters, or bank holding companies.”
One agency to rule them all
Establishing a consumer protection agency specifically for the banking industry creates a fear that perhaps the government may be splitting its efforts, then forgetting others. Thomas M. O’Brien, president and CEO of State Bank, thinks that some consolidation of federal supervisory agencies is in order because there are too many now, but he is a strong supporter of the dual banking system, due to its proven contribution to safe and sound operation and innovation.
O’Brien envisions one federal bank chartering and examining agency, the OCC, which could contain a thrift specialist section. The Fed could supervise all aspects of the top 25 banks, assessing fees for the efforts, and the FDIC would retain the right to inspect and examine insured institutions. In the normal course, the FDIC might not need to be on site at CAMELS 1- and 2-rated banks as frequently. As for state charters, he thinks the individual agencies should be sufficiently capable to support their work with the Conference of State Bank Supervisors (CSBS) or some other recognized authority used to establish best practices for the design, independence and staffing of state agencies.
“Enforcement should be consistently applied, understanding that the regulatory framework is one that takes a longer term view,” he stressed.
Elimination of thrift charter
One specific area of concern for some bankers is the administration’s proposal to eliminate the thrift charter. The Office of Thrift Supervision (OTS) provides what Tryniski describes as a robust dual banking system; eliminating it would allow too much government control.
“There’s a significant advantage to multiple regulators and multiple charter options,” Tryniski explained. “It creates an appropriate balance between the interests of the banks and the interests of supervision.”
Since the troubled banks are a minority of the total banks in the United States, he wonders if it is necessary to extend the very strict regulatory oversight, and the sanctions proposed for them, to all banks. Community Bank System has paid several million dollars to the FDIC in deposit insurance over the years, Tryniski said. It’s an example of good banks bailing out the bad banks, which he said is standard expectation in the industry.
“[In] how many industries do competitors bail out the failures?” he asked. “Legislatures need to keep that in mind when considering regulation.”
State Bank’s O’Brien also thinks that there is an excessive burden on all banks to support the few, and that “too big to fail” means “too big to exist.” Large financial services companies that may put the entire economy at risk should be supervised by the Fed, and pay a fee for the extra supervision and enforcement needed to keep watch over them. And they should be made to maintain meaningful capital levels and premium debt ratings.
Most bankers seem to agree that adding yet another consumer protection agency is unnecessary and burdensome. Tryniski is most concerned about the government mandating the types of products financial institutions promote to customers, going against a free market and capitalistic environment. “Banks have volumes of regulation already,” he said. “It may not improve this by creating the [consumer protection] agency.”
The American Banking Association (ABA) said that the plan will be difficult to enact, and will produce great uncertainty in the financial markets and among financial regulators while it’s pending.
“It needlessly rips apart all the existing regulatory agencies, eliminates charter choices and creates a new agency with powers to mandate loans and services that go well beyond consumer protection,” stated the ABA.
Hockett says that even the administration itself may not know exactly how it will all turn out.
“The administration actually seems pretty wishy-washy right now on just about all finance-regulatory questions,” he said. “It looks almost as though they’re still trying to figure out what actually caused the most recent difficulties and how best to address those causes.”
Lon Cohen is a freelance writer based in New York. He has eight years’ experience working and writing about the banking industry. He can be reached at firstname.lastname@example.org.