Rolling Back Dodd-Frank Regulation—Good or Bad?
Dodd-Frank Act was implemented in the aftermath of the worst financial crisis that the world faced in 2008. The goal of this regulation was to prevent another crisis. This Act had forced the financial institutions to meet a number of regulatory requirements. One such requirement was to keep a higher capital reserve. President Trump found this Act as an impediment for the banks to provide loan to businesses, thus impacting new job opportunities. He signed an executive order to review and roll back the entire regulation. On June 8, 2017, US Congress passed a bill named Financial Choice Act, which proposes rolling back few regulations under the Dodd-Frank Act. This bill needs to be passed by US Senate before being enacted as a law. The people who are opposing this move have the opinion that the system will again become vulnerable to another failure. Their argument is that the financial institutions will again indulge in making short money and won’t be able to repay their debt in case of crisis.
How will Financial Choice Act Change Dodd-Frank Act?
Let’s do a recap of 2008 crisis. Excessive risk-taking by financial institutions like AIG, Lehman Brothers led to the collapse of the entire system. The US government had to implement a massive bailout strategy for the impacted institutions, as they did not have the capital to cover their own losses. The Dodd-Frank Wall Street Reform and Consumer Protection Act, as it is officially known, was introduced in 2010 as a direct response to this financial crisis. Few important aspects of this regulation include:
- Formation of Financial Stability Oversight Council (FSOC), which identifies risks within the financial systems
- Formation of Consumer Financial Protection Bureau (CFPB) to oversee consumer financial products such as mortgages
- Volker rules to control the risky investment made by the banks that are potentially against consumer interests
The amendment proposed under Financial Choice Act will remove the authority of FSOC to designate financial market utilities as “systematically important” or “too big to fail”. Today, FSOC designates those institutions as “too big to fail,” which are interconnected and their failure might have a domino effect. The above entities are subject to additional restrictions on capital reserve and any risky investments. The amendment also proposes to prohibit the use of exchange stabilization fund, which is an emergency reserve fund of US treasury to bail out financial firms. It has also proposed sweeping changes to the responsibility of CFPB while renaming it to Consumer Law Enforcement Agency. The new agency will look for opportunities to promote competitive markets for consumer’s protection. If Senate approves this bill, then it would reduce the US fiscal deficit by US$33.6 billion over next ten years. This bill is also expected to bring regulatory relief to community banks and credit unions.
Is it Good or Bad?
Regulations enforced by Dodd-Frank Act appear burdensome and inflexible by many financial institutions. The growth of these institutions is already impacted due to poor market conditions and loss of people’s trust. They are unable to invest in new growth opportunities due to unavailability of capital and increased spend on governance, risk, and regulation. Mid-sized and smaller institutions are not able to compete with newer market forces that are thriving on digital technologies. On the other hand, bigger banks are still considered as risks to the financial system. The regulations failed to split up those bigger banks to reduce the vulnerability.
At the same time, critics of Financial Choice Act have shown concern that getting rid of Dodd-Frank Act may pave the way for another crisis. Big institutions may go back to massive and risky bets that will risk the consumer’s money. Although the primary political objective of this proposed amendment is to create more job opportunities, any breakdown could trigger more job losses. Global financial system is still in a vulnerable state, particularly in Europe after the Brexit mandate. Businesses that are desperate for growth may adopt an unfair and risky strategy if regulatory restrictions are removed. Hopefully, the US senate will evaluate all these factors before approving the bill. Rather than going for a major change in one go, a step at a time will help increase the benefits and manage the risks better.