An absolutely essential analysis by a great figure in American finance regulation. Which shows that nothing has changed towards reduction of risk in the banking sector (hfk)
February 24, 2014
The views expressed are those of the author and not necessarily those of the FDIC.
The United States is in its sixth year following the financial and economic crisis of 2008, and we are just about to start our fourth year since the enactment of the Dodd-Frank Act. Enormous energy has been expended in an attempt to implement a host of required reforms. The Volcker Rule has been implemented, and more recently a rule requiring foreign bank operations to establish U.S. holding companies has been adopted.
While these are important milestones, much remains undone and I suspect that 2014 will prove to be a critical juncture for determining the future of the banking industry and the role of regulators within that industry. The inertia around the status quo is a powerful force, and with the passage of time and fading memories, change becomes ever more difficult. There are any number of unresolved matters that require attention.
- This past July the regulatory authorities proposed a sensible supplemental capital requirement that is yet to be adopted. This single step would do much to strengthen the resiliency of the largest banks, since even today they hold proportionately as little as half the capital of the regional banks. The Global Capital Index points out that tangible capital to asset levels of the largest firms average only 4 percent.
- The largest banking firms carry an enormous volume of derivatives. The law directs that such activities be conducted away from the safety net, and we are still in the process of completing what is referred to as the push-out rules.
- Bankruptcy laws have not been amended to address the use of long-term assets to secure highly volatile short-term wholesale funding. This contributes to a sizable moral hazard risk among banks and shadow banks, as these instruments give the impression of being a source of liquidity when, in fact, they are highly unstable. The response so far has required that we develop ever-more complicated bank liquidity rules, which are costly to implement and enforce, and leave other firms free to rely on such volatile funding.
- Fannie Mae and Freddie Mac continue to operate under government conservatorship, and as such they dominant home mortgage financing in the United States.
- Finally, among the more notable and difficult pieces of the unfinished business is the assignment to assure that the largest, most complicated banks can be resolved through bankruptcy in an orderly fashion and without public aid. Congress gave the Federal Reserve and the FDIC, and the relevant banking companies, a tough assignment under the Title 1 provisions of the Dodd-Frank Act to solve this problem. It requires making difficult decisions now, or the die will be cast and the largest banking firms will be assured an advantage that few competitors will successfully overcome1.
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