By Morgan Hickman LL.B., Queen’s University Belfast<\/p>\n\n\n\n
The Trump campaign called for an overhaul of the regulation of finance in the United States, variously demanding the repeal of the Dodd-Frank act, the reinstatement of the Glass-Steagall act and significant deregulative measures within regulators. The transition from campaign to administration, however, has exposed some of the puff: while there have been some deregulative measures, some of which are substantial, alongside the watering down of the Dodd-Frank act, it does not represent the cataclysmic gear shift the President\u2019s supporters hoped for and his detractors feared. Though there have been criticisms from both sides of the aisle with the Trump administration\u2019s regulatory agenda being both too flimsy and overzealous.<\/em><\/p>\n\n\n\n In order to understand the current debate,\na broad analysis of the proposals implemented thus far in the administration\nwill be outlined, before examining the perspectives of commentators, reflecting\nparticularly on how they engage in, and contribute to, the general discussion\nregarding deregulation of finance in the modern United States of America. It is\nanticipated that much of the debate will favour neither stricter regulation nor\nsubstantial deregulation, instead supporting a lateral shift through regulatory\nreform. Furthermore, the perception of policies will be coloured by the\nrhetoric of the President, leading many potential supporters of the\nadministration\u2019s agenda to be sceptical of both its efficacy and motives.<\/p>\n\n\n\n Prima\nfacie<\/em>, the Trump administration could easily be\ncharacterised as pursing a neoliberal agenda: slashing regulation to make way\nfor exploitation by big business, championing the role of the market in\nself-regulation and economic stability. However, rarely are matters so cut and\ndried, and it is contended that such a characterisation lacks nuance.<\/p>\n\n\n\n There have been four key areas of financial policy that have had\nsignificant regulatory attention: the application of Dodd-Frank to community\nbanks, non-bank regulation, capital requirements and proprietary trading. Each\nof these have either been subject to deregulative action by Congress or by\nregulators under the Trump administration. However, the President has also\nengaged in structural reform of the regulatory system through the use of\nexecutive orders, which will be considered as part of his regulatory agenda.<\/p>\n\n\n\n Congress recently passed the Economic\nGrowth, Regulatory Relief and Consumer Protection Act,[1]<\/a> which significantly impacts\nthe regulation of banks holding under USD 10bn of assets (\u2018community banks\u2019).\nThis reform provides greater freedom from the Basel III accords and the Volcker\nrule, subject to satisfying specific regulatory requirements; some commentators\nhave hailed this as a boost to the financial sector generally.[2]<\/a><\/p>\n\n\n\n Supporters of the relaxation of the\npost-crisis regulation expect that this will \u201cpush community banks to win back\ncredit market shares, help US SMEs and foster growth\u201d,[3]<\/a> Garatti also comments that\nshould these reforms allow community banks to return to their\npre-crisis\/Dodd-Frank share of the loan market (26.7%), it would liberate\napproximately USD 500bn of additional credit for US enterprise and consumers.[4]<\/a> The substantial increase\nin credit available would decrease the cost of capital for customers, thus\nboosting their capacity for borrowing (and therefore growth) while\nsimultaneously increasing the profitability of investments made by the banks.<\/p>\n\n\n\n However, both Subran and Garatti also\nnote that this would expose community banks to significantly higher risk, with\nSubran identifying that nearly 500 community banks have CRE assets that\nrepresent over 300% of their capital.[5]<\/a> Following the recent\nreforms, these banks may be able to depart from the Basel III requirement for\ncapital if their \u2018Community Bank Leverage Ratio\u2019 is above the 8\u201310% threshold.[6]<\/a> Due to the concentration\nof CRE, and agriculture, assets in these banks, they are exposed to\nfluctuations in those markets and have a high risk concentration. By relaxing\nthe regulation, this may lead to increased instability in these core markets.<\/p>\n\n\n\n Ultimately it is clear that community banks were collateral damage\nwhen the Dodd-Frank act was enacted, significantly and negatively effecting\ncredit availability in \u2018Smalltown, USA\u2019, thus unwinding of some of the\nDodd-Frank provisions was inevitable. While the risks associated with this\nreform are apparent, the current debate seems to support limited deregulation\nin order to stimulate economic growth.<\/p>\n\n\n\n Following the Great Recession, non-bank\ncredit providing institutions have been the focus of controversy. Voices from\ntraditional banks contend that overzealous regulation of finance creates the\nfertile soil for the growth of so-called \u2018shadow banks\u2019.[7]<\/a> This represents an\northodox perspective, which argues that, to avoid regulatory arbitrage,\nregulations that restrict the abilities of banks to offer (high risk) credit\nshould be relaxed. <\/p>\n\n\n\n Duca supports this perspective,\ncontending that empirical analysis demonstrates that, in particular, the\nrelative burden placed on bank credit versus non-bank credit is a key factor in\nthe reliance on shadow banking for short-term credit.[8]<\/a> Similarly, Calomiris\nprovides two examples that illustrate how the demand for shadow banking is\ncreated by strict regulation on bank credit: high risk credit card customers\nand those seeking leveraged loans for private equity deals are no longer\nprovided for by banks, however are still in need of a line of credit and\ntherefore naturally turn to non-bank credit providers.[9]<\/a><\/p>\n\n\n\n Conversely, Garatti adduces evidence of\na strong correlative relationship between deregulation and shadow banking (R2<\/sup>=0.90),[10]<\/a> contending that the\nderegulation of banks increases the capital generally available to financial\ninstitutions, thus increasing the attractiveness of lucrative opportunities\noffered by shadow banks.[11]<\/a><\/p>\n\n\n\n While not deregulation sensu stricto<\/em>, the Trump administration\nis utilising its influence within the Financial Stability Oversight Council\n(FSOC) to trigger significant change in the practice of regulating non-bank\ncredit. Specifically, the vote to withdraw the designation of Prudential as a\nnon-bank systemically important financial institution (SIFI).[12]<\/a> The SIFI designation is\nintended to bring non-bank institutions under the purview of Federal Reserve,\nbecoming subject to stress tests.[13]<\/a> While there has been no\nmove to withdraw the rules or repeal them, as there are no longer any\ninstitutions designated as SIFIs, this represents a de facto<\/em> deregulative act. This has been deemed a \u201cstep in the\nright direction for the asset management industry\u201d[14]<\/a> as SIFI designated\ncompanies find it very challenging to actively invest in the capital markets.[15]<\/a> However, critics are\nconcerned that the designation will fall into disuse until another non-bank\ndisplays a systemic issue, which would be too late for it to be used\neffectively.[16]<\/a><\/p>\n\n\n\n The actions of the regulators under the Trump administration clearly\nrepresent a relaxing of controls akin to deregulation. While it remains unclear\nwhether non-bank credit is inherently problematic, most commentators believe\nthat the risk can be found when a significant financial institution (bank or non-bank)\nbecomes leveraged in unregulated securities, it could pose a systemic risk. The\nFSOC was instituted as a guardrail to prevent non-banks becoming leveraged in\nthis way without regulatory oversight, thus many critics are concerned that the\nUS economy may now be exposed to an unhealthy level of risk.<\/p>\n\n\n\n The reduction of capital requirements\nthroughout the financial industry, another key regulatory project of the Trump\nadministration, has attracted controversy. The significant reform in this field\nhas been through decisions made by the regulators who have been installed under\nthis administration. These proposals will impact significantly the compliance\nrequired by the largest financial institutions. Regulators have been able to\naffect this change by modifying the calculation of the leverage ratio, with\ntrading desks exposed to a higher proportion of low risk instruments able to\nenjoy adjusted regulation.[17]<\/a><\/p>\n\n\n\n Some commentators have argued that, in\nreality, capital requirements do not effectively ensure solvency in periods of\nfinancial instability, with Calomiris citing the example of Citigroup, which\nhad a capital ratio of 12% (over 3 times the current regulatory requirement) at\nthe time of its collapse in 2008.[18]<\/a> He comments wryly that\nthe requirements imposed by the Dodd-Frank act ensure that \u201cevery bank will be\njust as safe and sound as Citi was in December 2008.\u201d[19]<\/a> Similarly, in the context\nof the repo market, an investigation by Allahrakha, Cetina and Munyan concludes\nthat \u201cthe leverage ratio as a risk-insensitive capital standard may encourage\nfirms to increase the risk profile of their remaining activities\u201d[20]<\/a>, which mirrors the\napproach being taken by the Federal Deposit Insurance Corporation and supports,\nat least limited, deregulation.<\/p>\n\n\n\n This perspective is not shared by\ncritics of deregulation, who contend that by taking this step, regulators will\nopen the door to another financial crisis,[21]<\/a> with yet others\ncommenting that this change undermines the core aims of both Basel III and\nDodd-Frank.[22]<\/a>\nSome economists are calling for a simple (i.e. fixed) book-value leverage of at\nleast 15% (nearly 4 times the current regulatory minimum), which they claim\nwould accelerate the rate of recovery, if not actually decrease the risk of\nanother financial crisis.[23]<\/a> However, other economists\nbelieve that a counter-cyclical framework for the regulation of the leverage\nratio is required,[24]<\/a> as this would moderate\nbank lending over the boom cycle and embolden banks on the downswing. This\napproach clearly conflicts with the recent FDIC policy and the general\nderegulative scheme being undertaken by the Trump administration. Calomiris,\nhaving criticised the principles underpinning the Dodd-Frank act, subsequently\nargues that the leverage calculation should be based on the ratio between the\nmarket value of equity and the market value of assets, contending that this\nrepresents the investors\u2019 perceptions of the institutions solvency more\naccurately than a ratio relying on book value;[25]<\/a> this could limit the\nability of institutions to influence their ratio by accounting, furthermore it\ncould be contended that it makes effective hedging crucial.<\/p>\n\n\n\n It is clear that no commentator is wholly happy with the status quo<\/em> and that some form of reform\nis necessary in the imminent future; the current debate turns on how and in\nwhich direction the regulatory shift should move. It is contended that, though\nsome academic and political opinion tends towards (limited) deregulation of the\ncapital requirement \u00ad\u2013 often through a return to risk based requirements \u2013 the\nmajority favours newer, more innovative regulation, with specific calls for\nmarket value leverage and counter-cyclically adjusted capital requirements. In\nthe round, the current perspective on deregulation is broadly negative in the\ncontext of capital requirements.<\/p>\n\n\n\n The separation of investment banking\nactivities (principally speculative proprietary trading) from retail banking,\nunder which deposits are backed by the lender of last resort, is not a scheme\nnovel in the 21st<\/sup> century. It was first implemented rigorously by\nthe 1930s Congress in the Glass-Steagall Act.[26]<\/a> However, the mechanism by\nwhich it is implemented and who is subjected to the restrictions has been\nsubject to significant debate. There has been significant deregulation\nchampioned by the Trump administration against the current incarnation of the\nprinciple in the \u2018Volcker rule\u2019.[27]<\/a><\/p>\n\n\n\n The recent Economic Growth, Regulatory\nRelief and Consumer Protection Act exempted community banks from the Volker\nRule. This comes at a time where, as identified by Bubb and Kahan, there is a\n\u201crare bipartisan consensus\u201d that \u201cthe Volcker rule must be pared back or even\nrepealed.\u201d[28]<\/a>\nClearly, it was under this auspice that Congress was able to pass the recent\nreforms. However, in the same vein, the FDIC recently voted to \u201csimplify and\ntailor the implementing regulations\u201d with a view to \u201cincrease efficiency,\nreduce excess demands\u2026and allow banking entities to more efficiently provide\nservices to clients\u201d.[29]<\/a><\/p>\n\n\n\n These changes clearly represent a\nregulatory perspective that wishes to support business activity, however has\ncome under significant criticism as a \u201cdangerous plan to carve up the Volcker\nrule\u201d, with Gelzinis stating that banks with access to federal deposit\ninsurance or the Federal Reserve\u2019s discount window should be barred from\nproprietary trading. He claims that the changes to the regulation will allow\nhigh-risk activity to take place \u201cunder the guise of risk-mitigating hedging\u201d.[30]<\/a> Other critics have\nlabelled this an example of regulatory capture,[31]<\/a> given the recent\nappointments by the Trump administration, which enables financial institutions\n\u201cto play casino again\u201d.[32]<\/a><\/p>\n\n\n\n On the other hand, commentators such\nas Blackwell contend that this is a mischaracterisation of the changes: these\nrepresent more of a \u201cstreamlining than a dramatic overhaul.\u201d[33]<\/a> Other critics support a\nradical change to the regulatory scheme, arguing that the Volcker rule is\nsimultaneously over- and under-effective,[34]<\/a> mischaracterisations of\ntrading activity by banks (deliberate or otherwise) means that they could still\nengage in prohibited trading,[35]<\/a> while another, cautious\nbank, may restrict the desirable, permitted activity in case it is mistaken for\nproprietary trading.[36]<\/a> There is force to this\nargument against the \u2018define-and-ban\u2019 approach to regulation in general and\nagainst the Volcker rule in particular.<\/p>\n\n\n\n There is significant appetite for a\nreform of the Volcker rule, with the general consensus being that it is not fit\nfor purpose. The lobby divides over the necessity of an outright ban on\nuniversal banking, however in general there is little support for a return to\nthe Gramm-Leach-Bliley Act era.<\/p>\n\n\n\n In terms of proprietary trading, as has\nbeen identified, calls for a strict division between investment and retail\nbanking has not disappeared since the repeal of the Glass-Steagall act in 1999.\nMost notably, the commitment to its return was found in the Trump campaign of\n2016.[37]<\/a> In the context of what is\nnow the Trump administration, a reinstatement of the Glass-Steagall act would\nrepresent a radical culture shift within the White House and a U-turn on the\nkey deregulatory and cost control measures the Federal Reserve, FDIC and Office\nof the Comptroller of Currency (OCC) have implemented over the first two years\nof the administration, outlined above.<\/p>\n\n\n\n In spite of the rhetoric of the Trump\ncampaign, it does not appear that this administration will oversee the return\nof the New Deal regulation; it appears that the new Glass-Steagall may more\nclosely resemble a two-tier regulatory system, introducing more flexibility for\nthose not guaranteed by the lender of last resort.[38]<\/a> However, the perception\nof heavy regulation sheds light on the foundations of some of the perspectives\non deregulation in the current debate.<\/p>\n\n\n\n In the round, and unsurprisingly,\nthere is little desire for a wholesale return to the strict Glass-Steagall\nrestrictions on the practice of banks.[39]<\/a> Furthermore, key critics\nof the legislation argue that it was not (and feasibly could never have been)\nfully enforced by the OCC due to the burden it would place upon the core\nbusiness of banks.[40]<\/a> As has been identified,\nattempts to permit only actions required for the core operations of banks are futile,\nand have led to the complexities and ineffectiveness of the Volcker rule.<\/p>\n\n\n\n Proposals for the return of the rule,\nor some near permutation of it, has found support from politicians and former\npolicy makers, arguing that the Volcker rule is needlessly complex and\nunder-ambitious, whereas the simplicity and aggressive approach of the\nGlass-Steagall act could resolve the issue.[41]<\/a> Other critics simply\nargue that the US did not experience a crisis like the Great Recession while\nthe Glass-Steagall act was in force, and that if it wasn\u2019t broken, there was no\nneed to change it.[42]<\/a> <\/p>\n\n\n\n In general, while the movement to bring back the Glass-Steagall act\nhas sustained itself since the repeal nearly 20 year ago, it has usually been a\nminority of fringe voices in support.[43]<\/a> The overwhelming majority\nrecognise that the financial system of the United States has moved on from the\n1930s, and as such the solutions to problems need to move on too.<\/p>\n\n\n\n The Trump administration has implemented\nthe key elements of regulatory reform either by congressional act or by\nappointments to key regulators which have subsequently advanced a regulatory\nagenda that mirrors that of the administration. These, alongside other\nstrategic moves to reform the culture of regulators such as deregulation task\nforces and regulatory reform officers, are familiar from the tools used in the\nReagan and Bush (41 and 43) administrations. However, the Trump administration\nhas also implemented an innovative technique in the form of the \u201ctwo-for-one\u201d executive\norder.[44]<\/a> Much like other aspects\nof the administrations agenda, this move has received heavy criticisms from\nacross the political and economic spectrum.<\/p>\n\n\n\n Those in support of deregulation have\nobjected to the mechanisms the administration has implemented on the basis that\nit \u201chardly counts as durable regulatory reform.\u201d[45]<\/a> This concern is founded\nin the fact that an executive order can be overturned by a successive president\nwithout any intervention of Congress.[46]<\/a> Batkins and Brannon have\ngiven the damning indictment of the attempts at deregulation by the\nadministration as \u201cpiecemeal, subject to intense litigation, and likely to be\nunwound by a progressive successor\u201d, challenging the fact that the\nadministration is not \u201cactually repealing swathes of regulations\u201d as many had\nhoped.[47]<\/a> Other critics have\npragmatically noted that the two-for-one scheme should not be expected to make\nmajor headway as regulators are not expected to pass much regulation under the\nTrump administration, thus rending the deregulative obligation moot.[48]<\/a> Stronger critics have\nclaimed that the mechanism for implementation was defective: in particular, by\nonly considering the bare costs the scheme fails to consider the net benefits\nof regulations to be repealed, thus leading to a substantially suboptimal\noutcome.[49]<\/a><\/p>\n\n\n\n The other key objection to the method\nfor regulatory reform is in relation to Executive Order 13777,[50]<\/a> specifically, criticising\nthe fact that many of the appointees or contributors to the taskforces given\nthe task of reviewing the efficacy of regulations have (or have had) deep\nindustry ties, thus increasing the risk of regulatory capture.[51]<\/a><\/p>\n\n\n\nTrump\u2019s Regulatory Agenda<\/h1>\n\n\n\n
Community Banks<\/h2>\n\n\n\n
Non-Bank Regulation<\/h2>\n\n\n\n
Capital Requirements<\/h2>\n\n\n\n
Proprietary Trading<\/h2>\n\n\n\n
The New Glass-Steagall<\/h2>\n\n\n\n
Structural Reforms<\/h2>\n\n\n\n