Academic journal article Chicago Fed Letter

Implementing Financial Reform Regulations from the Dodd-Frank Act and Basel III

Academic journal article Chicago Fed Letter

Implementing Financial Reform Regulations from the Dodd-Frank Act and Basel III

Article excerpt

The Chicago Fed's 47th annual Conference on Bank Structure and Competition, which took place May 4-6, 2011, focused on the implementation of new regulations mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA) and proposed by the Basel Committee on Banking Supervision (BCBS) in its Basel III framework.

This Chicago Fed Letter summarizes two key panels from this year's Bank Structure Conference-one on the DFA's implementation and the other on the Basel III liquidity rules and regulations.

Implementing Dodd-Frank

The DFA panel featured Wayne Abernathy, American Bankers Association (ABA); Mark Van Der Weide, Board of Governors of the Federal Reserve System; Scott O'Malia, U.S. Commodity Futures Trading Commission (CFTC); Richard Berner, U.S. Treasury Department; and Matthew Richardson, New York University.

Abernathy reviewed the progress made toward implementing the DFA from the perspective of the ABA. He acknowledged that the DFA rulemaking process is an unprecedented challenge, but questioned the slow implementation pace. In 2011:Q2, regulators missed all 26 implementation deadlines for rulemaking, bringing the total missed to 30. Abernathy stressed that regulators need to walk a fine line: Although the speed of implementation is important, it should not inhibit the transparency and clarity of the rulemaking process. He also emphasized the need to simplify regulatory processes by getting rid of previous rules now covered by the DFA. Eliminating redundant rules, he argued, would lead to reduced costs and greater innovation, which would benefit consumers.

Abernathy also discussed DFA policies that focus on managing the risks associated with systemically important financial institutions (SIFIs) . The DFA provides regulators with the authority to close SIFIs in an organized, structured manner, which the ABA strongly supports. However, the DFA also provides regulators with the authority to keep SIFIs open. Abernathy argued that such regulatory powers might exacerbate the use of too-systemic-to-fail (TSTF) policies and place SIFIs at a distinct competitive advantage. He noted that historically, unsecured creditors of failed banks resolved by the Federal Deposit Insurance Corporation (FDIC) lost 20 or more cents on the dollar. In contrast, the FDIC recently calculated that had the resolution authority in the DFA been in place when Lehman Brothers failed in 2008, its unsecured creditors would have only lost 3 cents on the dollar.1 With the DFA now in effect, investors will respond accordingly and provide SIFIs with a distinct funding advantage-calculated to be nearly 80 basis points on uninsured debt instruments in today's environment.2 Overall, Abernathy said that the DFA places smaller institutions at a competitive disadvantage and institutionalizes TSTF.

Van Der Weide highlighted some of the core reforms mandated by the DFA One of the major components of the DFA is the creation of the Financial Stability Oversight Council (FSOC), which is in charge of identifying and mitigating systemic risk. A key task of the FSOC is to identify SIFIs, which will then be subject to the supervision of the Federal Reserve. The DFA mandates all bank holding companies (BHCs) with over $50 billion in assets be designated as SIFIs. In addition, the FSOC is in the process of finalizing the criteria for designating nonbanks as SIFIs. The criteria for such designation include the institution's size, degree of interconnectedness (to other institutions), lack of substitutes, and leverage, as well as the extent to which the institution is currently regulated. Van Der Weide emphasized that significant effort was being spent to determine the relative weight of each factor. Although the weights had yet to be determined, he said he was optimistic that, with time, the FSOC would disclose more of its SIFI criteria, increasing the predictability of its designation decisions.

Once the process of identifying SIFI status is established, the DFA requires the Fed to develop and impose enhanced regulation (capital requirements, liquidity requirements, etc. …

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