Comments on Regulation Based on Risk

The Dodd-Frank Act adopted a blunt approach to define systemically risky banks, using a $50 billion asset threshold to identify risk, even though many banks above that level carry very little threat to the stability of the financial system (the definition of systemic risk). Policy makers ranging from congressional leaders, regulatory officials to even the authors of Dodd-Frank have suggested the threshold should be revisited.

Barney Frank

Dodd-Frank co-author and Former House Financial Services Committee Chairman Barney Frank has suggested the $50 billion threshold should be revisited by Congress, saying in 2014, “We should look at that $50 billion again… We never thought $50 billion was a forever number.”

In 2016, he also called the $50 billion number a “mistake” and said, “When it comes to lending and job creation, the regional banks are obviously very, very important. I hope that if we get some regulatory changes, we give some regulatory relaxation to those banks.”

In 2017, he said, ““All numbers are arbitrary, and in the rush, $50 billion seemed like a much bigger number.”

Ben Bernanke

Former Federal Reserve Board Chairman Ben Bernanke responded to a question about the threshold by noting that “I would have to say also it’s not just size… And I think it has to do also with opacity, complexity, interconnectedness, and a variety of other things. So, it’s harder than just saying — you know, putting a size limit or something like that.”

Janet Yellen

Federal Reserve Chair Janet Yellen she testified before the House Financial Services Committee to a similar point: relying on asset size only was not the best way to measure a bank’s systemic importance, noting that the Fed is working “to tailor our regulations even with the $50 billion and above category,” Yellen said.

Daniel Tarullo

In 2011, Daniel Tarullo, the Federal Reserve governor in charge of financial regulation said, “By setting the threshold for these standards at firms with assets of at least $50 billion, well below the level that anyone would believe describes a ‘too big to fail’ firm, Congress has avoided the creation of a de facto list of too big to fail firms.” More recently, Tarullo suggested that there should be a vigorous debate about how to create a more finely calibrated regulatory structure that recognizes business model differences, not just asset thresholds, in setting macro-prudential regulatory standards.

Jerome Powell

“We should continue to tailor our requirements to the size, risk, and complexity of the firms subject to those requirements… we should assess whether we can adjust regulation in common-sense ways that will simplify rules and reduce unnecessary regulatory burden without compromising safety and soundness.”

Senator Sherrod Brown

“[Dodd-Frank] directed regulators not to take a one-size-fits all approach, so that a $50 billion bank would not be treated the same way as a $2 trillion bank… The failure of one regional bank, assuming it is following a traditional model, will not threaten the entire system.”

Steven Mnuchin

“I believe that banks that have FDIC insurance should be appropriately regulated. However, I believe in a regulatory framework that is determined by complexity and activity, not simply size,” wrote the nominee for Treasury Secretary to Congress.

Senator Mike Crapo

“[Rules] should be properly tailored and avoid a one-size fits all approach… My goal is to work with senators of this committee and financial regulators to better strike the balance between smart, thoughtful regulation and promoting economic growth.”

Tom Curry

Comptroller of the Currency Tom Curry has questioned the utility of the $50 billion “bright line,” suggesting a more sensible approach would be to “use an asset figure as a first screen and give discretion to the supervisors based on the risks in their business plan and operations.”

Congressman Blaine Luetkemeyer

Representative Blaine Luetkemeyer explained his legislation to change the $50 billion threshold to one based on risk saying, “Practically all the regional banks are basically just big community banks that don’t play in the risky world” of the biggest Wall Street banks. “Why should they be penalized?”

Thomas Hoenig

In an op-ed, the Vice Chairman of the FDIC wrote, “As I’ve long advocated, regulation should focus on the business model rather than arbitrary asset-size thresholds, and the distinct differences between commercial and universal banks, as illustrated by their financial footprint, call for such an approach… A principle advantage of this activities-based approach is that it would eliminate the need for the asset-size thresholds. Regulatory requirements that are determined by size rather than activity have the effect of further encouraging consolidation and pressuring the larger regional commercial banks to adopt the universal bank model as they seek to most efficiently absorb related supervisory costs. Even if the current thresholds are raised as part of the regulatory reform effort, they will quickly become obsolete and this trend will continue.”

Patrick Harker

“It’s less about size, and it’s more about the risk you present to the system,” the Federal Reserve Bank of Philadelphia president said.

Senator Patrick Toomey

“In my view, there is nothing magic about a $50 billion threshold, above which we ought to automatically assume every institution is systemically important and significant and dangerous. That threshold gives no consideration to the activity of the bank… Subjecting financial institutions that are not in fact systemically risky to these very onerous regulations imposes a real cost… At the end of the day, it means credit is less available and less affordable for American consumers and businesses.”

Robert Kaplan

“I do believe that we would be well served in the United States to segment regulatory regimes and do greater tailoring for small and midsized banks, who I don’t think pose a systemic risk, are very critical to lending in their communities and to business formation,” the Federal Reserve Bank of Dallas President said.

Paul Kupiec

Paul Kupiec, a resident scholar at the conservative American Enterprise Institute, recently testified, “the $50 billion threshold set for enhanced prudential standards … has erred on the side of excessive caution.” Kupiec observed, “There is no science evidence that supports a threshold of $50 billion for subjecting bank holding companies to heightened prudential standards.”

Senator Mark Warner

“We all agree that $50 billion is probably the wrong number… I think it’s less about asset size and more about business product size.”

Congresswoman Carolyn Maloney

“I am sympathetic to the concerns that some regional banks have expressed about the enhanced regulations not being properly tailored to their business model, which are very different from the largest banks.”

Financial Services Roundtable

The group’s Tim Pawlenty said in a comment, “Assessing an institution through various factors, as opposed to asset size only, will allow for a more comprehensive assessment of risk to the overall financial system. H.R. 6392 advances that goal and it will lead to more effective regulations while also allowing financial institutions to help grow the economy and serve both consumers and businesses better.”

Eugene Ludwig

Former Comptroller of the Currency Ludwig said, “We have to do more to support community development financial institutions and other community and regional banks. These banks can make a huge difference in the lives of middle- and lower-income Americans and small businesses. While efforts have been made to rectify the situation, right now we continue to overburden these institutions with needlessly complex and overly intrusive regulation.”

The U.S. Department of Treasury Office of Financial Research

The U.S. Department of Treasury Office of Financial Research, in its Brief Series 15-01 that examines the systemic risk of the largest U.S. banks, uses risk criteria of size, interconnectedness, complexity, global activity, and dominance in certain customer services (substitutability). The study concluded that JP Morgan Chase has a systemic risk score of 5.05 percent and Citigroup a score of 4.27 percent. None of the regional banks listed in the report have systemic risk scores exceeding 0.35 percent, mainly because the business model that regional banks operate is one of traditional lenders.

Instead of the one-size-fits-all regulatory method favored by AFR, a more thoughtful, analytical approach would make for a safer and sounder financial system while freeing billions of capital for investment in good-paying American jobs. In some cases, regulators have some ability to lift thresholds but it has proved a cumbersome process. Congress needs to reexamine the definition of systemic in order to focus regulators on preventing a repetition of the 2008 financial crisis and to assure that more traditional banks are able to help local communities grow their economies.