Why the principles of Dodd-Frank should not be neglected

Tony Ward

February 13, 2017

Tony Ward is chief executive of Clayton Euro Risk

My thoughts turn to the US this week, specifically the likely future of banking regulation.

On 3 February, US president Donald Trump (pictured) signed an executive order asking the US Treasury to conduct a review of America’s financial regulations, including the so-called Dodd-Frank Act.

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This piece of legislation was put in place following the 2007–8 global financial crisis; its aim, to stabilise and protect the banking system.

When enacted in 2010, Dodd-Frank was, as The Economist described it, ‘a monster of a law’.

It imposed more than five times as many restrictions as any other law passed by President Obama and his team.

In simple terms, its aim was to control the use of complicated financial instruments by institutions, increase the amount of money banks are required to hold to avoid tax-payer-funded bailouts and stop banks using their own money to invest in equity and debt products for profit (proprietary trading).

Dodd-Frank has its fair share of supporters, who maintain it makes the banking system more secure.

But it has also been attacked by many who suggest it is a piece of legislation that has gone too far, putting a stranglehold on banks, particularly smaller lenders.

And it’s those critics who seem to have momentum on their side; the president and his supporters have called it ‘a disaster’. So, change looks to be on the cards – but is this really a good thing?

Last week, Mario Draghi, president of the European Central Bank, attacked Donald Trump’s plans to relax rules on banks.

Mr Draghi said that any suggestion that the regime governing banks built up in the wake of the 2008 crisis should be dismantled was ‘very worrisome’.

In evidence to MEPs he said: “The last thing we want… is relaxation of regulation.” A slack regime, he argued, had been a key factor in allowing the crisis to take place.

Fair point.

Now, Sir Jon Cunliffe, the Bank of England’s deputy governor responsible for financial stability, has stepped into the fray.

He warned against relaxing banking regulation, saying it could damage the global economy.

“We’ve made very substantial progress since the financial crisis, increasing the resilience of the financial sector and increasing its ability to support the economy in times of stress,” said Sir Jon.

“Those changes were necessary. None of us want to see again the sort of events we saw between 2007 and 2009 and the costs of those events are still very clear.

“In order to have a resilient financial sector and consistent regulation internationally, we need international standards, we need the reforms we have had and it is important we preserve them.”

Sir Jon was careful to say that it was too early to judge what the outcome of the reform proposals instigated by President Trump would be.

However, he warned that as the UK’s financial services sector is very large – providing about 8% of the country’s economic output – high standards must be maintained.

“It is important we have proportionate, highest quality regulation – robust and in line with best international standards,” he said.

“In order to be a successful financial centre, you need good regulation, you need robust regulation and you need regulators that have credibility and experience.

“One doesn’t become successful as an international centre by having lax standards and by being open to crises and regulatory arbitrage [the use of regulatory loopholes to avoid banking costs].”

I feel uneasy about wholesale reform and agree with the views expressed by Sir Jon.

It is certainly true to say that measures to shore up banks’ equity funding have made America’s financial system more secure.

The six largest bank-holding companies in the US had equity funding of less than 8% in 2007; since 2010 that figure has stood at 12–14%. While one wants a regulatory system that is fair for all, one certainly doesn’t want to return to the excesses of the early 2000s.

A relaxation of capital requirements, to my mind, would not be a good thing.

Simplification must not come at the price of security.

Dodd-Frank was a milestone along the road to recovery, so let’s not dismantle it only to find we’re on a different road – one that looks worryingly familiar.

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