The United States wants to relax the strict rules which were laid down for banks after the financial crisis, a move that has many people pretty upset.
No wonder – after all, wrongdoing in the industry led to hardship and misery for people the world over. It would be fatal to hastily dismantle Dodd-Frank, the comprehensive law regulating banks.
The good news is that might not happen. It looks as though we can expect a more rational policy for bank regulation than for other areas like immigration. That's partly because banks played a lesser role in Donald Trump’s election campaign than the supposed dangers presented by Muslims and Mexicans.
And that is a good thing, because the decision about Dodd-Frank will need time. For starters, it's important to ask the right questions, like what really causes risks in the financial system and what makes it more secure?
Analyst Chris Whalen of the rating agency KBRA pointed out that a key thing is to prevent hidden debt, for example in separate, special-purpose entities or in funds which are refinanced by banks.
On principle, it's better to locate risks where losses cannot lead to bankruptcy, in funds rather than on banks’ balance sheets. That suggests it would be worth hanging on to parts of the Volcker Rule, which stops banks from engaging in risky business.
It should also be said that the more transparency there is, and the simpler structures are, the better it is. It makes sense to clearly separate different business sectors within financial companies and for companies to be built in a modular way. The future treasury secretary Steve Mnuchin seems to be thinking that way, which is a source of hope.
On the other hand, nobody seems to be asking a question posed by the former head of the Fed, Paul Volcker, years ago, namely shouldn’t the financial supervisory body itself be reformed so it isn't just a handful of independent organizations with overlapping functions? This question needs to be discussed.
U.S. President Donald Trump has tasked Gary Cohn and Steve Mnuchin with deregulation. Both men are from the financial industry, or to be more precise, from Goldman Sachs. As a matter of principle, of course it's wrong for an industry to put its own people in government as regulators. But in this case, it may be the lesser evil as, firstly, both have made pragmatic comments and secondly, the industry is less eager to tear up the legislation than the Republicans are.
That seems surprising, but the banks mainly want one thing, namely to be left in peace and not have to reorganize everything again. They have no interest in toning down the high capital and liquidity standards which were created following the financial crisis. These standards give them security and a lead over international competitors. The big financial companies also want the U.S. to coordinate these issues with other countries so they aren't stuck facing different rules worldwide.
These concerns are reflected in statements made by Mr. Cohn and Mr. Mnuchin, that suggest capital and liquidity standards aren't up for reconsideration. That might well help in discussing these issues with Europeans – after all we shouldn't forget that Americans have been stricter in these questions than Europeans.
On the other hand, the Americans want to revise or cancel all rules that involve a great deal of work but doubtful benefits, including the Volcker Rule, which creates complicated problems of definition in practice and is partly based on poor risk analyses.
They also want to abolish the living wills which are supposed to enable banks in difficulty to be wound down without money from the state. Experienced bankers never really believed this would work in the case of a financial crisis.
The problem is that many members of the Republican Party tend to view these as ideological questions, seeing Dodd-Frank as bad because it was created by Mr. Trump’s predecessor Barack Obama. They think anything stopping American business people from getting credit is a barrier too many.
Right now, it's party ideologists who are calling the shots on issues. But there's hope that well-informed pragmatists will carry the day with bank regulation. If that's the case, deregulation wouldn't necessarily mean greater instability in the banking world.
To contact the author: [email protected]