Banking’s Appalling Regulatory Structure

By Edward Yingling

As president of ABA during the financial crisis, I testified before Congress and appeared on TV on numerous occasions, during which I protested the overkill of the bill that became Dodd-Frank. At one point, I decided we needed to have a number for the pages of regulations that would result from Dodd-Frank. ABA’s economists produced an estimate of 10,000 pages of new regulations for a community bank. I was not sure anyone would believe it, but we went with it. In fact, the estimate was too low.

Certainly some of the reforms in Dodd-Frank were needed, but the massive overkill is both slowing economic growth and gradually driving many community banks to sell out. Therefore, it is not surprising that much of the industry focus in recent years has been on the avalanche of new regulations resulting from the financial crisis. The banking industry has been busy working on hundreds of proposed rules and trying to convince Congress to make some reasonable changes to Dodd-Frank and Basel III.

Unfortunately, the wave of regulations continues to grow, and addressing it must continue to be the top priority. However, it is not too early to begin the debate on the other aspect of regulation that will hurt our economy in the long run just as much and, in my opinion, slowly but surely force the banking industry into an untenable competitive position. Simply put, it is not just the number of regulations applied to banks, it is also the regulatory structure applied to banks that is draining the industry’s economic vitality.

As I have said before, no one in his or her right mind would design the complex regulatory structure we have today. Of course, banks are regulated by the Federal Reserve, the OCC, the FDIC and state bank regulators. It is not unusual for even a fairly small bank to have three of these agencies directly involved in its supervision. But the industry dealt with that pretty well until everything else was piled on.

We must now add the CFPB, which writes numerous rules affecting all banks, examines those with assets of more than $10 billion, and has the authority to go after smaller banks if it wants. And we have not begun to see what a fully staffed CFPB will do.

But, of course, at the federal level, there are many more agencies regulating banks in some fashion—FinCen, the SEC, the CFTC, FSOC, HUD, FHFA, the Labor Department and others.

Beyond the federal and state bank regulators, we also have aggressive attorneys general and areas where banks can be subject to class actions and other private rights of action, many of which can only be described as abusive—for example, the suits over missing (often torn off) disclosures on ATM machines. We have not yet seen the full extent to which Dodd-Frank enabled attorneys general and class action lawyers to go after banks.

Finally, we also have a de facto set of international regulators—the Basel Committee and the Financial Stability Board—whose pronouncements are eventually imposed on U.S. banks, in many cases on community banks.

I had the dubious privilege of being the only industry witness in the first two congressional hearings on the creation of the CFPB. I testified at length about the certainty that banks would be caught in conflicts between the new consumer regulator and their prudential regulators. One example I used was check hold periods, which the CFPB could require banks to shorten, while the prudential regulator could oppose such shortening because it would increase fraud.

While this problem of conflicting regulators—under which banks are told to do two conflicting things or, almost as bad, cannot get a definite answer on what to do—will grow, it is not the biggest problem; the biggest problem now, which I have seen often as counsel to banks, is piling on—more than one regulator working on the same issue. The primary example of this is in consumer regulation, where the prudential regulators continue to be deeply involved under the theory of “reputational risk” to safety and soundness. The result is prolonged and costly legal negotiations with multiple regulators, a ratcheting up of penalties, and multiple penalties for the same offense.

A third issue with the multiplicity of regulators is that often it is never over. A bank cannot be sure, even if it has reached an agreement with a group of regulators, that there will not be another regulator, attorney general or class action lawyer coming after it on basically the same issue.

A fourth issue is less obvious: uncertainty. For example, if a bank cannot be sure what the regulation is, or potential liabilities may be, for a new product, it is less likely to offer the product. Or it will only offer the product in super safe fashion, as we have seen in the mortgage market. There will be fewer loans, and innovation will be inhibited.

A fifth issue is cost. To a large degree, banks are paying the cost of this redundancy, and the cost can be expected to grow considerably.

Finally, the current system, together with regulatory implementation costs, will cause more community banks to sell out. Bank boards cannot be sure, no matter how carefully they oversee their bank, that from somewhere out of the blue they will not be hit with a devastating legal or regulatory cost.

Some critics will say that, given the impact of the financial crisis, this layering on regulators is a good thing. But in the long run, the multiple layers and, importantly, unclear responsibilities are a recipe for unfocused and, ultimately, failed regulation. The current system is also clearly driving business from banks to the less-regulated non-bank sector.

While it may be too soon to decide what regulatory structure should be, it is not too soon to begin the discussion of the need for one. Any change will take years to accomplish, but for now, the important thing is to develop a consensus on the need for change.

Regulatory structure reform will involve tough questions and is not without risk. Consolidation for consolidation’s stake is not the answer. Goals for good regulation should be articulated, and only then we should move on to how best to achieve them. I would suggest those goals should be: a strong, competitive banking system to support the economy; safety and soundness; consumer protection; preventing the use of the banks for illicit activities; and eliminating too-big-to-fail. Importantly, we should protect the dual banking system and guard against the type of regulatory consolidation that could stifle innovation in the industry and exacerbate the one-size-fits-all approach that is causing so much trouble today.

The current regulatory structure is completely unworkable and will only get worse. It will slowly crush our industry. We need a less complex structure where responsibilities are clear. The discussion should start now.

Edward Yingling is senior counsel at Covington and Burling and a former president and CEO of ABA.