In response to Executive Order 13772, on June 14, 2017 Treasury Secretary Steven Mnuchin published a report identifying recommendations for changes to the regulation of the U.S. financial system in a manner consistent with the Executive Order's "core principles." Some of the “core principles” laid out in the executive order are addressed in bills currently being debated in Congress. The report takes up some of these same issues, but with slightly different approaches than those proposed by legislators.
Given the size and complexity of the U.S. financial system and the more generalized nature of the principles expressed in EO 13772, the Treasury Department divides its review into several different reports:
- The depository system, covering banks, savings associations, and credit unions of all sizes, types and regulatory charters;
- Capital markets: debt, equity, commodities and derivatives markets, central clearing and other operational functions;
- The asset management and insurance industries, and retail and institutional investment products and vehicles; and
- Non-bank financial institutions, financial technology, and financial innovation.
The publication is the first in a series of reports planned by the Treasury Department. This report focuses on the depository system. covering areas like:
- Capital and liquidity;
- Community financial institutions;
- Regulatory engagement;
- Living wills;
- Foreign banking organizations;
- The Volcker Rule;
- The Consumer Financial Protection Bureau;
- Residential mortgage lending;
- Leveraged lending; and
- Small business lending.
Capital Reserves and Liquidity
While noting that banks are better capitalized at this point than they were prior to the crisis, the Treasury report cautions that overly stringent capital requirements may tend to inhibit economic growth.
"Capital and liquidity requirements must work together in providing a cushion against potential losses and providing adequate funding to reduce the risk of insolvency during periods of distress. Conversely, an excess of capital and liquidity in the banking system will detract from the flow of consumer and commercial credit and can inhibit economic growth."
The report still advocates both capital reserves and liquidity limits as necessary to avert catastrophic losses and insolvencies during times of market stress. However, the report recommends that these standards be altered to:
- take into consideration the size and complexity of financial institutions;
- reduce the burdens and costs of regulations;
- increase transparency; and
- foster “regulatory coherence.”
Leverage Ratios
Notably, the Treasury report warns of over-reliance on hard leverage ratios like the Leverage Ratio in Dodd-Frank and the similar ratio which is the centerpiece of the Financial Choice Act recently passed by the House of Representatives. According to the report’s authors, placing too much reliance on the leverage ratios can encourage risky behavior by banks rather than reduce it because a high leverage ratio environment could make central clearing economically unfeasible and drive such firms out of the business.
"The leverage ratio imposes significant capital requirements on initial margin, which is collected to reduce risk on centrally cleared exposures. Because of the low-margin and high-volume nature of the business of providing clients access to central clearing, high leverage ratio capital charges discourage firms from providing such services.”
Volcker Rule
Unlike the CHOICE Act which would repeal the Volcker Rule, Treasury proposes keeping the rule but adding some refinements and exceptions for lower risk banks.
- Exempting smaller firms entirely;
- Exempting banks with less than $10 billion in consolidated assets;
- Creating an exemption for firms with $10 billion in assets that have less than $1 billion in trading assets representing no greater than 10 percent of total assets.
Accord with Congress
There is more accord with the approaches being debated by legislators in other areas. On such area is increasing the rigor of required cost-benefit analysis by regulators. The report recommends more stringent and consistent cost-benefit analyses be performed by agencies like the SEC and CFTC before issuing regulations. This approach agrees with the Financial CHOICE Act and three other bills passed by the House recently. [1] Also in relative agreement with the CHOICE Act, the Treasury report recommends curtailing the powers of the Consumer Financial Protection Bureau, as well as limiting some of the discretion afforded to the CFTC and SEC in certain instances. There is also broad agreement in limiting regulatory complexity, lifting regulatory burdens on smaller financial institutions, as well as changes in the frequency, scope, and administration of bank stress tests.
International Standards
The report notes that the U.S. often has adopted standards that are more stringent than those proposed by the Basel Committee another international standard setting organizations making U.S. banks less competitively globally. The report recommends that U.S. regulators revisit regulatory requirements based on international standards and recalibrate and tailor them better to the U.S. market, taking into consideration international competitiveness. Treasury also recommends that the U.S. representatives to the G20, FSB, IOSCO, etc. “advocate for [the U.S.] financial regulatory agenda. . . and influence the international standard-setting process.”
The full Treasury report is available at:
http://business.cch.com/srd/OpportunitiesandChallengesinOnlineMarketplaceLending-061317.pdf
[1] Regulatory Accountability Act of 2017 (H.R. 5), Section 202 of the Commodity End-User Relief Act (H.R. 238) , and the SEC Regulatory Accountability Act (H.R. 78).