Aashrit Cunchala

May 23, 2023

With the latest bank collapse, questions are once again swirling regarding banking protection. After the 2008 crisis and the fall of Lehman Brothers, many assumed that the banking industry would be protected from a future meltdown. As recent events with Silicon Valley Bank (SVB) and Credit Suisse have shown, that is not the case. With that in mind, it is important to see how we got here so that we can learn how to change for the future.

The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law in 2010 in response to the financial crisis of 2008. The act aimed to reform the financial system, promote stability, and protect consumers from abusive financial practices. However, nearly a decade after its enactment, the effectiveness of Dodd-Frank in regulating banks is still up for debate. Some experts argue that Dodd-Frank has failed to successfully regulate banks and prevent another financial crisis [2]. This article will examine the failures of Dodd-Frank in regulating banks and explore potential reforms to improve the effectiveness of financial regulation.

One of the main criticisms of Dodd-Frank is that it has failed to address the problem of “too big to fail” banks. These are banks that are considered so large and interconnected that their failure could have devastating consequences for the financial system. The act attempted to address this issue by creating a framework for resolving failing banks without taxpayer bailouts. However, critics argue that the framework is flawed and would not be effective in preventing another financial crisis. For example, the Act created the Orderly Liquidation Authority (OLA), which allows the government to take over and liquidate a failing bank in an orderly manner. However, critics argue that the OLA is too complex and would not work in practice. They argue that the government is unlikely to be able to successfully liquidate a failing bank without causing disruption to the financial system. In the recent failure of SVB, the OLA was not even used due to the government’s negligence. While the OLA “permits the FDIC [Federal Deposit Insurance Corporation] to seize the resources of the failing bank’s parent holding company and use them to support the failing bank’s operation” and was specifically designed to prevent this issue, it wasn’t used. The reason for this was that using the OLA triggers a change in the company’s proprietary rights. In the case of SVB, the parent company of SVB Capital is still open and the government did not want to take over the company [4].

In addition, the act significantly beefed up the Financial Stability Oversight Council (FSOC), which is responsible for identifying and monitoring systemic risks to the financial system. However, critics argue that the FSOC has not been effective in identifying and mitigating systemic risks. For example, Lehman Brothers, which was a key player in the 2008 financial crisis, was not considered a systemic risk by the FSOC prior to its collapse. This was primarily due to the Moody’s ratings not actually being accurate which led to major issues for Bear Stearns and Lehman. For those unfamiliar with them, Moody’s ratings are “opinions of the relative credit risk of financial obligations with an original maturity of one year or more” [6]. In simple terms, they tell you how stable long-term securities and investments are. In the SVB failure, regulators at the FSOC knew of SVB’s issues and took no action. This shocking dereliction of duty is devastating to the overall health of the system [7].

Another criticism of Dodd-Frank is that it has not been effective in promoting transparency and accountability in the financial system. The act created the Consumer Financial Protection Bureau (CFPB) to protect consumers from abusive financial practices. However, critics argue that the CFPB has been too aggressive in its enforcement actions and has imposed overly burdensome regulations on the financial industry.

For example, the CFPB has imposed strict rules on the mortgage industry, which critics argue have made it more difficult for consumers to obtain loans. In addition, the CFPB has been accused of operating without sufficient oversight and accountability. Critics argue that the agency is too powerful and lacks transparency in its operations.

Furthermore, Dodd-Frank has failed to address some of the root causes of the 2008 financial crisis. One of the main repercussions of the crisis was the excessive risk-taking by banks, particularly in the mortgage market. Critics argue that Dodd-Frank has not done enough to address this issue and that banks are still engaging in risky behavior.

For example, some banks are still engaging in high-risk lending practices, such as subprime lending, which was a key contributor to the 2008 financial crisis. Critics argue that Dodd-Frank has not done enough to address these risky lending practices and that it has not provided sufficient incentives for banks to engage in safer lending practices.

One of the primary criticisms of Dodd-Frank is its complexity. The act created a web of regulations and regulatory bodies that are often overlapping and confusing. A common refrain from politician, SEC (Securities and Exchanges Commission) officials, and members of the financial industry is that this complexity has made it difficult for banks to comply with the regulations and has even led to unintended consequences, such as the consolidation of the banking industry.

To address this issue, some have proposed simplifying the regulatory framework. This could involve consolidating regulatory agencies or streamlining the regulatory process. For example, some have proposed combining the Commodity Futures Trading Commission and the Securities and Exchange Commission into a single agency, which would have the authority to c both the futures and securities markets.

Another issue that has been raised with Dodd-Frank is the burden it places on smaller banks. The act includes provisions that were designed to regulate larger banks, but many community banks have found themselves subject to the same regulations. Critics argue that this has led to a disproportionate burden on smaller banks, which has limited their ability to lend to their local communities.

To address this issue, some have proposed providing regulatory relief for community banks. This could involve exempting smaller banks from certain regulations or reducing the regulatory burden in other ways. For example, the Economic Growth, Regulatory Relief, and Consumer Protection Act, which was signed into law in 2018, provided some relief for community banks by exempting banks with less than $10 billion in assets from certain regulations. The issue of bank consolidation is of primary importance to regulators because of the potential dangers in the industry. Banks that consolidate can often take on billions and even trillions of dollars in assets and liabilities (J.P. Morgan is at over $3 trillion right now) which means that their failure can lead to the entire economy falling apart. If you’ve ever heard the phrase “too big to fail” it comes from these investment banks. These banks often have large numbers of assets because customers remain unconvinced that their money is safe in smaller banks and so these bills are meant to stimulate investment in smaller banks. The hope is that this will allow the banking industry to remain diversified.

Another issue with Dodd-Frank is the lack of accountability for regulatory agencies. Critics argue that the act has created a situation where agencies can regulate the banking industry without being held accountable for their actions. This has led to concerns about regulatory overreach and has made it difficult for banks to understand what is expected of them.

To address this issue, some have proposed increasing accountability for regulatory agencies. This could involve creating more oversight mechanisms or requiring agencies to justify their actions more explicitly. For example, some have proposed creating a bipartisan commission to oversee financial regulations, which would have the authority to review and modify regulations as needed.

One of the primary goals of Dodd-Frank was to address systemic risk within the banking industry. However, critics argue that the act has failed to do so effectively. In particular, some argue that the act has focused too much on regulating individual banks rather than addressing broader systemic issues.

In order to tackle the problem, some have proposed a more systemic approach to regulation. This could involve focusing on issues such as liquidity risk and interconnectedness, which can contribute to systemic risk. For example, some have proposed requiring banks to hold more liquid assets or developing new regulations to address the risks posed by financial technology companies.

Another possible reform to Dodd-Frank is to re-evaluate the use of stress tests. Stress tests were introduced as a key component of the Dodd-Frank reforms, with the aim of ensuring that banks have sufficient capital to withstand severe economic shocks. However, the stress tests have been criticized for being too predictable and not reflecting the full range of possible economic scenarios. In addition, the tests are resource-intensive and may be less effective than other measures in promoting financial stability.

One possible reform is to increase the transparency of stress tests. Regulators could provide more information about the scenarios being tested and the assumptions underlying the tests. This would help to increase market confidence in the resilience of the banking system and enable stakeholders to make more informed decisions.

Another possible reform is to expand the scope of stress tests. Currently, stress tests focus primarily on the largest banks and do not include smaller banks and non-bank financial institutions. Expanding the scope of stress tests could help to identify potential risks in the broader financial system and promote greater financial stability.

Finally, some analysts have proposed more radical reforms to Dodd-Frank, including the introduction of a system of universal banking. Under a universal banking system, banks would be required to hold a minimum level of capital, regardless of their size or risk profile. This would help to ensure a level playing field and reduce the potential for regulatory arbitrage.

The Dodd-Frank Act was introduced after the 2008 financial crisis to promote financial stability and protect the economy from systemic risk. While the act has made some progress in achieving these goals, it has also been criticized for being overly complex and burdensome for smaller banks.

Possible reforms to Dodd-Frank include simplifying regulations, increasing transparency, reducing regulatory overlap, and re-evaluating the use of stress tests. These reforms could help to promote financial stability and reduce the potential for future financial crises.

It is important to remember that banking regulation is an ongoing process, and reforms need to be regularly reviewed and updated to ensure that they remain effective in the face of changing economic conditions. By continuing to monitor the banking system and implementing effective regulatory reforms, policymakers can help to prevent future financial crises and protect the economy from systemic risk.

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Works Cited

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[1] Barone, Michael. Washingtonexaminer.com, https://www.washingtonexaminer.com/opinion/the-failure-of-dodd-frank. Accessed 16 Apr. 2023.

[2] Coffee, John C., Jr. “Has Dodd-Frank Worked?” Hbr.org, https://hbr.org/2018/07/has-dodd-frank-worked. Accessed 16 Apr. 2023.

[3] Epstein, Richard A. “The Failures of Dodd-Frank.” Hoover.org, https://www.hoover.org/research/failures-dodd-frank. Accessed 16 Apr. 2023.

[4] Kupiec, Paul. “Why Did Regulators Ignore Dodd-Frank and Orderly Liquidation for Failed Banks?” The Hill, The Hill, 16 Mar. 2023, https://thehill.com/opinion/finance/3903231-why-did-regulators-ignore-dodd-frank-and-orderly-liquidation-for-failed-banks/.

[5] McGrane, Victoria. “”Dodd-Frank Hasn’t Fixed Financial System, Critics Say.” Wsj.com, https://www.wsj.com/articles/dodd-frank-hasnt-fixed-financial-system-critics-say-1507839000. Accessed 16 Apr. 2023.

[6] “Moody’s Investors Service / Understanding Ratings.” Moodys.Io, https://ratings.moodys.io/ratings. Accessed 16 Apr. 2023.

[7] Sirota, David. “Document Shows Regulators Knew of SVB Risk Five Years Ago.” The Lever, 20 Mar. 2023, https://www.levernews.com/document-shows-regulators-knew-of-svb-risk-five-years-ago/.

[8 ]Wallison, Peter J. “Dodd-Frank after Five Years: Are We More Stable?” Aei.org, https://www.aei.org/research-products/report/dodd-frank-after-five-years-are-we-more-stable/. Accessed 16 Apr. 2023.