Introduction

Square-Off: Are Financial Institutions Overregulated?

We ask this question because it matters, not just to banks but to the entire U.S. economy. We need a healthy banking system for the economy to thrive. But banks are in a bind. On the one hand, we have the "fintech" upstarts who are making inroads into consumer lending and wealth management, to name two areas. They are disrupting traditional business models. On the other hand, we have banking regulators, who, in the wake of the financial crisis, have really clamped down on banks. What has that ..

While many bankers may jump to answer “yes” when asked if the industry is overregulated, a more relevant answer (or answers) must consider the intentions of the regulations. The purpose of the regulatory structure is three-fold: protect the safety and soundness of the banking system; ensure adherence with consumer compliance laws; and eliminate illicit activity.

Marina, Jose 2012

Jose Marina

Safety and soundness regulations. To evaluate whether or not this aspect of banking is overregulated, ask one question: Without the regulations, how would processes and governance change? For prudently managed banks, I would say not much.

Periodically stress-testing capital and liquidity, ensuring a diversified funding structure, managing interest rate risk, implementing an effective internal control system, and establishing strong credit policies are all effective tools to sustain public confidence and, in turn, earnings.

Of course, within the regulatory framework, there exist exercises that are more form than substance. For example, all banks must run +400 bps interest rate shock scenarios to identify the impact on net interest margin — even though such a scenario is improbable and decisions predicated on this unlikely occurrence would be misguided. Such exercises create “noise” and take away from analyzing more realistic scenarios upon which decisions should be based.

Overall, however, risk management practices are pragmatically beneficial and should be employed, regardless of the regulatory structure.

Consumer compliance. Looking at just the evolution of consumer compliance laws since the “Great Recession,” one could argue that banks are overregulated.

One specific area that has incurred an abundance of new regulatory attention is the residential mortgage market. While we can engage in a subjective debate over the effect of TRID and other rules, it is important to consider facts from the lending side:

  • Residential mortgages as a percentage of total loans in all FDIC insured banks have declined from 31% to 21% over the past 10 years.
  • The share of residential mortgages originated by commercial banks has declined from 74% in 2007 to 52% in 2014, according to the Mortgage Bankers Association.

There are also relevant macro trends since The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law in 2010:

  • Only one new bank has opened whereas new bank charters previously exceeded 100 per year for the prior three decades.
  • The average asset size of banks has increased by 62% to support the need for scalability, given increasing compliance costs and, admittedly, a challenging interest rate environment.

As CFOs, we like to let the numbers tell the story and, in this case, it is hard to ignore what the numerical trends are telling us about the impact of regulation.

Eliminating illicit activity. While the banking industry plays a critical role to block criminals and terrorists from gaining access to the U.S. financial system, enforcement of regulations can be subjective.

In response, many banks have been “de-risking” by closing higher risk accounts or exiting certain business segments. While it may make sense for individual banks to de-risk, broad de-risking across the industry can have unintended consequences, such as cutting off vulnerable consumers from accessing credit.

There is no denying that the proliferation of regulation since the “Great Recession” has affected the finance industry as banks change their business models and emphasize scalability to better absorb the increasing cost of compliance. With no significant changes in the foreseeable future, the industry must work with regulatory authorities and banking associations to ensure the rule-making process adopts a balanced approach as we move forward.

Jose Marina is CFO and executive vice president at TotalBank. 

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