Bank Regulatory Relief in Time for White House ‘Deregulation Day’

Happy Deregulation Day!

Today, the Trump administration is celebrating the benefits of an America liberated from red tape. As I mentioned in a blog post last week, one area that is desperate for reform is banking and finance. Fortunately, some important progress has been made, particularly in relation to a special government oversight status known as Systemically Important Financial Institutions (SIFIs), instituted under the Dodd-Frank Act of 2010.

The SIFI designation is applied in two circumstances: 1) to all banks over $50 billion in assets and 2) to non-bank financial institutions that a special government “super-regulator,” the Financial Stability Oversight Council (FSOC), believes are systemically important.

The SIFI designation was intended to end “too big to fail” by subjecting firms designated as systemically important to a swath of enhanced prudential and supervisory standards. However, it has more likely enshrined the status quo, as investors and creditors know the government won’t let a SIFI institution fail. As my colleague John Berlau has written, “With the SIFI designation, FSOC is both bestowing on a firm a potential benefit, by telling the capital markets that the government will not let this firm fail, and a potential harm by saddling it with an extra layer of regulation.”

With regards to the asset threshold applied to all banks, Sens. Claire McCaskill (D-Mo.) and David Perdue (R-Ga.) introduced a bill last Thursday to relieve small and medium-sized banks from the burden. The current one-size-fits-all approach relies on an arbitrary size limit that gives no consideration to whether a bank or its activities actually pose a systemic risk.

As a result, most of the banks designated under the SIFI limit pose no systemic threat at all. They often cover relatively small, simple institutions that overwhelmingly engage in traditional banking activities.

For example, the Regional Bank Coalition reports that “A recent Department of Treasury study …  concludes that JP Morgan Chase has a systemic risk score of 5.05 percent and Citigroup a score of 4.27 percent. None of the regional banks listed in the report have systemic risk scores exceeding 0.35 percent, in part because the business model that regional banks operate is one of traditional lenders.”

Instead of the arbitrary limit, regulators will have to justify whether an institution is systemically important through a set of criteria, such as interconnectedness, cross-border activities, and complexity. This should bring drastic relief for many small and medium-sized institutions that have inappropriately been caught up in the regulatory web.

The second change to the SIFI designation came on Friday, as the FSOC released insurance giant American International Group (AIG) from SIFI status. This follows an apparent role reversal for FSOC, reexamining the remaining non-bank financial institutions for possible dedesignation instead of adding more to the list, and may reflect the Trump administration’s focus on deregulation.

The removal of AIG is good news, but somewhat misleading. Insurance companies should not be regulated like banks at all, and the designation of AIG has been costly and without warrant. But out of the three non-bank SIFIs, including AIG, MetLife, and Prudential, AIG is certainly the most fitting candidate. Prudential is currently seeking the removal from SIFI status, while MetLife is defending a federal court decision to strike down its labeling. If AIG is to be removed as a SIFI, then the other two firms should follow. The SIFI designation process has been flawed and politically motivated from the start. Exempting AIG without the other two firms would make this blatantly obvious to all.

Eventually, the SIFI designation should be done away with altogether. For non-bank institutions, such as AIG, it has conferred an advantage on the one hand, telling markets that the firm is too big to fail, while on the other hand imposing $150 million a year in unnecessary regulatory costs. It has also punished consumers, as Berlau has written further, with the imposition of bank-capital standards to insurers like AIG raising life insurance costs by $5 billion to $8 billion.

The same is true for large Wall Street banks. Deemed too big to fail a decade ago, they are even bigger today, with an enshrined guarantee from the federal government. Perhaps worst of all, applying SIFI standards to community and regional banks over $50 billion in assets has significantly contributed to their collapse, with one in five banks disappearing since Dodd-Frank was enacted.

In the spirit of Deregulation Day, the Trump administration should continue to wind down the SIFI designation process. AIG should not be a SIFI—but neither should any other insurance firm. Congress should start the process of removing the designation entirely and pass the Systemic Risk Designation Improvement Act of 2017, which would exempt many small and medium sized banks from the regulation. These two reforms will help end the government’s stranglehold over banking and finance, creating a safer, more sound, and more efficient financial system for all.