Pros and cons of Obama’s financial reform proposal

The financial crisis that erupted last fall has brought into sharp focus the need to address shortcomings of the regulatory structure that is responsible for oversight of our financial system. The American Bankers Association — representing over 95 percent of the banking industry’s $13.3 trillion in assets — has been in constant communication with bankers, regulators and policymakers in an effort to ensure that the response to this crisis, and the regulatory reform efforts that are soon to follow, are thorough, but mindful of potential unintended consequences.

Even before the economic turmoil, many, including ABA, recognized the need for reform. Numerous non-bank financial institutions were offering products capable of doing significant harm to consumers, businesses and the broader economy, and no one had the mandate or authority to look out over our entire system to anticipate and identify systemic problems. Also, no mechanism existed (or yet exists) for the orderly resolution of systemically important non-banks. As a result, some entities have been viewed as too big or too important to fail, a concept with profound implications for both moral hazard and competitive balance.
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The need to address these shortcomings is now clear. There is significant consensus on the need to address key elements. However, it is important to recognize that there are limits to how much regulatory change can be enacted and implemented, especially when in the midst of a crisis. It therefore makes sense to build on current regulatory mechanisms wherever possible, rather than seek to build a new system from scratch.

The Obama administration’s recently issued white paper on regulatory reform is mindful of these limitations in many respects and offers a constructive starting point for reasonable reform. Like the administration, the ABA strongly supports creation of a systemic oversight council that has the primary responsibility of protecting the economy from major shocks, the creation of a mechanism for addressing failures of systemically important non-banks, and efforts to fill gaps in our regulatory structure. Of course, there is still much debate on the specifics of these three areas, and one unjustified element of the administration’s proposal is the elimination of the thrift charter.

The systemic oversight council would be tasked with looking across the entire economy and identifying potential systemic issues — issues that could relate to certain institutions, products or practices. The council should not, ABA believes, regulate institutions itself. Instead, it should have access to information from other regulators and the authority to compel financial institutions to produce further information as needed. To be effective, it should also have the authority to require regulatory action relating to systemic issues.

Creating a mechanism for resolving systemically important non-banks is a critical element for reform and will reduce the consequences of entities viewed as too big or too important to fail. The inability of our current structure to deal in a predetermined way with the problems presented by firms such as AIG, Bear Stearns and Lehman Brothers greatly exacerbated the crisis. It is reasonable in our capitalist system to allow institutions to fail because it ensures that bad actors are flushed out of the system. But it is also reasonable to ensure that the unwinding of such institutions is done in an orderly fashion that avoids chaos. The establishment of clear resolution policies stated in advance is necessary to achieve this objective.

The ABA also strongly supports the goal of closing regulatory gaps in the financial system and the industry is fully supportive of effective consumer protection. However, creating a separate consumer regulator is not necessary and may, in fact, work in contradiction to an integrated regulatory approach that recognizes that consumer protection and safety and soundness are two sides of the same coin.

It is now widely understood that the largely unregulated non-bank lending sector — particularly mortgage lenders — was a major factor contributing to the current crisis. Many of these providers had no interest in building long-term relationships with customers and were interested only in profiting from a quick transaction. The so-called “shadow banking system,” which also includes other non- or lightly-regulated financial services providers, undermined the entire system by abusing consumer and investor trust.

Banks, on the other hand, are in the relationship business, and satisfied customers are the cornerstone of the successful bank franchise. Simply put, banks cannot operate safely and soundly if they are mistreating customers. If the financial crisis has taught us anything it is that good underwriting is at the essence of both good consumer protection and good safety and soundness regulation. Making loans based on the ability of customers to repay protects consumers from taking on more than they can handle and also protects financial institutions from losses.
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Thus, that which protects both the lender and the customer should not be separated. After all, consumer protection is not just about the financial product itself; it is also about the financial integrity of the company offering the product.

Wherever there are perceived weaknesses in the protection of consumers by regulated depository institutions — banks and credit unions — they should be specifically addressed, but not by the creation of yet another regulatory agency.

Yingling is president and chief executive officer of the American Bankers Association.