Author – Hemant Chauhan
President Trump’s first 100 days has proved rather entertaining for the media, in the public domain. Certainly his statements and political decisions have proved controversial, perhaps without any rationality behind doing so. The 45th President now desires a reform in banking regulation, and has proposed a “haircut on Dodd-Frank”. This undermines his predecessor’s consumer protection rules, enacted in 2010.
The purpose and pragmatism of regulation
Banking regulation itself has presented a ‘moral suasion’ of substance. The main purpose, briefly speaking, is to provide consumer protection, increase market confidence, and to prevent a contagion of systemic risk. When the financial crisis of 2008 struck, the governments intervened, to save the deposit-taking arms of the investment institutions. The public’s money was at an incredible risk. The democratic-led authorities instilled confidence, by guaranteeing our bank deposits to a substantial level. In other words, taking over failing banks. As taxpayers, we foot the bill, in layman’s terms.
Financial crashes often occur. The Crash of 1929 was caused by commercial banks investing customers’ deposits in the stock market. They could not pay depositors back and this led to runs on banks, and inevitable bank failures. The US enacted Glass-Steagall, which said that banks could either be commercial or investment. They could not, however, be both. The purpose of this is to protect institutions from their own worse excesses and desires. Banks and bankers cannot be trusted, or even if they indeed can be entrusted, the consequences of wrong actions and poor risk management are so grave they need a regulating body. This is what Basel confers accordingly.
The aim of Dod-Frank was to prevent banking institutions from leveraging their positions, thus reducing systemic risk, and to segregate their investment and commercial institutions. President Trump has stated ‘some very strong’ change, in order to help their lending facilities to the general public at large.
In addition, the Basel II Accord was the product of many years of negotiation between the banking supervisory authorities making up the Committee on Banking Supervision. It is not enforceable law but creates a context within which banking provides the underling principles for all banking regulation. In effect, it is ‘soft law’. They have no direct legal enforceability, although they inform legally enforceable regulatory rules and practices from jurisdiction to jurisdiction.
However, the other purpose of regulation is to protect investors in the markets, in order to stop institutions harming others. Yet, this is arguably self-defeating. Regulators themselves are always at one remove – they are always outside the institutions they are seeking to supervise. The financial markets are riddled with complexity, with the slicing, dicing and on-selling of risk and the use of complex derivative-based synthetic instruments; it is argued that banks quite often do not really know what they are doing, notwithstanding the academic theoretical points that determine their position. Regulators are recruiting from the same talent pool as the banks but cannot remunerate accordingly.
Responsibilities are shuffled constantly. Certainly the UK regulatory system was found to be at fault during the most recent crises. Responsibility for economic and financial stability was shared between government (the Treasury for economic policy and the trade department for insurance company supervision), the Bank of England (monetary policy and financial stability), and the Financial Services Authority (market regulation and bank supervision). In relation to the USA, one could argue it is far more complex. There is the Federal Reserve, and a further 12 regional Feds. Then we have the Securities and Exchange Commission, but its remit does not extend to derivatives. They are supervised by the Commodity Futures Trading Commission because of their options, forwards and futures. However, a lot of power is vested in the head of the New York Department of Financial Services, New York’s top banking regulator.
Is President Trump pragmatic?
The above sub-heading is ironic. However, he has had the benefit of support of Jamie Dimon, chairman and chief executive of JP Morgan. The author shares this view, to an extent, that regulation has not been the direct answer to address economic problems on a grand scale. Investment banks are fiduciaries. They have a moral and professional obligation to that of their shareholders and clients. Ordinarily, a bank will not owe fiduciary obligations to its customers. This legal principle was formed in the 19th century when banks only operated normal bank accounts. Banks are only fiduciaries if they occupy a specific role in relation to a particular customer. There have been persistent problems with derivatives, for example. It is very limited to clearing transactions and to delivering information to trade repositories.
Trump does face a dilemma. Any major piece of proposed legislation, after Trump’s failure to push through healthcare reforms, has proved evermore difficult in a well-regarded political office.
In effect, the intended purpose of regulation has proved ineffective and rather costly. Indeed, this plague of ‘moral hazard’ has encapsulated the working lives of bankers and their shareholders.
Follow Legal Eagle for more in-depth reviews of Donald Trumps new policy changes…