The redrafting of financial industry regulation has sparked much discussion in Washington, with the House of Representatives last week passing extensive legislation to transform how the US financial system is governed.
Meanwhile, we have watched senators press the Trump administration to return to the regulatory structure created in the 1930s.
Radical change is not the answer. Instead, there is an opportunity for some common sense, targeted changes that can preserve the strength of the banking system while enabling the sector to better support the saving, investing and lending that promote economic growth and job creation.
More than 80 years ago, the US enacted the Glass-Steagall legislation that separated traditional commercial banking from investment banking. Over the ensuing seven decades, as global trade and finance expanded, the divide between commercial and investment banking broke down.
Recognising that global companies needed full-service banks, the US embraced a system adopted by most other countries, including Germany, Japan, Canada, the UK and Australia. Ending Glass-Steagall (the law was repealed in 1999) had nothing to do with the financial crisis, and there is no reason to return to it.
In 2010, Congress passed the Dodd-Frank Act which was designed to address the many issues that led to the crisis. The US financial system today is stronger for it. For example, financial institutions have doubled the capital they had 10 years ago. The basic architecture of Dodd-Frank makes sense. At the same time, as a number of regulators and legislators have observed, the act was a complex effort that produced thousands of pages of rules.
At its core, the current regulatory structure treats the health of a financial institution much the way you treat your own health. First, just as you follow a day-to-day regimen of diet and exercise, the regulatory system requires banks to maintain robust levels of capital, liquidity and client protection. Just as you watch your own diet, banks have regulators on-site, watching day-to-day activities to monitor risk management protocols and compliance.
Then, on a periodic basis, you go to the doctor for a thorough exam. And you prepare for the worst-case scenario by having a will in place. The financial system is similar: through the annual stress-test process, regulators assess each bank’s capital levels, requiring they be high enough to sustain the institution through a period of stress. And every bank is required to have a “living will” in place so that a failure would not undermine the wider financial system.
The stress-test process, though, is more cumbersome for the banks and the regulators than it need be. The content of the test should also be updated. Today, the stress test assumes that a bank under duress would grow its assets and continue returning capital to shareholders. That assumption is unrealistic, and should be eliminated. In a period of instability, an institution would look to shed assets and preserve capital.
Similarly, the stress test requires each bank to decide its dividend increases and share buybacks before getting its test results. Banks should decide on dividend increases and share buybacks after receiving the results of stress tests, when they know how much capital regulators wish them to hold.
To enable large US banks to support their clients better, the Volcker rule should be clarified. The rule proposed in 2010 by Paul Volcker, former chairman of the Federal Reserve, was aimed at limiting banks’ trading and investing for their own profit and loss. Unfortunately, the rule is so complicated it has undermined banks’ ability to provide liquidity to the market, making it more difficult and costly for market participants like pension funds to earn a return on their investments.
Regulators around the world have achieved an unprecedented level of collaboration since the financial crisis to create global standards for financial institutions. American regulators have largely viewed these international standards as a floor, and imposed higher standards on US institutions. Such “gold-plating” has gone far enough. Continuing down this road risks making the US financial sector uncompetitive, which could lead global companies to do business with banks elsewhere in the world.
We have had seven years of rulemaking since Dodd-Frank was enacted, and yet there are still new rules in the works. We should hold off further rulemaking, digest what is in place and focus on what is needed for economic growth.
These are commonsense steps, and can be accomplished without triggering the kind of contentious partisan debate that generates gridlock in Washington.
If these changes were enacted, US banks would continue to be among the safest in the world and would have the capital to help businesses, institutions and individuals pursue their financial goals and grow jobs. Isn’t that what we all want?
The writer is chairman and chief executive of Morgan Stanley