Financial Reform or Regress?

What does one make of a sweeping financial reform law with 2,319 pages, whose affects may not be known for awhile because the rules and regulations will be written over several years by federal bureaucrats with little or no political accountability? The harshest critics of Dodd-Frank, also known as the Wall Street Reform and Consumer Protection Act, believe it was passed with little understanding of its eventual outcomes. It's one of the pieces of legislation cited — the new health care law being the other — for embedding uncertainty into the business community for some time to come.

The bill mandates nearly 250 new rules and 64 studies, and some estimates say it will create several thousand new pages of regulations. Critics believe the uncertainty it creates will continue until the rules are written and interpreted by regulators, a process that could take until 2013. Far from its stated goal of restoring public confidence in the nation's financial system and establishing more consumer protections, the law instead is adding to industry jitters.

Dodd-Frank was signed into law last July by President Obama. It is named for its principal authors, former U.S. Senator Chris Dodd and U.S. Rep. Barney Frank, and could reach virtually every part of the domestic financial services industry. Among other things, it creates the Bureau of Consumer Financial Protection, a new governmental authority that is likely to have broad power to regulate retail financial products and services.

To put the size of this sweeping law into perspective, consider that the Glass-Steagall Act of 1933, a landmark response to Depression-era bank failures, was only 37 pages long, and the Sarbanes-Oxley Act of 2002, the government's solution to accounting and corporate scandals stemming from the 1990s boom years, was just 66 pages long.

Dodd-Frank's authors have repeatedly stated that its provisions, which not only ratchet up regulations on the financial services industry but give government overseers more power and funding, are needed to prevent, indeed head off, another financial crisis. Yet the law has drawn fire from observers who contend it will limit the availability of credit and choke off innovation.

Consumer Shields

The rules may take several years to write, but in terms of the impact on the banking industry and consumers, some likely trends already are apparent. Consumers will see much more protection due to the Consumer Financial Protection Bureau, which will be a branch of the Federal Reserve. Elizabeth Warren, a Harvard Law School professor who is the darling of many consumer groups, hasn't been named to head the new agency, but she has been named to direct its formation. To correct what is perceived as unreasonable fees, the new law charges the Federal Reserve with regulating the interchange fees charged for debit card transactions.

"The charge of that new agency is going to be to basically take over a lot of the consumer financial regulatory functions that traditionally have been handled by banking regulators, the Federal Reserve, and the Federal Trade Commission," said attorney Tim Crisp, a partner with the Foley & Lardner law firm. "We can expect, given the tenor of Dodd-Frank and with Elizabeth Warren setting it up, that it's quite likely to be much, much more protective of consumers, and perhaps give banks and financial entities many more worries about strong regulatory oversight and perhaps plaintiff and class-action lawsuits."

Dodd-Frank has provisions that are intended to ensure that no financial institution is "too big to fail," and that the Federal Reserve won't be bailing out the CitiGroups or the AIGs. While it sets up more oversight for institutions with a large asset base, only time will tell whether it prevents systemic risk in the financial system.

The Skeptics

It's fair to count Kurt Bauer, president and CEO of the Wisconsin Bankers Association, among Dodd-Frank's critics. Bauer firmly believes the Act inevitably will lead to more expensive and harder-to-obtain business and consumer credit. He used the word "tragedy" to describe its impact, charging that the size and complexity of the law will add uncertainty to banking, and therefore lending, for years — and in exchange for few tangible benefits.

"It will take years to assess the full impact of Dodd-Frank, but conservative estimates suggest that it will add 5,000 new pages of regulations that banks of all sizes must comply with," he stated. "The cost of that compliance will be passed on to borrowers, just like the cost of all business regulation and taxes are passed on to customers."

Bauer called the Consumer Financial Protection Bureau a wildcard whose impact on credit is impossible to quantify. Once created, he believes the CFPB will have unprecedented and nearly unchecked authority to promulgate rules that limit financial products and how much can be charged for them.

From a banker's perspective, he opined that Dodd-Frank failed to address the root causes of the financial crisis, namely the absence of a regulatory enforcement mechanism for existing consumer protection and related laws on nonbank lenders.

"Of course, when business borrowers are forced to comply with the 'new normal' of completing more paperwork and providing more documentation when applying for a loan, they won't remember to blame the 111th Congress," Bauer stated. "Unfortunately, they will blame banks."

Bankers' Hours

Six months after Dodd-Frank's passage, do individual bankers have an better gauge on its impact on how banks will serve small businesses? Is there any guidance from regulators that makes the impact clearer at this point, or are they still operating in a fog?

Mark Meloy, president and CEO of First Business Bank, said the vast majority of the law is still to be determined. He thinks it first will impact the 20 largest banks in the country, and those impacts will trickle down to community banks. He cited provisions that relate to price controls on interchange fees for ATM networks and debit cards, which is income that is very important to high-volume banks.

"Regarding how a business will react to that, one thing for certain is that it's not going to let the revenue go away," Meloy stated. "They are going to find a way to replace that revenue, whether it comes in lower cost of deposits or higher costs on the loans they make. That will all play out into the community banks."

Corey Chambas, president and CEO of First Business Financial Services, agreed that the fog has not cleared. "There is still lots and lots to be determined, but regarding the additional costs, particularly on the retail [products] side, banks will make it up somehow," he predicted.

It's too early to determine how the Act will affect small businesses, but Chambas offered a guess. "As far as Dodd-Frank goes, I would guess that, net impact, it will not be positive for small businesses. If you're taking revenue away from an industry in general, the industry has to figure out how to make it up."

For big banks, Chambas noted their reaction would be influenced by the fact that their shareholders demand certain returns and profitability levels, so their customers should anticipate some cost shifting from bank to consumer.

Meloy and Chambas had praise for recent adjustments to Small Business Administration lending programs, which are not part of Dodd-Frank. Both believe that changes in lending terms and larger allocations for loans already have had a very positive affect on small business lending. "It's probably one of the more impactful things, from a small business perspective, that has occurred in the past year or two," Meloy said.

Crisp is taking a wait-and-see approach about Dodd-Frank's impacts on bank costs. "A lot of it has yet to be determined with respect to how much it's going to increase the banks' cost of doing business," he stated. "I think it will increase banks" compliance costs, certainly on the consumer side. It's going to tighten capital requirements, so banks are going to have to shore up their capital and they are going to have to reserve more against deposits in certain cases.

"I think there is going to be greater state regulation of federally chartered institutions under the law, so they will have compliance costs and concerns about state regulation as well."

Crisp agreed that banks "will do their best" to pass those costs onto consumers. "It's going to depend on market conditions and how competitive they are," he stated. "There have been times in the past where the banking industry has tripped over itself to cut its margins down to slim or none in order to gain market share.

"It's kind of like the airline industry. If the competitive situation allows them to do it, they will pass along more. If it does not, then even the ones who want to won't be able to, and they will lose market share."

Over the top?

At the moment, Dodd-Frank does not appear to limit overdraft fees, but other legislation does. The Fed addressed overdrafts through revisions to the Truth in Savings and Electronic Funds Transfer Acts. Banks now are required to disclose, in each periodic account statement, all overdraft charges assessed to each account both for the statement period and year-to-date. Banks also are required to discuss account balances in automated services such as ATM or online banking, Bauer indicated.

The FDIC recently finalized its supervisory expectations regarding overdraft programs, which Bauer described as "very aggressive." In its supervisory guidance to institutions, the FDIC cited the need to protect consumers, noting that with changes in technology, overdraft has broadened to include ATMs, online transactions, and point-of-sale debit card use. It noted that overdraft fees can exceed the amount of the overdraft and can occur multiple times in a single banking day.

The agency also said extremely high costs in comparison to the overdraft benefit often results in customer dissatisfaction, complaints, and financial harm for people on low or fixed incomes. "Program participation has sometimes been based on automatic enrollment, and customers may not have fully understood the risk and potential costs involved," the FDIC added.

Some would respond with "buyer beware," noting that regulations could result in greater costs for consumers, but the new rules could also result in some unintended benefits. Crain's Chicago Business has reported that Chicago's largest banks are reinstituting monthly fees for maintaining checking accounts to make up for revenue they expect to lose as the federal government limits overdraft fees, a move smaller banks vow to exploit in order to gain market share.

Bauer expects the Consumer Financial Protection Bureau to have the authority and latitude, even without a specific mandate from Congress, to regulate overdraft programs. "It would be surprising," he contends, "if the bureau did not look to wrap overdraft practices into UDAP, now UDAAP (Unfair, Deceptive, or Abusive Acts or Practices) under Dodd-Frank."

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