Banking Regulation and Competition in the Eyes of Volcker
Former Federal Reserve Chairman Paul Volcker is still regarded as a sage on Wall Street and beyond, but his contention that banking-sector competition hasn’t lessened is flat-out wrong, some say.
The Dodd-Frank banking law, instituted two years after the financial crisis that brought on the Great Recession, has not crippled the financial-services sector, Volcker said in a speech at International Monetary Fund headquarters in Washington on April 19, although he said the law’s regulatory burdens on “true” community banks should be relaxed.
A summary of Volcker’s April remarks was released by the Volcker Alliance, a New York–based think tank founded in 2013.
Referencing growth in bank profits and loans, Volcker said “claims that Dodd-Frank and other regulatory approaches have somehow gravely damaged the effective functioning of American financial markets, the commercial banking system, and prospects for economic growth simply do not comport with the mass of evidence before us.”
Indeed, Volcker said of one of the law’s creations, Dodd-Frank’s Orderly Liquidation Authority is a safeguard against taxpayer bailouts of “too big to fail” institutions and should be kept. “Too big to fail” bailouts made the grandest headlines during the 2008 crisis and could occur at some future date absent the OLA, he said.
In its overall framing of the problems in banking, though, Volcker’s speech breathed “fresh air” into discussions about the “virtues of competition” in banking, which are “no different from those in every other market,” said William F. Shughart II, research director and senior fellow at the Independent Institute, based in Oakland, Calif., and J. Fish Smith professor in public choice at the Jon Huntsman School of Business at Utah State University.
Still, insufficient attention has been paid to the role regulators played in bringing on the crisis, he said. Shughart sees Dodd-Frank as inhibiting competition, saying rewriting or lowering of regulations should be the “first priority of reformers.” “Unlike Mr. Volcker, I would repeal Dodd-Frank in its entirety, making it clear that a policy of ‘too big to fail’ has no place in a globally interconnected financial services industry,” said Shughart. “One of the legacies of Dodd-Frank is a set of regulatory rules with which all financial institutions, big and small, must comply, thereby contributing to the disappearance of many community banks. The financial services industry nowadays is dominated by fewer and larger institutions than it was before; it accordingly is less competitive.”
Volcker’s voice of concern about the burden of Dodd-Frank on community banks is welcome and lines up with the views of the Fed, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the White House and Congress, said B. Michael Rauh Jr., chairman of the Connecticut Bankers Association and president and CEO of Groton, Conn.–based Chelsea Groton Bank. “The problem is that in Washington, even when people agree on something, they still can’t seem to find a way to get it done,” he said. “There is a lot of sympathy and philosophical support, but very little tangible action. It’s very frustrating.”
While agreeing with Volcker that portions of Dodd-Frank should be kept, Rauh noted that the legislation was heaped on top of dozens of banking laws dating back to the Civil War. “The conversation almost always seems to be focused on the most recent piece of legislation or one particular aspect of one particular law or regulation,” he said. “The real problem is the sum of all the regulations that banks are required to abide by.”
Rauh agrees with Shughart that Dodd-Frank has hurt competition. According to FDIC definitions, 92 percent of FDIC-insured banks were classified as “community banks” as of December 2016, yet just 12.5 percent, or $21.4 billion, of sector earnings in 2016 went to those banks, Rauh said. Put another way, 87.5 percent of earnings went to the largest 8 percent of banks, he said. Speaking to the causes of the skewed distribution of earnings, Rauh said, “What Dodd-Frank has done is disproportionately add burdens to small banks.”
Another, long-held concern of Volcker’s, speculative trading, underlay his remarks about community banks as well as the rule that bears his name. The Volcker Rule bans proprietary trading and hedge and equity fund investments by banks. The Volcker Rule has been beneficial on balance, Volcker contends, although one prominent member of the Fed sees it differently.
Volcker’s concern about speculative trading inspired a complex and lengthy rule following five years of being “grist for the lobbying mills” and regulators with different priorities, the former Fed chairman reflected. The rule has curtailed risky activity and reduced conflicts of interests, while market liquidity has remained within historic norms, Volcker said, referring to recent data from the Fed.
Yet about two weeks earlier in a speech at Princeton University, Volcker’s alma mater, departing Federal Reserve governor Daniel Tarullo unexpectedly criticized the Volcker Rule, calling it “too complicated” and too demanding on bank resources, according to a New York Times story. Tarullo is viewed as the central bank’s most powerful authority on commercial-bank regulation.
In his April speech given at the annual meeting of the Bretton Woods Committee, Volcker also called for policy makers in the United States and abroad to renew teamwork on financial reforms. He called on the Trump administration and Congress to begin a “serious study” aimed at rebooting the regulatory landscape. Adopting “idiosyncratic domestic approaches” would lessen fair competition and reduce the efficiency of markets globally and invite paralysis during international crises, Volcker warned. “The presumed unshakable commitment on sustaining reform appears to be waning,” he said.
With his 90th birthday approaching in September and his iconic public cigar smoking a thing of the past, Volcker remains an active teacher and participant in debates over the world’s finances and regulatory frameworks. Last year the Volcker Alliance issued a report urging regulatory reforms titled “Unfinished Business: Banking in the Shadows.” A report titled “Reshaping the Financial Regulatory System” was released in 2015.
