Dodd-Frank and the Profitability of Major Banks

By James Dail (CMC ’20)

A group of Republicans have just passed a resolution of disapproval addressing the proposed repeal of a regulation that benefits the financial industry over consumers. The proposed repeal would prevent consumers for filing class action lawsuits against financial companies. Though it might not be as newsworthy as some of their other Republican legislative initiatives, this resolution is just one of many that Congressional Republicans have passed with the aim of rolling back regulations from the Dodd-Frank Financial Wall Street Reform Act. Dodd-Frank was passed during the Obama Administration with the aim of preventing another financial crisis. The House attempted a full repeal of Dodd-Frank with the Financial Choice Act in June, and Trump Administration is currently rewriting a provision of the reforms known as the Volker Rule. The Trump Administration is insisting that many of the regulations are burdensome and are affecting the profitability of the industry, and that so long as a few baseline reforms are in place, another crisis is unlikely to occur. Are the reforms implemented in the wake of the crisis working to protect the American economy, or are they imposing an undue and damaging burden on the financial industry?

There are two reforms in particular that have had a significant impact on the profits of banks. The first takes the form of increased capital requirements. This requires banks to have a certain percentage of their holdings, which Dodd-Frank designated as either 8% or 10% depending on whether or not banks engage in securities trading, on hand so that they will have enough cash on hand to bail themselves out in case of a crisis. The increased capital requirements act as a form of insurance. While the increased capital requirements do cut into banking profits, part of the reason that many banks faced collapse during the crisis was because they were saddled with faulty assets and not enough cash on hand to make up the losses. They ended up having to rely on the government to bail them out instead. The increased capital requirements ensure that banks will be able to support themselves during a crisis, and that they will never again have to be bailed out at the expense of the taxpayer.

The second, and more controversial provision, is known as the “Volker Rule.” This attempted to restrain speculative activities among the banks by preventing them from investing with hedge funds or money market funds. The chief idea behind this is that, while banks play an important role in the economy through lending money, they contribute nothing when they attempt to increase their profits through speculative practices. Major banks have lobbied hard to repeal the Volker Rule, arguing that speculation was not what caused the financial crisis. The argument for the Volker Rule is that while speculation may not have cause the financial crisis in 2008, there is always the possibility that it could lead to a future crisis. Before the financial crisis, very few people thought that it was possible for homes to significantly depreciate in value. By definition, speculation involves betting on a certain outcome. If enough banks make large quantities of bad bets, then it could force them into bankruptcy, triggering a financial crisis. As speculation does nothing to contribute to economic growth, allowing banks to engage in this sort of activity poses a risk to the economy with the only benefits going to the banking industry by way of increased profits.

Though these two provisions decrease the profitability of the major banks, both are measures taken with the aim of preventing another catastrophe. The Volker Rule in particular directly addresses the speculative practices that were a major contributing factor in the last crisis. Caution should abound since the U.S. economy is only just now beginning to fully recover from the 2008 Financial Crisis. The Crisis was caused by bad behavior and mistakes in the banking industry, and every measure possible should be taken to prevent another one. As for the profitability of the banks themselves, if a child misbehaves, then he should be punished—not rewarded. Even though Dodd-Frank impedes the growth of the financial industry, Republicans should put the entire American economy before one specific sector.

 

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