Dodd-Frank and Capital, Revisited

My previous post, inquiring as to the actual impact of the Dodd-Frank Act on bank capital, elicited some comments, mainly in the form of tweets, from Dodd-Frank’s defenders.  Here are some of the issues raised, along with my response.

A tweet from former Schumer staffer and current law professor David Min suggests that, while my analysis referred to depositories, the real issue is consolidated bank holding companies.  I don’t think the distinction matters much, because the capital requirements in Section 2(o)(1) of the Bank Holding Company Act, mirror those in Section 38 of the Federal Deposit Insurance Act, which I had discussed.  In any case the fact remains that bank regulators had more than sufficient authority before Dodd-Frank to set almost any capital standards they wanted, whether for bank holding companies or their depository subsidiaries.

That said, the question remains whether  bank holding companies’ capital levels  have in fact gone up since Dodd-Frank.  Let’s see.  In 2010, the year  Dodd-Frank was passed, the largest bank holding companies, on a consolidated basis, had a tier 1 leverage ratio of 9.05%.  By 2015 the ratio had risen to 9.69% — a mere 64 basis points.  Again, color me unimpressed.  Other leverage measures for holding companies show slightly different numbers, but the magnitudes are all similar.

In another tweet, Mike Konczal suggests that the 64 basis-point increase, although slight, is nevertheless the result of Dodd-Frank.  But that conclusion may well be doubted.  As I’ve observed, regulators might have insisted on a similar, if not greater, increase before Dodd-Frank.  In fact, I believe the  increase is most likely do to  the Basel process, rather than to domestic regulatory pressures.

Konzcal, in contrast, suggests that the increase may be due to Dodd-Frank’s capital “surcharge” on very large banks.  Were that the case, one would expect the largest holding companies to have witnessed the greatest increases in capital, with  smaller banks not subject to the surcharge experiencing smaller gains, or none at all.  As mentioned above, the leverage ratio for the largest bank holding companies increased by 64 basis points since Dodd-Frank.  But holding companies just below this in size ($3B – $10B), which are not subject to the Dodd-Frank surcharge, also witnessed an increase of 64 basis points.  If we go further down the list, and look at the community banks between $500MM – $1B, the increase in the capital ratio is actually higher, at 127 basis points.  This runs counter to Konzcal’s suggestion.  Now other things may be going on here, so my evidence doesn’t necessarily amount to a refutation.  But it does at least cast doubt upon the claim that Dodd-Frank capital surcharges were an important cause of the overall (modest) increase in post-2010 bank capital ratios.

Although my post specifically concerned bank capital, both Min and Konzcal also say that the real issue concerns non-banks (a view nicely consistent with candidate Clinton’s position).  They suggest that, even if I’m correct about the impact of Dodd-Frank on bank capital, Dodd-Frank has nonetheless made a big difference by allowing bank regulators to extend both capital and liquidity requirements to designated large non-banks.

So, let’s consider that possibility.  So far, only four non-banks have been designated under Title I of Dodd-Frank.  Three of these non-banks are predominately insurance companies.  That’s important for a number of reasons.  For starters, the Dodd-Frank liquidity requirements explicitly exclude nonbank financial companies that “have substantial insurance activities.”  It follows that three of the four non-banks cannot possibly have had their capital holdings raised as a result of Dodd-Frank’s requirements.  Also, despite what Konzcal’s tweets seems to suggest, insurance companies were not “unregulated” prior to Dodd-Frank.  State insurance regulators monitor insurance companies’ liquidity, impose liquidity requirements, and enforce capital standards, as they’ve being doing to some extent since at least 1837.

In fact it makes little sense to imagine, as Min appears to do, that imposing bank-like regulation on non-banks will raise their capital levels, since non-banks have always been far less leveraged than banks.  Even Goldman already met the standards of Dodd-Frank before that law was passed.  Yes, Title I of Dodd-Frank subjects insurance companies, hedge-funds, and some other non-banks to additional regulatory oversight;  but it doesn’t follow that it will cause them to hold more capital, for they already hold more than that law requires — as should not be surprising given that they also do not enjoy the level of government guarantees enjoyed by the banks.  In fact, the only non-banks that are more leveraged than banks, and notoriously so, are Fannie Mae and Freddie Mac.  Yet neither Dodd-Frank nor any other recent legislation attempts to impose meaningful capital requirements on either.

Two much-balleyhooed arguments for Dodd-Frank are that it has given regulators needed tools they lacked beforehand, and that it has made the financial system safer by subjecting certain non-banks to bank-like regulation.  Both arguments are false, and dangerously so.  If we truly wish to avoid future financial crises, we had better assess Dodd-Frank’s consequences honestly, instead of confusing what many claimed it would accomplish with what it has accomplished in fact.

[Cross-posted from Alt-M.org]