The lost jobs, homes, savings, retirements and dreams of tens of millions of Americans due to the financial crisis of 2007-2009 highlight the critical importance of having strong banking regulations combined with effective and assertive supervisory oversight to ensure the largest banks are both financially resilient and safely run. Pre-crisis banking rules for the largest banks were woefully deficient and ineffective. Weak standards for liquidity and capital sufficiency in particular allowed large banks to take on too much risk, contributing to a crisis that had devastating effects on Main Street families and businesses. At the same time, banking supervision—the day-to-day oversight of these firms that should complement and fill in potential gaps in rules to ensure banks are not dangerously run—failed dramatically, and combined with the weak rules, created a particularly fragile banking system with disastrous consequences.
As a result of the many lessons painfully learned from the financial crisis, Congress passed the DoddFrank Act (DFA) in 2010 and directed banking regulators to implement tougher standards for “systemically important” banks—those that can pose a substantial risk to financial stability and the broader economy. Although these tougher standards were relentlessly opposed by the financial industry, regulators did implement them. Those post-crisis banking sector reforms have worked largely as intended during the pandemic and, so far, have prevented a banking and financial crisis, even if those reforms did not go far enough in some important areas, as we detailed in a recent paper.
While these reforms have not come close to ending the too-big-to-fail problem as some had hoped, they have strengthened the U.S. banking system substantially. Indeed, post-crisis banking sector reforms are the key reason the largest banks entered the COVID-19 pandemic in relatively strong financial condition, and they have so far been able to serve as a source of support for the economy rather than contributing to and exacerbating the downturn as they did in the last crisis.
Nevertheless, many of the reforms have been under attack by the industry from the start, and, under the Trump administration’s deregulatory efforts, a number have been weakened over the past several years by legislation and rulemaking. For example, in 2018 Congress passed the bipartisan Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA). The new law changed the definition of systemically important banks, raising the asset size-based threshold for the required application of strongerrules and standards for bank holding companies from $50 billion to $250 billion.
The law eliminated the legislative requirement that enhanced standards be applied to bank holding companies with between $50 billion and $100 billion in assets. Importantly, EGRRCPA also gave the Federal Reserve broad discretion to determine whether it should continue to apply the stronger, “enhanced prudential standards” to bank holding companies with assets of between $100 billion and $250 billion. While many of the post-crisis reforms remain largely intact for the very biggest banks (those classified as Global Systemically Important Banks or GSIBs), there have been significant changes that undermine the value of what is perhaps the most important post-crisis initiative: the Federal Reserve’s stress testing program and related banking supervision efforts. The stress tests apply to all banks with over $100 billion in assets. The lowering of other key standards has been most notable for those large banks with assets between $100 billion and $700 billion. Congress did not require the Fed to ease standards for these large banks, but, with Trump’s regulators in charge, it nonetheless exercised its discretion to do so, over detailed dissents.2 Importantly, banks in this range represent a large share of the U.S. banking system, and problems at such banks could well represent a threat to the system in a downturn, particularly for any one of those at the upper end of this range or if problems occurred at many of them at the same time, which is most likely to occur during a severe downturn.
Together, these changes made by the Fed (often with other regulators) undermined the progress that had been made since the crisis. They have made the economy more vulnerable to the threats large banks can present and have reduced the confidence taxpayers can have that the banking system is resilient enough to withstand a severely stressful period without requiring another taxpayer-supported bailout.
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