At Long Last, a Compromise on Dodd-Frank Reform

A recent op-ed by Mayra Rodríguez Valladares suggests that the financial reform bill proposed by Sen. Richard Shelby could be a Trojan horse for smuggling gifts to large banks. I am astonished by this criticism, given the bipartisan and balanced nature of the draft reforms. The bill contains no Wall Street giveaways, and there is no risk that the suggested changes would endanger the financial system.

The bill offers sensible compromises on banking safety and soundness regulations. First, it establishes an "examination ombudsman" — an independent office in which banks could voice concerns about the supervision process.

This is an important provision, since bank regulators have tremendous supervisory discretion under Dodd-Frank. For example, banks may fail or pass stress tests according to the discretionary judgment of the Federal Reserve Board. Banks may question such judgments, but Dodd-Frank includes no avenue for banks to appeal supervisory assessments. Establishing an independent examination ombudsman seems like a reasonable way to begin addressing this problem.

The Shelby proposal also includes some direct reductions in banks' regulatory burden. For example, it raises the asset threshold at which banks are allowed 18-month intervals between onsite examinations and reduces the detail required in two of the four quarterly regulatory reports that banks must file for banks. To be eligible for either benefit, a bank must receive a good rating on it last onsite supervisory exam. These changes will allow supervisors and banks to reallocate their resources to more productive uses.

The bill also exempts institutions with under $10 billion in assets from the Volcker rule. Few if any institutions under this size engage in proprietary trading, and yet the Volcker rule imposes large compliance costs on any risk-reducing hedging they may undertake.

Ms. Valladares' biggest concern is the designation process for bank holding companies subjected to enhanced Fed supervision.Currently, all bank holding companies larger than $50 billion in consolidated assets are subjected to enhanced supervision and regulation by the Federal Reserve. It's been widely argued that this threshold is too low — a $50 billion bank holding company is nowhere near systemically important. Even Federal Reserve Board governor Daniel Tarullo has testified in favor of raising the $50 billion threshold.

Moreover, the Shelby compromise revises the automatic threshold at which banks are considered systemically important to $500 billion. But the bill also requires the Federal Reserve to identify bank holding companies between $50 and $500 billion for possible designation. The Financial Stability Oversight Council must thoroughly investigate candidates identified by the Fed and designate the institutions that should be subjected to enhanced supervision and regulation. Since the FSOC still has the power to designate any and all bank holding companies larger than $50 billion, it is hard to see this as a giveaway to Wall Street. It's clearly more sensible than a blanket $50 billion threshold.

The Shelby bill also proposes improvements for the FSOC. The bill would allow more officials from the FSOC member agencies to attend FSOC meetings and have access to FSOC materials — not just the heads of FSOC agencies. The bill also proposes changes in the SIFI designation process both for bank holding companies and for non-bank financial institutions. New designation procedures would require the FSOC to provide a potential designee with a detailed explanation of why it is being considered and give the potential designee an opportunity to meet with the FSOC and offer a plan to diffuse concerns. The FSOC would then be required to react to the plan and consider revisions. These changes would improve transparency and give companies under designation consideration an avenue that could forestall their designation.

The bill's changes to qualified mortgage rules would improve credit availability for Main Street consumers. It would allow more loans to count as qualified mortgages, recognizing the common-sense notion that if a financial institution is willing to make and hold a mortgage loan on its books, we should trust the institution's professional assessment of the borrower's ability to repay the loan without imposing a slew of additional government underwriting rules to constrain the lending process. This update, along with other minor changes to QM, would enhance the availability of mortgage credit without reducing consumer protection or the safety and soundness of the banking system.

When I read Sen. Shelby's draft proposal, I don't see a Trojan horse. I see reforms that look like good government, offering a positive and balanced way to fix some problematic parts of the Dodd-Frank Act.

Paul H. Kupiec is a resident scholar at the American Enterprise Institute. He has also been a director of the Center for Financial Research at the Federal Deposit Insurance Corp. and chairman of the research task force of the Basel Committee on Banking Supervision.