NCPA - National Center for Policy Analysis

Dodd-Frank Thinks Banks Are Really Special

June 22, 2015

The Dodd-Frank Act sought to reduce the safety net for financial institutions in the wake of the financial crisis. Instead of repealing the multiple, ad hoc bailout provisions, Dodd-Frank codified their structure with what its authors believed to be tighter, stricter limitations.

Provisions included the following:

  • Orderly Liquidation Authority (OLA) for nonbanks. OLA is supposed to be an alternative to bankruptcy for nonbank financial institutions.
  • Bank-like oversight of nonbanks. Dodd-Frank imposes extended oversight and standards regarding risk-based capital and leverage on nonbank financial institutions.

Current regulatory efforts still attempt to solidify the notion that banks are special: Commercial banks are prohibited from engaging in proprietary trading or activities that involve speculation, such as owning a hedge fund or a private equity fund. This prohibition is intended to reduce the assumed risk banks take on, in order to prevent future demands on the safety net. However, the rule perpetuates the idea that financial regulatory agencies can reduce risk in banking while it also encourages banks to cut back on risk reduction activities in order to avoid regulatory scrutiny.

Some policymakers have called for a return to the regulatory regime of the 1930s through 1990s, under which commercial banks could not be associated with investment banks. Reform-minded legislators neglect important historical facts relating to Glass-Steagall, the 1933 law that separated commercial and investment banking. Risky investments by commercial banks cannot be sufficiently defined, nor can such investments be entirely separated from traditional banking.

Financial institutions of all kinds are subject to risk, but the government should not assume the risk for institutions that are capable of assuming it themselves.

Source: Vern McKinley, "After the Crisis: Revisiting the "Banks Are Special" and "Safety Net" Doctrines," Mercatus, June 18, 2015. 


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