In November, 2008, as the financial crisis raged on and amid serious challenges to the global economy, leaders of the G20 group of industrial nations met in Washington, and using words such as “interconnected” and “contagion,” agreed to an ambitious and comprehensive strengthening of international regulatory standards for banks.
Canadian politicians and regulators — and particularly former Bank of Canada Governor Mark Carney — were instrumental in creating a global co-operative approach to the regulation.
But that system is coming under immense pressure, and new policies under U.S. President Donald Trump threaten to introduce fissures that could undermine it completely. Trump has called for a review of the Dodd-Frank Act, a key piece of legislation enacted by the Obama administration to ensure a financial crisis could never happen again, arguing the regulation is too onerous on business and the economy.
“It will likely reduce cooperation, and my guess is the U.S. will go its own way,” a former Canadian bank director said, after reading the executive order on financial regulation signed by Trump late last week.
On Monday, the European Central Bank warned that the deregulation discussions in the United States could lay the groundwork for the next financial crisis.
“The last thing we need at this point in time is the relaxation of regulation. The idea of repeating the conditions that were in place before the crisis is something that is very worrisome,” ECB president Mario Draghi told the European Parliament’s committee on economic affairs in Brussels.
Tiff Macklem, who was Carney’s deputy at the Bank of Canada, says the financial system was made “much safer” in the post-crisis years due to the reforms that required banks to hold more and higher-quality capital, enhance liquidity, and put a “Canadian style” cap on leverage.
“I would not like to see the U.S. roll back these reforms. Financial markets are global, and for these rules to be effective, all of the major jurisdictions need to participate,” Macklem, who served as the central bank’s representative on the global Financial Stability Board, told the Financial Post.
Tweaks could be made to trim the regulatory burden from reforms such as the Volcker Rule, a part of the U.S. Dodd-Frank reform legislation that was not coordinated internationally, he said. But Trump has created ample leeway for the unwinding of global regulation to go much further.
“When President Trump says he is ‘going to be doing a big number on Dodd-Frank,’ there is room to be both deeply concerned that important reforms may be rolled back, and hopeful that we may see some sensible rationalization of ineffective rules and overlapping regulators,” said Macklem, who is now dean of the Rotman School of Management at the University of Toronto.
The Dodd-Frank legislation was a key plank in the broad global regulatory overhaul that followed the financial and economic meltdown and government bailouts of banks in the United States and Europe.
The last thing we need at this point in time is the relaxation of regulation
Carney, who is now Governor of the Bank of England, and Canada’s former federal finance minister Jim Flaherty, played a key role in the overhaul, which led to standards being developed globally and adopted in domestic markets including the United States, Europe, and Canada. At subsequent summits over the years, Canada was among the G20 countries that reaffirmed their commitment to the new global regulatory structure aimed at improving the safety and stability of the financial system.
But cracks are beginning to appear in that structure, and Trump’s executive order is the latest wedge.
“Certainly the U.S. is likely to pull away from international bodies like the G20 and Basel (Committee on Banking Supervision) and negotiate bilateral regulatory standards from now on,” said Douglas Landy, a partner in the New York office of Milbank, Tweed, Hadley & McCloy, who has advised banks in both the United States and Canada on regulatory issues.
Trump’s executive order represents a “first step” in advancing the platform of reducing the burdens the Dodd-Frank legislation. And though it is unclear how much will be unwound, since it is up to Congress to rewrite the law, the change in the way the United States will interact with global regulatory organizations is already clear, said Landy, whose areas of focus include the requirements for bank capital under Basel III rules, and foreign bank operation in the United States.
The language in Trump’s executive order says American interests and the competitiveness of its companies must be central to any international financial regulatory negotiations.
The international Basel Committee was responsible for increasing the amount of capital banks have to hold as a cushion to help prevent them from failing, with an even higher requirements for the largest global banks deemed “systemically important” or too-big-to-fail — many of them in the U.S. — and to mitigate the damage to the financial system and the economy if they do.
Bank officials have long chafed at these aspects of the post-crisis regulatory overhaul that raised costs and constrained business. Complying with the raft of new rules added substantial costs for banks, including Canadian financial institutions, and required them to withdraw from some activities perceived to be risky. Additional expenses stemmed from reporting requirements to justify the remaining activities to regulators wherever the banks do business.
The former Canadian bank director who spoke with the Financial Post, and who sat the board of a major bank during and in the aftermath of the crisis, said loosening the regulations could benefit domestic banks that have substantial operations in the U.S., such as Toronto-Dominion Bank and Royal Bank of Canada. If capital were freed up, it would be on the table to potentially fund higher dividend payouts, share buybacks, or acquisitions.
But John Aiken, an analyst at Barclays Capital in Toronto, said Canadian banks have already put a lot of money and effort into complying with the current set of rules and regulations, and will be in no rush to change strategy until it is clear when, and how, regulations will be changed under Trump.
However, if they wait too long, they risk losing business to competitors.
“If I were a Canadian bank CEO with U.S. operations, I would be pissed,” Aiken said, adding that while the operations are likely to benefit from reduced compliance costs, bank executives and boards are being put in a position where they may have to do a “180 on the fly.”
We could see both a weakening of global financial stability and fragmentation of the financial system
It is noteworthy that Trump’s growing team of advisers includes several former senior Wall Street executives, notably a number of ex-bankers from Goldman Sachs such as chief strategist Steve Bannon and incoming Treasury Secretary Steven Mnuchin.
But those who track the internecine world of bank regulation say the cracks were beginning to appear in the global model of regulation even before Trump signed the executive order – an example, perhaps, of the current climate of breakups most apparent in Britain’s pending departure from the European Union.
Sources familiar with the work of the Basel Committee on Banking Supervision and the Financial Stability Board say U.S. regulators were already beginning to chart a separate path on bank capital and liquidity. This was due in part to European banking authorities balking at proposed targets.
As evidence, they point to a delay in the Basel Committee’s solution to a wide variation in how banks calculate risk-weighted assets, which determines how much capital must be held against them. The standards, which would reportedly boost capital requirements for European banks, were to be delivered in December. But, after an early glimpse was reportedly given to key players, the European Union signalled that it would not follow the committee’s latest recommendations because higher capital requirements would hurt Europe’s economy.