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KBRA: This should be the focus of Trump’s regulatory reform

End practice of holding capital as "panacea" for preventing crisis

President Donald Trump held to another one of his campaign promises last week, when he signed an executive order that is expected to begin the process of revamping (or replacing) the Dodd-Frank Wall Street Reform Act.

The specific details of the Trump administration’s plan for financial reform were not contained in the executive order, but what should the Republican-led regulatory reform efforts focus on?

A new report from Kroll Bond Ratings Agency lays out one specific area where regulatory reform can make a significant impact in the health of the country’s financial system – capital standards.

Trump’s executive order laid out six “core principles” for the country’s financial regulatory system moving forward. Those principles are:

  • Empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth
  • Prevent taxpayer-funded bailouts
  • Foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry
  • Enable American companies to be competitive with foreign firms in domestic and foreign markets
  • Advance American interests in international financial regulatory negotiations and meetings
  • Restore public accountability within Federal financial regulatory agencies and rationalize the Federal financial regulatory framework

House Financial Services Committee Chairman Rep. Jeb Hensarling, R-Texas, who stood by Trump’s side when he signed the order, said that the order “closely mirrors” the Financial CHOICE Act, the Republican effort to repeal and replace Dodd-Frank.

In a new report, KBRA’s senior managing director Christopher Whalen writes that many of the post-crisis financial regulations, including Dodd-Frank, require financial institutions to hoard capital as a buffer to avoid bailouts in the event of another financial crisis.

And now, the Trump administration and the Republican majority in Congress have the ability to change those requirements, which, in Whalen’s view, will have positive impact on financial markets.

“Perhaps the biggest change for all financial services companies and professionals in 2017 is that the political narrative regarding financial regulation has shifted from a punitive focus with anti-business effects to a more traditionally conservative agenda focused on growth and jobs,” Whalen writes.

“By easing the political headwinds against banks and non-banks alike, the Trump Administration can greatly improve liquidity in the financial markets and enhance the opportunities for economic growth,” Whalen continues.

In Whalen’s view, the “proximate” cause of the financial crisis was a lack of liquidity in the market, rather than a lack of capital.

“Yet since 2008, regulators and policymakers have focused on increased capital for banks and restrictions on risk taking as a general panacea for preventing a future crisis,” Whalen writes.

And in Whalen’s view, many of the capital requirements established after the crisis do not address the issues that caused the crisis.

But that can all change now, Whalen states.

“In general, KBRA believes that modifications to the Dodd-Frank law that lessen the regulatory burden but address the underlying causes of the crisis will be positive for investors,” Whalen writes.

“Any changes to the current regulatory system need to de-emphasize the mechanistic use of capital as a catch-all response to the financial crisis and instead construct policies to prevent the reoccurrence of acts of financial deception, particularly the use of hidden leverage to enhance short-term financial returns, that ultimately caused the 2008 financial crisis to occur in the first place,” Whalen concludes.

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