The largest banking reform bill since the financial crisis has been signed into law, and it makes some significant changes to the U.S. banking system.
In this segment from Industry Focus: Financials, host Michael Douglass and Fool.com contributor Matthew Frankel give a rundown of what’s in the bill and what it means to you as an investor.
A full transcript follows the video.
This video was recorded on June 11, 2018.
Michael Douglass: Deregulation is something that we’ve talked about in the past as being a bit of a cycle. There are number of cycles in financials, whether it’s the regulatory cycle, the credit cycle, interest rate cycle, and a variety of other things. Today, we’re going to be talking specifically about the deregulatory cycle.
Congress has passed a major financial reform, a deregulation of the financial services industry. It’s pretty similar to the one that we discussed on the March 19th episode of Industry Focus: Financials. If you’re looking for a deeper discussion of it, head back to that one. That’s where we get into the nitty-gritty. Let’s talk about the broad strokes of it, because it has big impacts on bank profitability going forward.
Matt Frankel: Basically, this was in response to what a lot of people consider to be over-reforms after the financial crisis. The Dodd-Frank reforms were the big banking reforms designed to prevent the financial crisis from ever happening again. And what this bill does, it’s not a complete roll-back, it doesn’t eliminate the Dodd-Frank rules. But it does roll a lot of them back. The biggest provision in the bill changes the definition of what a systemically important financial institution or SIFI is, which up until now has been defined as a bank with more than $50 billion worth of assets. This, in two steps, will raise that threshold five-fold to $250 billion. It increases it to $100 billion immediately, and then to $250 billion in 18 months.
This reduces the number of banks that are considered SIFIs to about a third of what it is currently. This makes sense. Even Barney Frank, whose name is on the Dodd-Frank bill, supported raising the threshold somewhat. The logic goes, if, say, Bank of America were to collapse, we would all be in trouble. That would be a big shock to our financial system. But if a bank like, say, SunTrust or BB&T were to go under, it would be a big shock wave, but would it collapse our financial system? Probably not. That’s what they’re going for here, to make the SIFI threshold more indicative of what actually is a too-big-to-fail bank.
Douglass: It’s interesting, because Frank certainly did support increasing the threshold. I think his number was more like $100-125 billion. This is still bigger than what that number was. But, as you pointed out, this really gets to this core idea of, what does systemically important mean? And this has been the decision. Also, banks with less than $10 billion in assets are exempt from the Volcker rule, which prohibits various risky investments. Smaller banks can now do a little bit more to try and juice their profitability.
Frankel: Yeah, definitely. The Volcker rule, in addition to the real estate provision for smaller banks, where banks with less than $10 billion of assets can now also make mortgages that don’t necessarily conform to the traditional Fannie Mae, Freddie Mac standards, giving them a little competitive edge in that market.
The other reform that I think is really what got a lot of bipartisan support on this is a consumer protection reform that makes credit freezes free. Before this, to put a freeze on your credit cost about $10, depending on what state you were in, per credit bureau, and you need to put one individually on all three credit bureaus. So, this is a big win for consumers, and it’s kind of why I think some Democrats went over the fence and decided to vote for this bill.
Douglass: Let’s talk briefly about the investing implications here. As we touched on in greater depth in our March 19th episode — again, head back to that one if you really want the full discussion, because that bill was fairly similar to what ended up coming out of Congress and being signed by the president — this doesn’t really do anything to benefit the Bank of Americas of the world. And it doesn’t really do that much to benefit your $10-50 billion banks, so, a lot of your regional banks. But what it does do is, it benefits banks that were right on that $50 billion threshold. Now, they can grow without triggering a lot of extra reporting and a lot of extra regulation. So, you can probably expect to see some more mergers and acquisitions in that space, at that size.
Then, of course, as you noted, Matt, there are some benefits for really, really small banks. Of course, the flip side of that is, those benefits often come with some additional risks. Conforming loans are conforming for a reason, for example. When you start doing mortgages that are really outside of what Fannie and Freddie go for, sometimes there’s a good reason for that, and sometimes there are not great, let’s say, risk-adjusted reasons for that.
Frankel: Right. To be clear, to your first point, the SIFI requirements for banks are pretty expensive. New York Community Bank is one that I talk about frequently that is on the cusp and had been preparing for these extra costs, and it’s cost the bank billions of dollars and really driven down profits. This is a big deal to banks that otherwise would have to comply with the SIFI requirements.
To your second point, the small banks, yes, mortgages are conforming for a reason. The non-conforming mortgages were, arguably, the reason for the financial crisis. But, like you said, there are some valid reasons. As long as this is done responsibly, it’s a big win for the smaller banks. But it does come with a certain level of risk, and it should be closely monitored to make sure that non-conforming mortgages that are being offered aren’t getting out-of-hand again.
Douglass: Right. So, they key investing takeaway here is, at least in the short to medium-term, there are some significant benefits here, especially for some of your medium to large banks in particular.
Matthew Frankel owns shares of BAC and NYCB. Michael Douglass has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.