Financial reform Q&A

Jerome Idaszak, an associate editor Kiplinger, said in a recent report that the federal financial reform bill now sitting in the U.S. Senate will be approved and soon head to President Barack Obama for his signature.

The bill, already approved by the U.S. House, “cuts a wide swath, giving broad power to Uncle Sam to protect consumers and discourage banks from engaging in risky behavior,” Idaszak noted.

He said key parts of the bill give federal authorities power to seize big troubled firms before contagion spreads, requires the largest banks to increase their reserves so they will be less vulnerable in economic downturns, and gives feds more power to police lending, new financial products, derivative trading and potentially risky financial instruments.

Idaszak cautions that the legislation will require regulators to write more than 350 rules and regs to implement the new law. He quotes Cam Fine, president of the Independent Community Bankers of America, as saying: “We’ll be up to our eyes in regulatory battles for at least the next five years.”

Idaszak also provides some Q&A on the legislation.
• If banks have higher capital requirements, won’t loans be tougher to get?
To some degree. Any dollar put aside to cushion future losses is a dollar that can’t be loaned to a business. In that sense, the change could delay a return to a more normal credit climate. Still, the slow phase-in will limit immediate pain.

• Will the law crimp a housing recovery?
No, but it’s going to be slow anyway. The easy lending days are gone. Borrowers will have to prove their ability to repay, and lenders will have to be more forthcoming about how high mortgage rates can reset. Banks that bundle loans and sell them will have more skin in the game — they’ll have to retain 5% of loans made. More paperwork spells some additional cost.

• How tough is the new law on small banks?
Much less than for the big guys. Smalls escape one capital requirement that would be onerous for them, but a new debit card rule will sting, even though they don’t have to comply with it. The Federal Reserve gets authority to set caps on fees big banks can charge merchants for card transactions. Smalls worry that as bigs are forced to cut fees, they’ll have to as well.

• What about competition overseas? Will American firms be at a disadvantage?
Well, the new law sure won’t help them. It will hurt U.S. banks, for example, because their foreign competitors won’t have the cost of divesting their hedge funds or curtailing proprietary trading. But the transition period (up to a dozen years) will mitigate the effect. A bigger problem may be the European Union’s regulations that make U.S. hedge funds operating in western Europe provide more information than U.S. regulators require. Longer term, this divergence in regulatory approaches will be a huge headache, forcing multinational firms to comply with multiple rules.

• So, bottom line, the legislation will slow the economic recovery?
In the short term, yes. Less credit will obviously be a drag on the economy, though the gradual phase-in of most of the bill’s provisions will mitigate the harm. Longer term, the economy should benefit from the reduced risk and protections written into the bill to guard against another round of contagion.