Trimming outdated bank regulation is a good idea that won’t be easy

 When it comes to financial regulation in America, “no rational person would have set out to design the current system of regulation. It is inefficient and inequitable, sometimes completely ineffective, and badly out of step with the times.” While these words can be said today, they were actually said by co-author Bill Isaac in 1985 when he was chairman of the FDIC, in testimony before Congress on the Blueprint for Reform issued by Vice President Bush’s Task Group on Regulation of Financial Services.  

Both of us were involved in that effort to modernize financial regulation. The Blueprint called for the consolidation of banking agencies and stripping the Federal Reserve of its supervisory powers — so we can’t help but smile as it is reported 41 years later that the Trump administration is planning on trimming or abolishing a number of federal bank regulators.  

It is an effort long overdue, but we hope that they will dust off the Blueprint. The issues are nuanced and complex, and most of whatever is ultimately recommended would require congressional approval. (Good luck finding votes in Congress to cede oversight authority that has translated into millions in campaign contributions over the years.) 

An impetus for the Blueprint was the explosion of money market funds, which transformed the financial landscape in America by sucking deposits out of banks and savings and loans as interest rates soared toward 21.5 percent. Beyond consolidating federal banking agencies, Bush’s task group recommended moving toward functional regulation. Today, that would mean that a broad range of companies, not just banks, offering financial services would have to adhere to an appropriate range of regulatory standards. As we know, nothing came of the effort.  

Functional regulation is needed more than ever today. Banks are no longer the dominant players in the financial services market, leaving financial regulation hideously asymmetrical. It simply doesn’t match what markets look like. Even more problematic, it facilitates the migration of excessive risk to parts of the economy that are not regulated. Nonbank subprime mortgage lenders in 2008 and cryptocurrencies today are a glaring example of how risk migrates to create the antithesis of what regulation and a sound financial system are about.  

The solution, however, is not merely reducing the number of agencies.  

Over the last five decades years, policymakers have ignored changes in the marketplace that have created unprecedented threats. A digital revolution has allowed customers anywhere to access the financial products of providers everywhere — regulated or not. Mutual and money market funds have dwarfed the deposits of banks, and cryptocurrencies have catapulted into the spotlight by marketing random algorithms anchored to nothing tangible. In 15 unregulated years, cryptocurrencies have been permitted to mature into highly speculative investments reliant on the theory of the greater fool and currencies that seem tailor-made to finance crimes, terror and human trafficking.  

Trimming the number of regulatory agencies may save some money, but it will take a herculean political effort. And in the end, that effort will not address the most significant deficiencies in the system that can lead to financial crises. Even if all nine or so federal bank, securities and secondary market regulators were merged into one, there would still be more than 150 state, local and foreign regulators that banks would have to deal with every day.  

Any attempt to recalibrate financial regulation in America must reevaluate the extent to which all financial providers should be regulated, as well as how deposit insurance can be reimagined to keep the calm in an economy where almost 50 percent of deposits are uninsured and social media can burn down a bank in a matter of hours.  

We also were also involved in submitting extensive reports to Congress in the early 1980s outlining different options for deposit insurance moving forward. A similar effort was recreated in May 2023 in the FDIC’s Option for Deposit Insurance Reform. Nowhere among the creative recommendations in these reports separated by four decades is a suggestion that deposit insurance be moved to the Treasury, as has apparently been floated by Trump’s advisers. Among other things, such a change could politicize deposit insurance, a move that could undercut its objectivity and credibility. 

The administration and Congress have a huge task before them to reform and modernize financial regulation. We recommend that they start by adopting several bite-size principles.  

First, the number of federal financial regulators should be reduced, preferably into one commission that combines the supervisory and regulatory functions of the Federal Reserve, the Comptroller of the Currency, the FDIC, the National Credit Union Administration and the Federal Housing Finance Agency. It would be led by a five-member presidentially appointed board consisting of a chairman and vice chairman from opposite parties, along with a Federal Reserve governor, the chairman of the FDIC and a senior official of the Treasury. The Federal Reserve would maintain its monetary policy role and the FDIC would provide deposit insurance, including managing liquidations, receiverships and conservatorships.  

Second, policymakers should determine whether in this new economy deposit insurance may be offered by nonbanks, what it should cover, and how it should be priced. Finally, regulation must become smarter and less focused on ratios and rules. Regulators should be better armed with technology to be able to regulate developing technologies. 

We applaud the Trump administration for attempting to tackle the size of the federal financial bureaucracy. Winning this game will take a combination of perseverance, drafting finesse and raw political power. That will require a lot of talent and patience. 

William M. Isaac, former chairman of the FDIC and Fifth Third Bancorp, is chairman of Secura-Isaac Group, a global consulting firm for financial institutions.  

Thomas P. Vartanian, former general counsel of the Federal Home Loan Bank Board and FSLIC, is executive director of the Financial Technology and Cybersecurity Center and author of “200 Years of American Financial Panics” and “The Unhackable Internet.”  

https://thehill.com/opinion/finance/5056846-reforming-financial-regulation/