The Financial Crisis Hangover

From Washington - Winter 2012 | By Kathleen Collins

Kathleen W. Collins

All of these negative effects from Dodd-Frank are being felt before the Bureau of Consumer Financial Protection (CFPB) really kicks into gear. The CFPB has already requested an additional $28 million in funding from the Federal Reserve for fiscal 2011, which is 21 percent more than the $142 million budget estimated by the White House. Without a confirmed permanent director until Richard Cordray's controversial appointment on January 4, the agency lacked the authority to begin regulating non-bank providers of consumer financial products or services. Until that time, banks alone lay in its crosshairs.

While slowing somewhat, regulatory enforcement actions remain near record highs. In 2009 the federal banking agencies issued more than 1,100 formal enforcement actions, followed by over 1,500 such actions in 2010. As to failed banks, a handful of director and officer lawsuits emanating from the 2007-2009 financial crisis have been filed, and the industry awaits the barrage of suits previously threatened by the FDIC. As of Oct. 11, 2011, the FDIC says it has authorized suits in connection with 34 failed banks against 308 individuals with damage claims of $7.3 billion.

While slowing somewhat, regulatory enforcement actions remain near record highs.

The "Occupy Wall Street" movement ensures that the political heat associated with a typical economic downturn will not dissipate soon, reflective of the longer term damage wrought by the 2007-2009 financial crisis.

So as bank regulatory cycles go, this one has a far different feel to it: Longer and meaner, with a developing sense that as bad as this regulatory crisis was, the Congressional and supervisory responses to it have gone too far and are draining management energy and resolve, with little corresponding benefit. According to reports in American Banker, banking industry veterans launching a significant hedge fund for merger and acquisitions predict a huge consolidation wave coming, with the number of banks decreasing from 7,000 to between 4,000 and 5,000, largely due to the costs of complying with Dodd-Frank financial reform. So fewer but bigger banks is an early, unintended consequence of the legislation.

Financial Institutions Examination Fairness and Reform Act (H.R. 3461)

With all of this as background, we can turn to one of the more interesting "push-back" developments by the banking industry post-financial crisis. The Financial Institutions Examination Fairness and Reform Act (H.R. 3461) was introduced on Nov. 17, 2011 by Rep. Shelley Moore Capito (R-WV), chairman of the Subcommittee on Financial Institutions and Consumer Credit, which oversees the CFPB, and Ranking Member Carolyn Maloney (D-NY). The legislation, which had picked up 15 additional co-sponsors by early December, is aimed squarely at the perceived bete noir of community banks—the bank examination process itself.

Representatives Capito and Maloney said the purpose of the legislation is to address concerns regarding the increase in regulatory compliance issues for financial institutions and the fairness of the examination process since the recent financial crisis. "I have heard from banks in my district who feel that there is a disconnect between guidance coming out of Washington and exams that are being done in the field. I am hopeful that this bill, which codifies existing guidance, will help ensure that the examination process is being conducted consistently and will offer banks an impartial outlet when they feel wrong determinations have been made," stated Ranking Member Maloney.

Some see a huge consolidation wave coming, with the number of banks decreasing from 7,000 to between 4,000 and 5,000—largely due to the costs of complying with Dodd-Frank financial reform.

The legislation has four components: timely examination reports; clear examination standards; creation of a new, independent, interagency Examination Ombudsman to ensure the consistency and quality of all examinations; and an expedited process for banks to appeal examination decisions without fear of retaliation by a regulatory agency.

While spokesmen for the federal bank regulators have not commented on the proposed legislation, let's just bet H.R. 3461 is not a regulatory crowd-pleaser.

The clearer examination standards aimed at commercial loans would have the practical effect of slowing down an examiner's inclination to move such loans into nonaccrual status. Some familiar with the 1980s' thrift crisis would cite the doctrine employed then—one of regulatory forbearance—as reason alone to nix this provision

An alternative referee

The federal banking agencies currently each employ an ombudsman, but this statute would create an alternative referee to be housed in the Federal Financial Institutions Examination Council. This FFIEC Examination Ombudsman would investigate complaints from banks about examinations, review the examination procedures of the agencies to ensure that written policies are being followed consistently in the field, conduct a regular program of examination quality assurance for all types of examinations conducted by the regulatory agencies, process supervisory appeals, and report annually to Congress on all of these issues.

Unlike the ombudsman arrangements already in place, the supervisory appeal process involving the Examination Ombudsman would entail a hearing before a specialized administrative law judge (ALJ) that is an independent entity not subject to control by the agency, with the ALJ making his or her recommendations to the ombudsman based upon an independent review. A final decision by the ombudsman on an appeal is due not later than 60 days after the hearing, and it will bind the agency as well as the bank making the appeal.

It is way too early to handicap the prospects for H.R. 3461, but it should be an interesting test of the Congressional waters during a major election year. The banking industry would be happy for even a small splash at this point in the regulatory cycle.

Kathleen W. Collins is a partner in Morgan, Lewis & Bockius, and Washington Counsel of the Bank Insurance & Securities Association.