SRC Insights: First Quarter 2011

Navigating Dodd-Frank: An Implementation Update and Resource Guide

This special SRC Insights feature provides an update on events associated with the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act or the act) and examines potential effects on Third District bankers and regulators. This is the first of a recurring segment that will be devoted to covering the transition of the Dodd-Frank Act from law to practice. This piece is intended to heighten awareness of and offer a basic perspective on the dynamic implementation and interpretation process currently underway.

Bankers should note that this is not meant to be a comprehensive or authoritative review of this historic legislation, but it is primarily intended to convey key information and suggest relevant resources that may assist Third District bankers in learning about and applying new rules and regulations. The Supervision, Regulation, and Credit (SRC) department of the Federal Reserve Bank of Philadelphia has a series of well-established outreach programs and publications to update bankers on the latest news pertaining to Dodd-Frank Act events. Third District bankers are encouraged to continue to participate and interact with SRC through this outreach.

Financial Crisis Spurs Reform

The past few years have been characterized by unprecedented events and disruption in the financial system. There are typically three phases in resolving significant financial crises. Initially, there is a containment phase designed to address and contain problems in the financial markets, such as central bank intervention to alleviate interbank liquidity strains. A second phase centers on loss recognition, restructuring, and recapitalization. A third phase seeks to implement fundamental reforms. This is a lengthy process, but it should ultimately strengthen the financial system and improve the way the system responds to future crises.

The recent financial disruption and economic recession have led to a period of profound transformation aimed at making the financial system more resilient. To accomplish this, risk management practices must be enhanced, and significant regulatory reform must occur. The objective is to lessen the industry's risk and impose a regulatory framework that monitors the stability of the whole sector more effectively and that allows it to react quickly to early warning signs of potential problems.

Regulatory Reform

The historic Dodd-Frank Act is a federal statute enacted by the 111th U.S. Congress and signed into law on July 21, 2010. The passage represents the most sweeping U.S. financial regulatory reform since the 1930s.

The Dodd-Frank Act represents a principled effort to strengthen financial regulation and supervision and to create stronger protections for consumers of financial products and services. It takes meaningful steps by providing the tools and authority needed to prevent or mitigate future financial crises. The intent described within the Dodd-Frank Act is to “promote the financial stability of the United States by improving accountability and transparency in the financial system, to end “too big to fail”, to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.”¹

Federal Reserve Supervision and Regulation

The efficacy of the legislation depends in part on how the act is implemented by the regulatory agencies. Although the terms supervision and regulation are often used interchangeably, they are, in fact, two distinct, although complementary, functions. Bank regulation refers to the laws and rules that govern the industry, while bank supervision involves the monitoring, inspecting, and examining of banking organizations to assess their condition and compliance with relevant laws and regulations. Both are essential to a safe and sound financial system. Supervision should remain balanced and consider its effect on banks, nonbanks, capital markets, global supervision programs, and the broader economy.

Future financial stability success will depend on complementing micro-prudential supervision and regulation aimed toward improving the resilience of individual institutions with effective macro-prudential practices that focus on the financial system as a whole. The goal of an enhanced regulatory structure includes reinforcing the relationship between consumer protection and market stability while providing the regulatory incentives and infrastructure for robust financial markets in a global economy.

The supervision process continues to evolve through a process of learning and applying new rules and regulations. The largest, most interconnected, and highly-leveraged companies face stricter prudential regulation, including higher capital requirements and more robust consolidated supervision. In addition, there will be extensions of regulatory technique (e.g., stress testing), increased emphasis on data and analytics, more sharing of information between agencies, higher expectations for corporate governance, and a change in the approach to financial innovation.

The Federal Reserve has already begun to refine its supervisory approach. For example, the Large Institution Supervision Coordinating Committee (LISCC), a multi-disciplinary committee, was formed to coordinate the FRS large bank supervision framework. The LISCC incorporates systemic risk considerations and provides strategic and policy direction for supervisory activities across the Federal Reserve System.

In November 2010, the Federal Reserve Board established an internal Office of Financial Stability Policy and Research and appointed Board Economist J. Nellie Liang as its director. The office will bring together economists, banking supervisors, market experts, and others in the Federal Reserve who will be dedicated to supporting the Board's financial stability responsibilities. The office will develop and coordinate staff efforts to identify and analyze potential risks to the financial system and the broader economy by monitoring asset prices, leverage, financial flows, and other market risk indicators; following developments at key institutions; and analyzing policies to promote financial stability. It will also support the supervision of large financial institutions and the participation of the Board of Governors on the Financial Stability Oversight Council (FSOC).²

The Dodd-Frank Act also makes changes to Federal Reserve System governance and supervision policy matters. Greater transparency around the supervision process will result. One example is that a current Board of Governors member will be appointed to serve in the role as vice chair for Supervision. This individual will develop policy recommendations regarding supervision and regulation for the Board and will be required to report to Congress semiannually.

Writing Rules: The Next Step

Reform involves a dynamic, ongoing process. The act is categorized into 16 titles and requires regulators to create rules, conduct studies, and issue periodic reports. Implementation will occur in stages, with much of the rulemaking at the forefront over the first 6 to 18 months following the passage. The rulemaking phase began shortly after enactment, and widespread and complex changes are expected.

The Dodd-Frank Act contains more than 300 provisions that expressly indicate that rulemaking is either required or permitted. However, it is unclear how many rules will ultimately be issued pursuant to the act because, among other things: 1) many of the provisions appear to be discretionary (e.g., stating that an agency “may” issue a rule); 2) individual provisions may result in multiple rules; 3) some provisions appear to provide rulemaking authorities to agencies that the agencies already possess; and 4) rules may be issued to implement provisions that do not specifically require rulemaking. Nearly 80 percent of the relevant provisions in the Dodd-Frank Act assign rulemaking responsibilities or authorities to four agencies: the Securities and Exchange Commission (SEC), the Board of Governors of the Federal Reserve System, the Commodity Futures Trading Commission (CFTC), and the Consumer Financial Protection Bureau (CFPB).³

The Federal Reserve's Role in Implementation

The Federal Reserve System is involved in implementing over 250 Dodd-Frank Act initiatives, three-quarters of which are mandated by the legislation. The Federal Reserve is the lead agency responsible for implementing two-thirds of these initiatives.

Current Fed initiatives vary in type: about 40 percent are rulemakings; 40 percent are process development/changes; 10 percent are studies and reports; and the remainder of these consist of consultations with other agencies on rulemakings, studies, and reports.

Current Federal Reserve Initiatives

The Federal Reserve, however, groups its Dodd-Frank Act initiatives into several significant work streams. About one-quarter are related to financial stability and systemic risk; another quarter to banking supervision (non-systemic); another quarter to consumer protection; and one-tenth to payment, clearing, and settlements. The remainder of these are being devoted to derivatives and Federal Reserve governance, transparency, and audit.

Federal Reserve Initiatives Under Dodd-Frank

Impact on FRB Philadelphia

The sweeping reform also ushers in a transitional phase for the Federal Reserve and SRC. The overall role and responsibility of the Third District SRC department will grow considerably; however, most of SRC's existing core examination responsibilities will remain largely intact.

Thrift holding companies will be added to SRC's supervision portfolio. The Dodd-Frank Act transfers authority for consolidated supervision of savings and loan holding companies (SLHCs) and their nondepository subsidiaries from the Office of Thrift Supervision (OTS) to the FRB effective July 21, 2011. As of September 30, 2010, 34 SLHCs in the Third District had individual savings institutions under them, ranging in size from $30 million to $88 billion.

The FRB is currently engaged in a range of activities to implement this transfer; a status report on the implementation plan was made available in January.⁴ For example, the federal bank and thrift regulatory agencies recently released a notice of intention to require SLHCs to submit the same reports as BHCs, beginning with the March 31, 2012, reporting period.⁵ In addition, staffing and training preparations are well underway to facilitate the process. Considerable effort will be devoted to ensuring that this transition is carried out smoothly and effectively.

The Dodd-Frank Act also expands the Fed's authority to examine and regulate nonbank subsidiaries of bank holding companies. It modifies Gramm-Leach-Bliley Act restrictions and requires the Fed to examine bank-permissible activities of nonbank subsidiaries not functionally regulated. This authority becomes effective on the transfer date of July 21, 2011, unless extended.

Demand for SRC's Retail Risk Analysis Unit, a group that includes PhD economists and statisticians with retail credit expertise, has grown significantly since the crisis began. The unit played an integral role in the Supervisory Capital Assessment Program (i.e., stress test) and continues to contribute greatly to macroprudential supervision.

One critical area of reform to emerge from the financial crisis has been the recognition that researchers and examiners within the Federal Reserve need access to more granular and timely data on mortgage performance, credit markets, and securities instruments. SRC staff led an initiative to acquire, centralize, and make available large databases for such purposes. The RADAR (Risk Assessment, Data Analysis, and Research) project consists of a data warehouse featuring a wide array of key U.S. consumer credit datasets with powerful analytical tools for querying, mapping, reporting, and charting data. RADAR also has a separate securities evaluation service that provides the capability to conduct surveillance on all parts of ABS/MBS markets and evaluate securities in investment portfolios at banks and other systemically-important institutions. The Mortgage Outreach and Research Efforts (MORE) Initiative, based at the Chicago Fed, notes RADAR's contributions to System efforts, stating, “The launch of RADAR in 2010 has greatly increased the ability of Fed staff to produce timely reports and research papers that can inform monetary policy, bank supervision and regulation and community development, as well as assist in macroprudential supervision as part of regulatory reform.”⁶

Efforts to enhance transparency may also affect Third District institutions. The Federal Reserve Board's public website has detailed information about more than 21,000 individual credit and other transactions conducted to stabilize markets during the recent financial crisis. As outlined in the Dodd-Frank Act, the first release occurred on December 1, 2010, and included transaction-level details for select programs. Additionally, discount window and open market operation transactions after July 21, 2010, will be posted with a two-year lag.⁷

The Dodd-Frank Act mandated that an Office of Minority and Women Inclusion be established by January 21, 2011, at the Federal Reserve Board, Reserve Banks, and certain other federal agencies. Headed by a director, the office will be responsible for the agency's “diversity in management, employment, and business activities.” The office will also assess the diversity policies and practices of entities regulated by the particular agency and of contractors providing services to the agency. In addition to promoting diversity at the Board and throughout the System, as required by the Dodd-Frank Act, the Board's Office of Diversity and Inclusion will play an integral role in developing standards to assess the diversity practices at entities regulated by the Federal Reserve. Senior Vice President Mary Ann Hood was selected to head the office at the Federal Reserve Bank of Philadelphia.⁸

Impact on Third District Institutions

In recent testimony, Federal Reserve Chairman Bernanke reiterated the importance of not overburdening community bankers. "We want to make sure we do all we can not to increase the regulatory burden that small banks face," Bernanke said. "Small banks have been playing just an incredibly important role, particularly as large banks have cut back on their lending to small business, and in other contexts they have in many cases stepped up and proven their worth to the U.S. economy."⁹

Some Dodd-Frank Act provisions are geared toward larger institutions and exempt smaller institutions based on asset size. For example, all financial companies with more than $10 billion in assets must conduct annual internal stress tests. Publicly-traded bank holding companies (BHCs) with assets of $10 billion or more and nonbank financial holding companies supervised by the Fed are required to establish a board-level risk committee. There are also carve-outs from the CFPB regarding enforcement and examination for banks and credit unions with $10 billion or less in assets. Smaller institutions will be examined for consumer protection compliance by their primary regulator instead of the CFPB, but still must comply with the regulations issued by the bureau and may be required to file reports with the CFPB.

The majority of institutions and holding companies in the Third District are considered to be community banks that would fall below these threshold levels. To put this into perspective, consider the following tables using data as of September 30, 2010:

Third District Bank Holding Companies
Size	Number	Assets (billions)
Greater than $10 billion	4	$216
Between $1 billion and $10 billion	15	$33
Between $500 million and $1 billion	34	$24
Less than $500 million	53	$13

Third District Commercial Banks (excluding credit card banks)
Size	Number	Assets (billions)
Greater than $10 billion	2	$182
Between $1 billion and $10 billion	20	$55
Between $500 million and $1 billion	31	$22
Less than $500 million	94	$22

In some instances, assessing the impact of Dodd-Frank Act provisions can be further quantified, given that a limited number of institutions participate in certain products or securities. For example, the practical effect of the Collins Amendment is that securities known as trust-preferred securities (TPS) will no longer qualify as tier 1 capital for BHCs. Current TPS issuances by BHCs with assets greater than $15 billion as of December 31, 2009, will be phased out between 2013 and 2016, allowing those BHCs time to raise replacement capital. TPS at BHCs with less than $15 billion in assets are grandfathered, and this amendment does not apply at all to the smallest BHCs—those with less than $500 million in assets. Because of the exclusions, this will affect a limited number of BHCs. In the Third District, 28 BHCs have issued $1 billion in TPS. Only one entity is over $15 billion in assets and will be required to exclude the TPS from capital on a phase-out basis. Four are less than $500 million and will not be affected. The remaining 23 will not be required to phase out their TPS, but any additional TPS issued will not qualify for tier 1 capital treatment.

Dodd-Frank Act changes for community banks are meaningful, but are typically less onerous. Third District community bankers should benefit from the Dodd-Frank Act provision allowing banks to pay interest on demand deposit accounts (effective July 21, 2011), the retroactive increase in FDIC deposit insurance coverage to $250,000, and favorable changes in the calculations of FDIC premiums that redefine the assessment base.

Conversely, some Dodd-Frank Act provisions that were intended to address larger bank issues may still have a great bearing on a wider segment of the industry. One example is the Durbin Amendment, a provision that addresses interchange transactions. While this provision exempts debit card issuers that, together with their affiliates, have less than $10 billion in assets, community bankers perceive it as having a broader influence on their fee generation strategy. In these instances, therefore, it is important that bankers voice their opinions during the implementation phase. In the case of the Durbin Amendment, a formal comment period on the Federal Reserve's proposal was offered through February 22, 2011.¹⁰

Financial Regulatory Structure: New Agencies

The Dodd-Frank Act focuses on closing gaps in oversight that became apparent during the financial crisis. One criticism of the previous regulatory structure was the perception that it allowed banks to “shop” for the most favorable regulator. The Dodd-Frank Act attempts to minimize shopping by troubled banks. Title III, cited as the “Enhancing Financial Institution Safety and Soundness Act of 2010,” is intended to streamline banking regulation and reduce competition and overlaps among different regulators. Overall, the regulatory structure was strengthened, but not necessarily simplified.

One agency, the OTS, was abolished, but the formation of several important new agencies was mandated. The following sections provide basic background information and a status update on the newly-created agencies.

Bureau of Consumer Financial Protection (CFPB)

Led by an independent director appointed by the President and confirmed by the Senate, with a dedicated budget in the Federal Reserve, the bureau will be able to autonomously write rules for consumer protections covering all financial institutions—banks and nonbanks—offering consumer financial services or products. The CFPB will also oversee the enforcement of federal laws intended to ensure fair, equitable, and nondiscriminatory access to credit for individuals and communities.

The CFPB will oversee consumer borrowing and the use of other financial services by:

Implementing and enforcing federal consumer financial laws
Reviewing business practices to ensure that financial services providers are following the law
Monitoring the marketplace and taking appropriate action to better ensure that markets work as transparently as they can for consumers
Establishing a toll-free consumer hotline and website for complaints and questions about consumer financial products and services

Under the Dodd-Frank Act, the Secretary of the Treasury is responsible for standing up the CFPB until a bureau director is confirmed by the Senate.

On September 17, 2010, President Obama announced the appointment of Elizabeth Warren to serve as assistant to the President and special advisor to the Secretary of the Treasury on the CFPB.
On January 5, 2011, the CFPB's implementation team signed a "memorandum of understanding" with the Conference of State Bank Supervisors to coordinate and share supervision information on consumer financial products and services providers.
Additional information is available online.

Financial Stability Oversight Council (FSOC)

The FSOC has a clear statutory mandate that creates for the first time collective accountability for identifying risks and responding to emerging threats to financial stability. It is a collaborative body chaired by the Secretary of the Treasury that brings together the expertise of the federal financial regulators, an insurance expert appointed by the President, and state regulators. The FSOC has important new authorities to constrain excessive risk in the financial system.

The FSOC held its inaugural meeting on October 1, 2010.
On January 18, 2011, the FSOC issued a notice of proposed rulemaking regarding authority to require supervision and regulation of certain nonbank financial companies.
On January 18, 2011, the FSOC released a study and recommendations regarding the implementation of the Volcker Rule. On the same day, it also released a report on the concentration limit of large financial companies.
Additional information is available online.

Office of Financial Research (OFR)

The Dodd-Frank Act establishes the OFR within the Treasury Department to improve the quality of financial data available to policymakers and facilitate more robust and sophisticated analysis of the financial system. The OFR is tasked with providing administrative, technical, budget analysis, and other support services to the FSOC and its affiliated agencies. The OFR has broad latitude in performing support services for both the FSOC and other member agencies, including collecting data, performing applied research and essential long-term research, and developing tools for monitoring risk.

The OFR will be headed by a director who is to be appointed by the President with the advice and consent of the Senate for a six-year term. The director will be required to testify annually before Congress regarding the activities of the OFR and its assessment of systemic risk. During the first two years following the date of enactment, the Federal Reserve shall fund the office.
Additional information is available online.

Federal Insurance Office

The Dodd-Frank Act establishes within the Department of the Treasury the Federal Insurance Office. This office is tasked with monitoring all aspects of the insurance industry (except health insurance, some long-term care insurance, and crop insurance), including the identification of gaps in regulating insurers that could contribute to financial crises.

Keeping Track of the Implementation Process

As mentioned earlier, this special report of SRC Insights will be the first of a recurring series of articles providing updates on Dodd-Frank Act milestones and pending initiatives that are particularly relevant to Third District bankers. Given the dynamic pace of change surrounding the act's implementation, bankers are also encouraged to keep abreast of the latest events through other reliable websites.

In the interest of transparency and accountability, and in order to facilitate the tracking process, the Board of Governors of the Federal Reserve has devoted a portion of its website to tracking regulatory reform initiatives. Sections for initiatives, both completed and planned in the near-term, are available. The site is available online.

The Federal Reserve Bank of St. Louis has also provided an excellent roadmap for tracking the Dodd-Frank Act Regulatory Reform Rules from start to finish. E-mail notification service alerts are available that provide a brief description and a link to a recent posting. The site is available online.

Finally, the American Bankers Association (ABA) provides a useful and comprehensive rulemaking date chart and a Dodd-Frank Tracker Calendar on its website.

Future Regulatory Improvement

“Improving Regulation and Regulatory Review,” an Executive Order signed January 18, 2011, outlines the following guiding principles for government agencies when crafting regulation:¹¹

Consistent with law, agencies must consider costs and benefits and choose the least burdensome alternative.
The regulatory process must encourage public participation and an open exchange of views, with an opportunity for the public to comment.
Agencies must attempt to coordinate, simplify, and harmonize regulations to reduce costs and promote certainty for businesses and the public.
Agencies must consider low-cost approaches that reduce burden and maintain flexibility.
Regulations must be guided by objective scientific evidence.
Existing regulations must be reviewed to determine that they are still necessary and crafted effectively; if not, they must be modified, streamlined, or repealed.

Together, these principles will create a more effective and cost-efficient regulatory framework.

The ABA reports that, “As of January 3, 2011, less than six months after the Dodd-Frank Act was signed into law, regulators have issued over 1,000 pages of regulatory proposals and over 360 pages of final rules. Many more pages of regulations, upwards of 5,000, are expected.”¹²

The intent is not to craft more regulation, but to introduce better regulation. The interpretation and implementation process remains critical to that objective. To this end, the Federal Reserve Bank of Philadelphia reinforces its commitment to outreach during this dynamic period of sweeping reform. Regulators recognize that community and regional banks serve an important role in the economy. Ultimately, all parties are working to repair the damages from the crisis, restore public confidence, mitigate future risks, and emerge with a more robust and resilient banking system. If you have any questions regarding this article, please contact Senior Specialist Bob Rell at (215) 574-4382.

To obtain more comprehensive information about the legislative history and to access select reports, summaries, and commentaries of the act, the following resources are available to the public:

Library of Congress (THOMAS)

U.S. Government Printing Office (PUBLIC LAW 111â€“203—JULY 21, 2010)

Law Librarians' Society of Washington, D.C.

¹ Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, July 21, 2010, available online.
² Board press release, November 4, 2010, available online.
³ Copeland, Curtis W., “Rulemaking Requirements and Authorities in the Dodd-Frank Wall Street Reform and Consumer Protection Act,” CRS Report for Congress, November 3, 2010, available online.
⁴ Joint Implementation Plan, 301-326 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, January 2011, available online.
⁵ Joint press release, February 3, 2011, available online.
⁶ Addressing the Impact of the Foreclosure Crisis Federal Reserve Mortgage Outreach and Research Efforts, available online.
⁷ Board press release, December 1, 2010, available online.
⁸ Board press release, January 18, 2011, available online.
⁹ Borak, Donna, “Bernanke Backs Small Banks,” American Banker, January 10, 2011, available online.
¹⁰ Board press release, December 16, 2010, available online.
¹¹ Improving Regulation and Regulatory Review, White House Executive Order, January 18, 2011, available online.
¹² “Dodd-Frank Proposal Burden Exceeds 1,000 Pages in Less than 6 Months Since Passage,” ABA Dodd-Frank Tracker, January 14, 2011, available online.

The views expressed in this article are those of the author and are not necessarily those of this Reserve Bank or the Federal Reserve System.