What it means
The bill was a Republican proposal aimed at the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Its supporters argued that Dodd-Frank had added heavy compliance costs, especially for community banks, and had not ended the idea that some firms were too big to fail.
Its critics argued that the bill would remove safeguards that were put in place after the crisis. A central idea was an off-ramp from certain heavy regulations for banks that held a high level of capital.
Under the proposal, a bank that kept a high leverage ratio, set in the bill at 10%, could opt out of a list of requirements. The logic was that a thick cushion of the owners' money should substitute for detailed rules.
The bill also proposed restructuring the Consumer Financial Protection Bureau, changing its funding and leadership, and limiting some of its powers. It would have repealed the Volcker Rule (the restriction on banks trading for their own account) and replaced the orderly liquidation authority with a bankruptcy-based approach for large failing firms.
Although the act did not become law, parts of its thinking resurfaced in later legislation that eased some rules for smaller and mid-sized banks. For that reason, finance professionals still refer to it when they discuss regulatory direction and the way political changes can affect banks' compliance costs.
The act is a good reminder that regulation is a trade-off. Stricter rules can lower the chance of a crisis but raise costs for lenders and borrowers, while looser rules may support lending but increase the risk of losses spread across the system.
Supporters said that community banks in particular faced the same style of rules as the largest institutions, even though their risks were far smaller. They pointed to the cost of compliance staff, reports and legal advice, which falls hardest on firms with few employees.
Opponents replied that capital alone cannot replace oversight, because problems at large firms often grow out of sight until a crisis exposes them.
In practice
Real-world examples.
Example
A community bank's chief executive reads about the proposal and calculates that her bank's capital level is above 10%. She estimates how much compliance staff time could be saved if the opt-out had applied. The saving looks attractive, but she notes that the bank would have to hold its capital above the threshold at all times to keep the relief.
Example
A consumer advocate writes to lawmakers opposing the bill. She argues that changes to the consumer protection agency would make it harder to act against unfair lending practices. Her letter includes examples of complaints from borrowers who were helped by the agency's work.
Example
A bank analyst includes the proposal in a risk scenario for investors. He shows how a lighter regulatory regime could raise returns on equity for some lenders while also raising uncertainty about long-term stability. He gives each scenario a probability so that investors can see how sensitive bank share prices are to the policy outcome.
Formula
Calculation
The off-ramp idea depended on a leverage ratio:
Leverage ratio = Equity capital / Total assets
A bank has $1,200,000,000 of equity capital and $10,000,000,000 of total assets. Its leverage ratio is $1,200,000,000 / $10,000,000,000 = 12%, which is above the 10% threshold in the bill, so it would have qualified for the opt-out. A bank with $800,000,000 of equity and the same assets would have a ratio of $800,000,000 / $10,000,000,000 = 8%, and would have stayed under the existing rules.Case study
Seen in the real world.
Prairie Ridge Bank is an illustrative, fictional community lender whose board followed the progress of a deregulation bill in the legislature. The chief financial officer calculated that, with its high capital ratio, the bank might qualify for relief from a long list of requirements.
She prepared two budgets: one assuming the bill passed and one assuming it failed. In the first, compliance savings would be reinvested in small business lending, while in the second the bank would keep its current staffing.
In this illustrative story the bill stalled, and the bank used the second budget. The exercise taught the board to plan around policy uncertainty and not to bank on savings that had not yet been enacted.
Watch out
Common mistakes.
- Believing the Financial CHOICE Act became law, when it passed the House in 2017 but did not pass the Senate.
- Assuming the act is the same as Dodd-Frank, when it was a proposal to change or repeal parts of that law.
- Treating a high leverage ratio as a loophole, when the proposal was designed to trade lighter rules for more capital.
Questions
People also ask.
What did the Financial CHOICE Act aim to do?
It aimed to reduce regulatory burden on banks, reshape the consumer protection agency and replace the orderly liquidation process.
Why does an unpassed bill matter?
Because its ideas shape later debates and sometimes reappear in other legislation, and banks and investors need to understand the direction in which policy may move.
Who proposed it?
It was led by Republicans in the House Financial Services Committee, and it was opposed by most Democrats in the House.
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