Dodd-Frank: Congress just wound back Wall Street’s clock and throttled innovation
Congress has just approved a bipartisan rollback of major banking regulations. This evening the House of Representatives passed a bill that cleared the Senate last March in a 67–31 vote, a rare example of cooperation across the aisle. The legislation takes aim at parts of the Dodd-Frank Act, the financial regulatory overhaul that President Obama signed into law in 2010 following the 2008 economic crisis.
Most notably, the bill releases 25 of the largest 38 banks from the enhanced government oversight that accompanies designation as a “systemically important” financial institution. It also exempts many smaller banks and credit unions from certain rules and supervision and modifies several housing-related regulations.
The Trump White House has already signaled its support, making the bill’s likely enactment a vindication of the financial sector’s sustained lobbying efforts for deregulation. By one recent measure, banks spent $2 billion on political activity during the last election cycle, more than double that of any other business sector. Over the past six years, senators who supported this bill received more than twice the amount of campaign contributions from banks and credit unions than those who opposed it, according to one watchdog group’s analysis.
While the legislation’s intentions, which include leveling the playing field for some smaller institutions, aren’t necessarily bad, it misses the big picture. At a time when banks have surged toward record profits and already stand to benefit significantly from the recently enacted U.S. tax reform, the bill seems more likely to further prop up Wall Street than to incentivize the real–and responsible–financial innovation Main Street actually needs.
We need better financial services, not more big banks
Since the recession, an entire industry of fintech companies has begun to transform our financial system–often serving people and communities better and more efficiently than banks ever have. With this bill, Washington again passed up the chance to modernize financial services, choosing instead to hang the American economy’s fortunes on returning a cohort of major banks to business as usual.
Take small businesses, for example. It’s a sector politicians frequently acknowledge as the backbone of our economy, yet small businesses don’t receive nearly the support from traditional financial institutions that big businesses do. And this gulf is only widening: Federal Deposit Insurance Corporation (FDIC) data shows that even as the value of bank lending to commercial and industrial customers climbed 68% between 2010 and 2017, the share of that lending going to small businesses decreased over the same period.
The 2008 financial crisis worsened things for entrepreneurs, with banks further pulling back from lending to small businesses, a trend that continues well after lending to big businesses recovered. Tighter regulations may be a factor, but so are legacy systems, infrastructure, and underwriting models, not to mention the simple fact that banks consider other products and services (like consumer checking accounts and residential mortgages) more profitable than extending credit to small companies and startups.
Congress needs to think much more broadly than offering “relief” for incumbent financial institutions. Restoring parts of a pre-crisis status quo ante is a narrow and misplaced ambition–one that conveniently forgets that this environment wasn’t all that great for many Americans in the first place. If legislators really want to spark innovation in a way that brings more Main Street businesses and consumers into the financial mainstream, here are four areas they need to focus on instead:
1. Embrace experimentation
A proposal in front of Congress, first introduced in 2016 by Representative Patrick McHenry (R-NC), would establish a “sandbox” where companies can test innovative new financial products and services in a controlled environment, with real customers, under the watchful eyes of regulators. The U.K. launched such a regulatory sandbox in 2015. Its success in promoting competition, access to finance, and collaboration between regulators and innovators–with 90% of the companies that participated in the first round of applications for the sandbox going on to market—led British officials in 2018 to take steps toward developing a global sandbox beyond its own borders.
2. Support entrepreneurial capital formation
In 2012, the bipartisan JOBS Act set out to catalyze increased funding opportunities for small businesses. Unfortunately, by focusing on equity crowdfunding, the JOBS Act didn’t provide a viable approach for entrepreneurs seeking loans. By adopting several minor amendments to that law, Congress could open up significant new avenues for debt capital formation for small businesses. Not only would this be consistent with the JOBS Act’s original objectives, but it’s also crucial to actually fulfilling them.
3. Improve small business data access
Unlike the consumer credit world, constraints in available data make small business creditworthiness particularly difficult for lenders to assess. For example, there’s no commonly agreed-upon credit score for businesses like there is for consumers. More and better data on small businesses would drive higher loan-approval rates, better pricing, and faster decisions.
As a first step, Congress should pass proposed bipartisan legislation introduced in both chambers by McHenry and Senator Corey Booker (D-NJ), respectively, enabling the IRS to securely transmit tax returns to a lender the instant a loan applicant gives permission. This would turn today’s manual, paper-based process into a digital one, and give lenders the ability to consider a more complete financial picture of applicants.
4. Look forward, not backward
The regulatory landscape hasn’t kept pace with the realities of today’s financial system. This leaves many fintech companies operating in what Harvard Business School analysts have termed a “spaghetti soup” of federal, state, and local rules–many of which were written long before the advent of the internet or suffer from inconsistencies in scope or application. Rules that apply to banks may or may not apply to fintech companies providing identical services, and vice versa.
Federal and state agencies have made varying efforts to modernize regulation for financial innovators, such as charters for fintech companies that offer banking services or state-licensing compacts, but none have succeeded so far. Balancing innovation with protecting customers and our financial system has never been easy, but we can’t let that challenge continue to deprive millions of American small businesses of capital access they need to grow and create jobs.
None of these are new ideas. But they’ve all failed to garner much support from lawmakers, who instead seem content to turn back the clocks for entities that have failed to meet the needs of small businesses and consumers time and again–even irrespective of the Dodd-Frank regulations Congress has just undone. Still, fintech is only going to become a bigger component of our financial system no matter what, and it’s time for Washington to catch up.
Conor French is U.S. General Counsel for Funding Circle, a global platform for small business loans. He also cofounded the Marketplace Lending Association and the Responsible Business Lending Coalition, serves on the Conference of State Bank Supervisors’ Fintech Industry Advisory Panel, and was recently selected as a Presidential Leadership Scholar.