Too Early to Tell if Dodd-Frank Ends “Too Big To Fail”

Bradley Sabel is partner and co-head of the Financial Institutions Advisory & Financial Regulatory practice group at Shearman & Sterling LLP. This post is based on a Shearman & Sterling client publication by Donald N. Lamson and David L. Portilla; the full text, including footnotes, diagram, and chart, is available here.

The debate regarding “too big to fail” (“TBTF”) has reemerged as a focus of regulators, legislators and the media. We review the regulatory activity since the Dodd-Frank Act was enacted and show that new proposals intended to address TBTF tend to put the policy cart before the regulatory implementation horse.

By our count, regulators have amassed over 1,650 pages in proposed and final rules that seek to address TBTF, which we roughly define as proposals that seek to limit the size of financial institutions, the scope of their activities or otherwise seek to protect the Federal safety net (which we use as a term to refer to any Federal assistance, including deposit insurance). In addition, there are provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act (“DFA”) which address TBTF that do not require rulemaking.

Despite this volume of regulatory work to implement the DFA’s reforms, which is mostly not yet complete, proposals for new measures are being put forward, including:

  • legislation sponsored by Senators Sherrod Brown (D-Ohio) and David Vitter (R-Louisiana) that would impose new capital requirements that are significantly higher than those in place today, place limits on transactions banks can enter into with affiliates and place new restrictions on the use of the Federal safety net; [1]
  • a proposal by Federal Reserve Governor Daniel Tarullo to place a cap on a bank’s non-deposit liabilities as a fraction of US gross domestic product; [2]
  • a proposal by Federal Reserve Governor Daniel Tarullo to implement additional capital surcharges for institutions reliant on short-term funding; [3] and
  • a proposal by Richard Fisher, the President of the Federal Reserve Bank of Dallas, to limit access to deposit insurance and discount window loans to commercial banks. [4]

In addition to these proposals, additional reforms are being discussed in the United Kingdom and European Union, such as legislation to implement the “Vickers Report” in the United Kingdom and the “Liikanen Report” in various EU jurisdictions.

This note includes two parts. The first part (available here) is a diagram showing that the majority of the DFA’s reforms that are most directly intended to address TBTF are aimed at limiting the scope of financial institution activities. These proposals also may limit size indirectly. Other proposals do not directly address size or scope (although they may indirectly), but are intended to limit risks to the Federal safety net. Our diagram shows these distinctions. Of course, to some degree, most of the DFA is intended to address TBTF, and so the proposals highlighted below are inherently under-inclusive and represent more of a “top ten” list than a comprehensive cataloguing. For example, derivatives reforms seek to bolster the stability of that market and its largest participants, and reforms to the mortgage and securitization markets are intended to address shortcomings that were exposed during the crisis and led to significant losses at financial institutions (but are not included on the diagram). But the proposals noted in the diagram are the ten aspects of the DFA that we judge to be most directly aimed at the size and activities of large banking organizations, and that should be completed before any new reform proposals are considered.

The second part (available here) is a chart that accompanies (and, in a soft copy of this note, is clickable from) the diagram and provides summary explanations of the ways in which the proposals noted in the diagram affect size and scope. This chart provides links to the relevant primary source materials and Shearman & Sterling client publications on these issues.

While categorizing these reforms in this way cannot be scientifically precise, we seek to demonstrate that the DFA includes significant new regulatory tools to address TBTF, and most of these tools are not yet fully developed. Before new reforms are introduced, policymakers should take stock of the reforms in the DFA, not even three years old, and wait until these reforms are implemented by regulators and absorbed and understood by the market before initiating further action.

The full publication, including detailed diagram and chart regarding regulatory efforts to end TBTF, is available here.


[1] S. 798, 113th Cong. (2013), available here.
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[2] Daniel Tarullo, Governor of the Board of Governors of the Federal Reserve System, “Industry Structure and Systemic Risk Regulation” (Dec. 4, 2012), available here.
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[3] Daniel Tarullo, Governor of the Board of Governors of the Federal Reserve System, “Evaluating Progress in Regulatory Reforms to Promote Financial Stability” (May 3, 2013), available here.
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[4] Richard Fisher, President, Federal Reserve Bank of Dallas, “Ending ‘Too Big to Fail’: A Proposal for Reform Before It’s Too Late (With Reference to Patrick Henry, Complexity and Reality)” (Jan. 16, 2013), available here.
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One Comment

  1. dan weston
    Posted Monday, June 17, 2013 at 12:46 am | Permalink

    Dodd-Frank didn’t *start* TBTF, nor will it *end* TBTF.

    The question is: Who and what allowed SDI’s to emerge, and to fail, then escape (formerly) compulsory bankruptcy / re-org rules and regs?

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