THE SENATE has authorized a financial- regulation bill that adjusts the Dodd-Frank Act framework enacted eight years ago in the aftermath of the worst financial crisis since the Great Depression. At the moment, final passage is stalled, because of a conflict with the House, which wants a commitment from the Senate to vote on additional provisions — including a good number that were adopted on a bipartisan basis in the House. This is an unwelcome development to the extent that it delays passage of the measure’s innocuous provisions, such as regulatory relief for small community banks. The delay is welcome, though, to the extent that it gives both chambers time to reconsider the bill’s more dubious provisions, such as the potential redesignation of banks with up to $250 billion in assets as no longer subject to the strictest level of supervision.
An especially questionable provision would relax Dodd-Frank rules for the arcane but crucial business of custodian banking. In contrast to full-service commercial banks, custodian banks specialize in taking deposits from other large financial institutions. They make their money charging fees for this and other services, rather than by lending, as ordinary commercial banks do. Three large institutions — Bank of New York Mellon , State Street and Northern Trust — dominate the business, with combined assets of $720 billion in 2017. Under Dodd-Frank, the custodian banks must meet the same capital requirements as other giants, for the sake of overall systemic stability. However, they argue that their business is inherently less risky, since they redeposit a lot of the funds they take in at the rock-solid Federal Reserve, and should therefore be allowed to hold smaller capital cushions. The Senate bill provides this relief, as the banks’ lobbyists requested, and as the Trump administration recommended last year.
The problem is that, while a handful of banks provide custodian services as their main business, more than 30 others — including giants such as JPMorgan Chase and Citigroup — also engage in it to a certain degree. They don’t see why they should not get the same credit for their deposits at the Fed, and their argument does have consistency on its side. If only the three biggest custodian banks get regulatory relief, they would acquire a permanent competitive advantage, which, over time, would reduce competition, which would itself destabilize the system. The Senate bill was not drafted in such a way as to require that JPMorgan Chase and Citigroup get the same deal as the three largest custodian banks, but the Congressional Budget Office puts the chances at 50 percent that regulators could interpret it as so. Then all the other banks would demand similar treatment, and pretty soon the whole carefully constructed Dodd-Frank system for ensuring adequate bank capital would be undermined.
If the financial crisis should have taught us anything, it is that financial risks may lurk even in segments of the system that seem secure. The Senate ignored that lesson, but there is still time to correct the mistake.