Tiered Regulation: Good or Bad for Banks?

March 25, 2015 | Charles Bowen


Is Tiered Regulation good or bad for banks?



It depends on the type and size of the bank and its respective regulatory requirements.

Known as “The Great Recession,” the major economic decline of the late 2000s continues to have significant impact on the performance and regulation of markets in the United States and globally. The unemployment rate in the U.S. doubled when over 7.5 million jobs were lost, home values plummeted, businesses failed and trillions of dollars in net worth evaporated. Much of the decline is blamed on a systematic failure in the real estate market and the marketing of mortgage backed securities (MBSs) and derivative products by financial institutions.


In the wake of the recession, the Dodd-Frank Wall Street Reform and Consumer Protection Act (often referred to as “Dodd-Frank”) was signed into federal law in July of 2010 by President Obama. With the goal of preventing future financial crises as the result of excessive risk-trading, Dodd-Frank sets out many rules intended to “build a safer, more stable financial system.”Banking regulation

Industry Regulation

While there were once more than 18,000 banks in the U.S., there are now fewer than 7,000 federally insured institutions nationwide. There are also around 7,000 credit unions which provide many of the same financial services as banks but are member run and not-for-profit organizations. The relative size of financial institutions varies greatly and there are several regulatory agencies that oversee them including:

  • Federal Deposit Insurance Corporation (FDIC)

  • Board of Governors of the Federal Reserve System (The Fed)

  • Federal Financial Institutions Examination Council (FFIEC)

  • National Credit Union Administration (NCUA)

  • Office of the Comptroller of the Currency (OCC), part of the U.S. Department of Treasury

Tiered Regulation Overview

Consistent with Dodd-Frank, the Fed and other regulatory agencies are taking a tiered approach to banking supervision and regulation. Institutions are categorized based on their size (assets held), complexity and “level of risk they pose to the overall financial system” which dictates the  level of regulation and oversight for each tier. The Fed currently groups banks as follows:

  1. Community Banks: assets of $10 billion or less.

  2. Regional Banking Organizations: assets between $10 billion and $50 billion.

  3. Large Banking Organizations: assets greater than $50 billion.

  4. Systemically Important Financial Institutions (SIFI): assets greater than $50 billion and whose collapse would pose a serious risk to the economy (often referred to as “too big to fail”). Recently there has been growing pressure to raise the asset threshold for this category to as much as $250 billion.

The Case For

The list of U.S. SIFIs is currently around 25 institutions and the number of large regional banks is about the same; over 85% of banks nationwide are community banks. These smaller banks are critically important to community lending and the financial system as a whole. While they hold only 20% of all bank assets, community banks make nearly 60% of small business loans.

community bankOver the past seven years, regulators have published nearly 10,000 detailed rules and regulations for the banking industry. Staying abreast of these rules (not to mention the administrative effort required to ensure they are being adhered to) can be a significant financial burden to banking institutions, particularly smaller organizations. As Rob Braswell, resident and chief executive of the Community Bankers Association of Georgia and the former Banking Commissioner for the State of Georgia wrote about recently in American Banker, a proposed bill called the Community Lending Enhancement and Regulatory Relief Act, or the CLEAR Relief Act, is gaining bipartisan support. The goal of this bill is to provide community banks some regulatory relief, “allowing them to once again be the economic engines of their local communities for years to come.”

The Case Against

When written, the tiered regulations authorized by the Dodd-Frank Act used size (asset holdings) as the primary corollary to risk. Thus, the larger the bank, the greater the number and strictness of the regulations. An article written by Thomas Vartanian and David Ansell, partners at the international law firm Dechert LLP, details many of the regulations that are imposed on banks at various tiers including:

  • Quantitative minimum liquidity;

  • Higher capital requirements - supplementary leverage ratios ranging from 3-6%;

  • Leverage buffer rules;

  • Countercyclical capital buffers;

  • Employee incentive compensation limits;

  • Monthly or annual internal stress tests;

  • Annual resolution plans known as “living wills”;

  • Annual capital plans; and

  • Caps on merchant interchange fees on debit card purchases.

Vartanian and Ansell argue that “The fact that regulation is increasingly geared to size imposes a progressive growth tax on banks [and] will affect almost every operational and strategic decision that banks make going forward.” If regulation continues to escalate, banks will have to weigh the financial benefits of growth against the cost and limitation of regulation.

Bottom Line

Banks provide valuable credit and liquidity services to households and businesses. The banking industry is a large, complex and integral component of the local, national and global economies. Regulation is required in order to limit unnecessary risks associated with short term strategies. With such a wide variance between the size, structure and practices of various banking institutions, a one size fits all approach is not practical. Thus tiered regulation makes sense in theory, but the question really becomes exactly how are tiers defined (i.e., is size truly representative of risk?) and what is the level of regulation at each tier that will actually achieve the goals of risk reduction without discouraging healthy growth? These questions are being considered by the Fed; adjustments will take place and new regulations will undoubtedly surface (read a recent post about Georgia Banking Law changes here). Only time will tell whether they will actually further their intended goals.


Topics: Georgia Banking Law