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Blame Regulators, Not Congress, for Dodd-Frank Frustrations

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Banks are grappling with the reality of simultaneously implementing two watershed regulatory reforms: Dodd-Frank and Basel III. And while the transition to Basel III is moving along on schedule, Dodd-Frank is teetering on the edge of collapse as regulators fail to put the law into action. The result is uncertainty for banks large and small, and a financial system with systemic issues still unresolved.

Basel III -- early success
The Basel Accords aim to enhance the the global financial system's stability. An international group of regulators sets the rules, which each participating country voluntarily agrees to uphold. Basel III sets out a framework to increase minimum capital and liquidity ratios in response to the financial crisis, on a timeline beginning in 2013 and ending in 2019.

The Basel regulators' greatest success is the simplicity of the regulation and the exceptionally clear expectations for implementing the rules. Basel III first sets forth specific capital ratio targets based on the risk on the bank's balance sheet (its "risk weighted assets"). The regulators then set forth a defined timeline for implementation. The regulators then said that they would observe liquidity requirements and publish targets for liquidity ratios in 2015. The entire process can be summarized succinctly in a single page (page 2 of this Ernst and Young report, for example).

And the banks have responded. Each of the four largest U.S. banks now reports its Basel III capital ratio, and each is moving to full implementation.

JPMorgan Chase (NYSE: JPM  ) reported a Basel III ratio of 8.9% for Q1, an improvement from Q4's 8.7%. Bank of America (NYSE: BAC  ) has been aggressively reducing its risk-weighted assets, which has sent its Basel III capital ratio skyrocketing from 7.95% in Q2 2012 to 9.52% in Q1 2013. Citigroup (NYSE: C  ) reported a 9.3% ratio, and Wells Fargo (NYSE: WFC  ) reported 8.39%.

As a group, the nation's largest banks are proactively and successfully preparing their balance sheets for full Basel III implementation. Unfortunately, U.S. regulators are not making the transition to Dodd-Frank so easy.

Three years and little progress
The finalized Dodd-Frank bill encompasses 848 pages of legislation, and lawmakers delegated to regulators the final rulemaking and implementation of the law. Since then, those regulators have written 8,843 pages (and counting!) of rules and regulations to implement the law. Worse yet, experts estimate that it is less than 1/3 finished.

Make no mistake: The U.S. needs financial reform. But with a rulebook approaching 10,000 pages and growing daily, it's wholly unreasonable to expect banks to keep following those rules.

With typical bravado, JPMorgan CEO Jamie Dimon told BusinessWeek in early 2012 that, "If you want to be trading, you have to have a lawyer and a psychiatrist sitting next to you determining what was your intent every time you did something."

For the regulators, it may be too late. Looking back to the savings and loan crisis of the late 1980s, Congress initially passed the Financial Institutions Reform, Recovery and Enforcement Act in 1989. After only two years, legislators deemed the initial bill insufficient and passed the FDIC Improvement Act. Don't be surprised if financial reform is once again being debated on Capitol Hill in 2014, this time with an eye toward overhauling the regulatory agencies that failed to implement Dodd-Frank.

A lesson for regulators
Our financial system's problems need to be addressed, but the regulators have mangled the legislation into an overly complex, convoluted, and ineffective apparatus.

And yet, despite Dodd-Frank's slow progress, there is hope. Basel III is moving along as planned, and history has many examples of effective regulations. Glass-Steagall, a very pertinent example, worked pretty well for 60-plus years. The common theme for both successful efforts? Simplicity and clear expectations.

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