The U.S. Senate recently passed a bill to relax certain banking regulations, and the biggest change is that the definition of a Systemically Important Financial Institution, or SIFI, would change dramatically. In this clip, Michael Douglass and Matt Frankel break down what a SIFI is and what the changes would mean to the roughly two dozen banks that would be affected.

A full transcript follows the video.

This video was recorded on March 19, 2018.

Michael Douglass: Let's talk about the biggest part of this legislation, or certainly the headline number, which is the asset requirement to be considered a systemic important financial institution, or, as we call it around here, a SIFI, would rise from $50 billion in assets to $250 billion in assets. But first, let's talk a little bit about what a SIFI is.

Matt Frankel: A SIFI is basically an institution, you've heard the term too big to fail. This would be an institution that, if it fails, could really threaten the stability of our financial system in this country. In the wake of the financial crisis, there were these reforms put into place to control what was defined as a SIFI, first of all, because that's a new thing, and to watch them a little closer than you would, say, a smaller bank. So, the effect of this is, SIFIs have higher regulatory expenses than other banks and are required to keep higher capital levels and don't really control their own dividend and buyback policies and things of that nature.

Douglass: Right. Essentially, if you're a SIFI, it's going to be a little bit harder for you to compete with everyone else. On the flip side of that is this idea that SIFIs also have a scale advantage. They are the largest institutions. And this proposed shift from $50 billion in assets to $250 billion in assets means that the number of banks in that group would drop from around 40 to around a dozen. So, it would really take us to the very biggest ones, and your household names, folks like JPMorgan, Bank of America, Citigroup, Wells Fargo, instead of hopping down further and further into a lot of banks, some of which a lot of listeners of the show will probably have never heard of.

But, let's also consider this on the flip side, thinking about this through the lens of the financial crisis. Lehman Brothers had $600 billion in assets when things started going south. So, they certainly would have been, in this proposed new framework, they would still be considered a SIFI. But subprime mortgage lender Countrywide had $211.7 billion in assets at the end of 2007. Remember that Bank of America bought it in January of '08. So, it would not be considered a SIFI under this new framework. And yet, when Country-Wide failed, a lot of really bad, big things happened pretty quickly.

Frankel: Right. I wouldn't put the Country-Wide failure in the same league as the Lehman Brothers failure in terms of the threat to the financial system.

Douglass: That is very true.

Frankel: But, that's kind of the point of this. And it's kind of a fluid concept. There's no real perfect answer to where the actual cutoff is, which is kind of what they're trying to figure out. When things like the financial crisis happen, you tend to see really knee-jerk reactions to make sure things don't happen again, and rightly so. And what happens is, things tend to go a little too far in the other direction. And what they're trying to do now is find the correct point.

Douglass: It's interesting, because the way they've set it up is essentially, banks up to $100 billion in assets would immediately be not subject to SIFI requirements. From the $100-250 billion in assets group, they would be subject to some of the requirements for a little while longer. And then, further down the line, the Fed would still do some stress tests on that group, and they'd have the ability to demand more regulatory responsiveness from those banks when they needed to, when they felt that was appropriate. But it wouldn't be at the same level of consistency that you would have for the over $250 billion group.

Frankel: Right. And like you said, this is a very fluid idea. There's no telling what it's going to look like in the final draft. But $50 billion is too low. Everyone pretty much agrees on that. Barney Frank himself, who the Dodd-Frank legislation is partially named for, recently came out and said, the real number is probably around $125 billion. He said $50 billion was a little bit low, but $250 billion might be a little too high. It excludes some banks that we really should probably keep a close eye on. He mentioned the Country-Wide situation. So, under what Barney Frank would want to do, Country-Wide would still be considered a SIFI, under his ideal situation. So, we'll see where it actually ends up. There's going to be some wiggle room before the final legislation goes for a vote.

Douglass: Right. And the thing that we just talked about is this piece that, the Fed would have the ability to do some things when they felt it was appropriate. To quote Fed chair Jerome Powell, he gave some testament on this, he said the Fed would have "the tools that we need" to apply where necessary.

Now I'll say, on the flip side of that is the fact that, when the Financial Crisis Inquiry Commission, which was a panel specifically designed to take a look at the financial crisis and comment on what things should have been done differently, they had some pretty nasty things to say about regulators at the time. The Fed "had a pivotal failure to stem the flow of toxic mortgages." And the SEC "failed to restrict banks' risky activities, did not require them to hold adequate capital and liquidity for their activities." This, thanks for the Washington Post's excellent reporting on that commission's findings.

So, there's a lot of stuff here that's up to discretion of regulators. And regulators haven't always shown themselves to really be appropriately aggressive. I'll also throw out there, course, that hindsight is 20/20. And my hope would be that people have learned from this, so regulators would be more active when that's appropriate.

Frankel: Right, but there still a big difference between what regulators could do and what regulators have to do.

Douglass: Right, and that's the piece that we're seeing here with this proposed $100-250 billion, I'm going to call it transition zone, between banks that they think are distinctly not SIFIs and those that are distinctly SIFIs, again, that over $250 billion group. What other thoughts do you have on that, Matt?

Frankel: Like I said, it'll just come to where this ends up in the end and what the Fed is required to do and what they have to do.

Matthew Frankel owns shares of Bank of America. Michael Douglass has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.