What are the benefits of banking regulation

USA relax banking rules: what does that mean for Europe?

With the banking, financial and economic crisis, people became aware of two buzzwords: "Too big to fail" and "Bank bail-outs". The Dodd-Frank Act in the USA was supposed to get both problems under control. Banks or insurers are too big to fail if their failure threatens the financial system as a whole, i.e. if they are systemically important. In the wake of the crisis almost exactly 10 years ago, many financial institutions that were considered systemically important had to be rescued with sums of billions from the tax pots of states: They had to be bailed out of what is known as the English bail-out.

As a result, most states introduced stricter regulations designed to prevent this from happening. For example, the Dodd-Frank Act in the USA required banks with total assets of over 50 billion dollars to carry out regular stress tests. It tested how the banks react to poorer conditions on the financial markets. Those who failed had to make improvements and ensure more stability and security in their own house. For example, with a higher share of your own capital.

Tailwind for US banks

The Donald Trump administration will now raise the threshold for these tests - from 50 to 250 billion dollars of the assets under management of a bank. The aim is to encourage smaller banks up to this limit to be able to take more risks again, for example by extending more loans to the economy. That should benefit the economy. Some experts doubt whether this will really happen as a result of the deregulation that has now been decided. In any case, the US banks had already received a tailwind from their president - because they too are profiting from the US tax reform.

The new advance in deregulation in the banking sector and the tax reform are thus giving US banks advantages that credit institutions in other regions of the world do not have for the time being, or in other words: in case of doubt, the measures bring disadvantages for competitors in other regions of the world - for example in Europe. "You can clearly see that the regulation gap in the banking sector is widening even further," says Johannes-Jörg Riegler, President of the Federal Association of Public Banks. "We are discussing much smaller amounts of money. Regulation should be uniform. This is the only way to ensure competitiveness between the USA, Europe and China."

That should become increasingly difficult under the current US President, who likes to emphasize his motto "America First" out loud. And the gap between different regulations in the financial sector could widen even further. Because the dismantling of the Dodd-Frank rules is probably not yet completed with the loosening of banking regulation that has now been decided.

New danger looms

The "Volcker rule", named after a former US Federal Reserve chief, is a thorn in the side of the investment banks in particular. This standard prohibits US banks from speculating on their own account in order to better protect customer deposits. The US Federal Reserve and other US authorities are already working on a draft for a lighter restriction of this speculation. "I see a danger in that," says banking expert Wolfgang Gerke, President of the Bavarian Finance Center. "Actually, this is a limit that must not be crossed again. But President Donald Trump doesn't care about such limits anyway."

Apart from the fact that the risks for the financial system in the USA are likely to increase, relaxation of regulation in one part of the world is also putting pressure on other parts. This could ultimately lead to a downward spiral in banking regulation. The banking association points out that the European and German banks could be left behind. "The European institutes are in danger of falling further behind and losing business shares," stated the chief executive officer of the banking association, Christian Ossig.

The banking expert Wolfgang Gerke currently does not consider the risk of a downward spiral in banking regulation in Europe to be too great. "But it is quite conceivable that for competitive reasons we will also be forced to liberalize in the future. That would be a dramatic mistake. Because it would of course make the next financial crisis more likely. And then the question arises of how many banks would survive it. "