Customer Logins

Obtain the data you need to make the most informed decisions by accessing our extensive portfolio of information, analytics, and expertise. Sign in to the product or service center of your choice.

Customer Logins
Same-Day Analysis

Landmark Financial Sector Overhaul Clears Final Hurdle in U.S.

Published: 16 July 2010
With three Republicans joining the Democrats, the Senate finally passed bold financial regulation reforms yesterday that promise to reshape the sector and hopefully prevent a re-run of the 2008/09 crisis.

IHS Global Insight Perspective



The Senate vote was the last hurdle before President Barack Obama signs the reforms into law, and came only after agonising brinkmanship.


The reforms give the government considerable new powers over the sector and will adjust the business models of many players. Consumers are also afforded greater protection against unscrupulous players with the establishment of a new agency.


In general, the design of the reforms appears sensible, but their full impact will not be known until the detailed rules are written and the new system is tested in practice.

Congress Gives Green Light

After months of bargaining and brinkmanship, Democrats have managed to squeeze a major overhaul of financial-sector regulation through Congress. The final hurdle was Senate assent, with the House of Representatives already having given its approval. The final Senate vote carried 60-39 yesterday, Democrats requiring three Republican votes to get to the 60-seat super-majority required to overcome blocking tactics. The three broke ranks with their party despite the intensely partisan atmosphere in the build-up to the November mid-term elections. The bill now goes to President Barack Obama for his signature. As with healthcare reform—which successfully passed earlier this year—the financial overhaul came perilously close to unravelling on numerous occasions. It is a testament to the political skills of the Democratic leaders in Congress and of Obama himself that the legislation somehow survived to see the light of day. What is more, in both cases the reforms were not watered-down significantly in the process.

The regulations are very wide-ranging and will have profound structural implications for the sector, but at the same time there are concerns that they will still leave the door open to the kind of excessive risk-taking that contributed to the financial crisis of 2008/09. Banks have campaigned vociferously against elements of the overhaul, but broadly they seem confident that they can survive and prosper in the new environment. The full impact and shape of the reforms will not be known until detailed rules have been written by the various regulatory agencies. There is much to play for during this process, so there will be another huge onslaught of lobbying. Republicans opposed the reforms on the basis that they could choke the banking industry and reduce credit, and for expanding government dangerously.

A Closer Look at Reforms

The bill addresses key issues such as revamping and streamlining the structure of the financial and regulatory system, the role of the Federal Reserve, systemic risk mitigation, the "too big to fail" principle, and stabilising the massive financial derivatives market. The final version of the bill stripped out many of the more controversial proposals—including regular audits of the Federal Reserve, restricting the Fed's supervisory ambit, carving all proprietary and derivatives trading from the banking systems, and overly punitive fees. The "Volcker rule" was substantially watered down, with banks retaining the ability to conduct proprietary trading up to 3% of Tier 1 capital, and banks are still permitted to engage in a wide range of core derivatives trading, including interest rate, foreign exchange, and gold/silver. Only the most risky commodity derivatives would have to be spun off into affiliates. The bank fee to cover future large bank failures to be collected by the Federal Deposit Insurance Corporation (FDIC) was scaled back from US$50 billion to only US$19 billion.

The ten major elements can be summarised as follows:

  • A modified "Volcker rule", whereby banks can engage in propriety trading through investments in hedge and private equity funds up to 3% of Tier 1 capital.
  • "Standardised" derivatives transactions to take place on registered exchanges under Commodity Futures Trading Commission (CFTC) supervision with enhanced reporting requirements. Customised derivatives still need to be reported to regulators. Overall derivative prudential standards would be tightened up.
  • Banks still allowed to conduct derivatives and swaps for interest rates, foreign exchange, and gold and silver, but trading in other commodities would be pushed out to affiliates.
  • Revamped bank capital standards, including the removal of trust-preferred securities as Tier 1 capital with a five-year phase-in period.
  • Treasury to form a "Financial Stability Oversight Council" to oversee the broader financial markets and monitor systemic risks to the financial system and the economy.
  • An "Orderly Liquidation Authority" established that creates mechanisms for liquidating systemically important firms under the FDIC. Banks with assets over US$50 billion would have to pay fees to create a fund of US$19 billion over 10 years.
  • The role of the Securities and Exchange Commission (SEC) will be substantially expanded, with additional registration and systemic risk-reporting requirements for derivatives traders and large hedge funds. The SEC is also mandated to oversee credit rating agencies, and study conflicts of interest with a view to potentially greater supervision.
  • Originators of mortgage-backed securities and other collateralised debt obligations (CDOs) to hold at least 5% of the credit risk.
  • Establish an "Office of National Insurance" under the Treasury to monitor industry, identify national insurance issues, and establish standards and report on insurance industry systemic risk issues. A "Bureau of Consumer Financial Protection" would be created under the Federal Reserve.
  • Federal Reserve supervisory authority over banks remains intact, including thousands of community banks. Congress requires only a one-time audit of all of the Fed's emergency programmes from the financial crisis. Details of loans through the discount window and open-market operations to be released after two years, while bankers would not be allowed to select the presidents of the regional banks.

Outlook and Implications

The financial reform bill addresses a number of key weaknesses in the U.S. financial regulatory structure that led to the financial meltdown in 2008 and early 2009. The most important of these elements is to streamline the existing regulatory structure, expand regulated frameworks for standardised derivatives, subject the credit rating agencies to greater accountability, and create a mechanism for liquidating systemically important firms. In addition, the bill attempts to accomplish all of this without severely handcuffing the major banks or seriously undermining the pre-eminent competitive position of the U.S. money centre banks in global financial markets. Thus, there is at least a thread of common sense in this bill—a thread which was difficult to detect in the early stages of negotiation. The financial sector overhaul does not stop here; as mentioned above, the detailed rule writing will determine the reach of the reforms, and the administration has also indicated that it will move on to consider the future of the government-run mortgage finance giants Fannie Mae and Freddie Mac. They emerged as key weak links in the system during the crisis. This may be an easier legislative task as there are many Republicans who have called for change in this area.

Politically, the breakthrough is another important success for Obama's administration in the face of ferocious opposition. Recent months have also seen healthcare reform proceed and several important foreign policy achievements. The domestic victories have come at a price, however, and Obama's popularity has been weakening in recent polls. His opponents' charge that he is expanding government dangerously has struck a chord with many voters. The weakening economic recovery is adding to the sense of gloom and doubt over Obama's strategy. The Democrats are braced for heavy losses in the November mid-term elections, which would make legislative progress on bold initiatives much harder over the following two years. One key outstanding priority for Obama is comprehensive energy and environment legislation. The administration remains committed to bold changes in this area, but for now is proceeding with a scaled-back bill given the political realities. In future, Obama will have to pick out priorities that he knows will find some support among the Republicans. He is also likely to focus more on foreign affairs if he finds himself frustrated domestically.

Filter Sort