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The Double-Barreled Regulatory Assault on Retail Banking

March 28th, 2012 |

shotgun.jpgFollowing the financial crisis, one can cite any number of areas where the regulatory pendulum has swung too far.  Retail banking is one of those areas.  The Dodd-Frank Wall Street Reform and Consumer Protection Act ushered in a new—and an oddly schizophrenic—regulatory regime for retail bankers.

The premise of the new legislation is that, had the prior retail banking regulatory regime been different, material aspects of the financial crisis would have been averted.  In particular, proponents of the legislation asserted that federal bank regulators focused on safety and soundness considerations significantly to the exclusion of consumer protection.

Whether these problems were real or imagined, they were given a legislative “solution.”  Dodd-Frank created a new federal super-regulator for consumer financial services regulation, the Bureau of Consumer Financial Protection (CFPB).  With generous funding and a singular focus on consumer protection without regard for prudential considerations, the CFPB has a host of unprecedented powers, including:

  • rulewriting authority for 18 federal consumer credit laws;
  • authority to issue rules implementing the new consumer protections added by Dodd-Frank, most notably the statute’s open-ended proscription on unfair, deceptive or abusive practices;
  • direct compliance-related supervisory authority for banks with total assets of more than $10 billion.

In other parts of the Dodd-Frank legislation, however, Congress seems to have forgotten that the CFPB was the “solution” to the perceived problem of lax federal oversight.  Notwithstanding the CFPB’s creation, Dodd-Frank ushers in a wholly separate alternative “solution.”  Specifically, Dodd-Frank increased state enforcement authority.  State attorneys general, in particular, in effect have been deputized to enforce aspects of federal consumer financial protection law.  Dodd-Frank also erected an array of barriers to federal preemption, the principle by which banks that operate on a multi-state basis often are permitted to follow a single uniform federal standard rather than a hodgepodge of different and potentially inconsistent state laws.

Although federally chartered banks and thrifts will bear the worst of the new anti-preemption changes, state chartered banks also stand to lose some of the preemption efficiencies they have enjoyed.  Many preemption rules apply without regard to charter type and, even where preemption is specific to federally chartered banks, most states have some variety of “wildcard” statute offering state banks parity with their federal counterparts.

It was shortsighted to have concluded that preemption is always contrary to consumer interests and that rolling back preemption and hamstringing it in the future ensures better public policy.  Let us recall some examples from a prior financial crisis— the extraordinarily high interest rate environment of the late 1970s and early 1980s when the prime rate of interest, at its peak, skyrocketed to 21 percent.

  • Many state usury limits were set at well below market rates of interest.  Credit, particularly housing credit, was unavailable to consumers as banks were forbidden from charging rates at prevailing market levels.  The solution was federal preemption of mortgage loan interest rates.
  • In that extreme rate environment, banks and consumers alike often preferred adjustable rate mortgages.  ARMs would have reduced the bank’s risk of rate volatility, and consumers with immediate housing credit needs could have avoided locking in historically high rates for the long term.  Unfortunately, this was not possible in a number of states that mandated that loans have level payments that could not vary over the life of the loan.  The solution was federal preemption of these state rules.
  • Also during this era, consumers did not always get the rates and other mortgage loan terms they deserved based on their credit history.  Various states prohibited “due-on-sale clauses,” the contractual provisions permitting a bank to deem the entire note due and payable upon sale of the property.  Under these laws, mortgage loans became “assumable” by any purchaser of the property, including one less creditworthy than the initial borrower.  Hence, the initial borrower was forced to pay a risk premium even if he or she had no intentions of selling.  The solution, again, was federal preemption of state prohibitions on due-on-sale clauses. 

These examples demonstrate that states are not always the best source of enlightened retail banking public policy (or always nimble in making adjustments in a crisis).  These examples also show that preemption can be pro-consumer and an important tool in meeting an economic crisis.

Unfortunately, these policy lessons of the past seem to have been lost.  Retail bankers now face a double-barreled assault focused on consumer protection from the CFPB and the states.  Either one of these “solutions” to perceived regulatory failures of the past would have prompted bankers substantially to tighten their internal consumer compliance controls.  Facing both “solutions” simultaneously means that compliance must be a high priority at every level of the bank, starting at the board of directors.

wzalenski

Walter E. Zalenski is a partner in the Washington, DC office of Weil, Gotshal & Manges LLP and has practiced in the area of consumer financial services and banking law for over 25 years.   Zalenski is engaged in a broad practice consisting of retail banking, residential real estate finance, consumer privacy law, electronic consumer finance and due diligence counseling in connection with mergers and acquisitions. He also defends banks in connection with enforcement actions and class actions involving claims under federal and state consumer credit protection legislation.  

 

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