Dodd-Frank Regulations: Impacts on Community Banks, Credit Unions and Systemically Important Institutions
Released: 2015-12-30T00:00:00

Letter

Background

Federal Prudential Regulators

In the banking industry, the specific regulatory configuration generally depends on the type of charter the banking institution chooses. Depository institution charter types include commercial banks, which originally focused on the banking needs of businesses but over time have broadened their services; thrifts, which include savings associations and savings and loans, and were originally created to serve the needs—particularly the mortgage needs—of those not served by commercial banks; and credit unions, which are member-owned cooperatives run by member- elected boards with an historical emphasis on serving people of modest means.

All depository institutions that have federal deposit insurance have a federal prudential regulator that generally may issue regulations and take enforcement actions against institutions within its jurisdiction. These regulators also oversee depository institutions for safety and soundness purposes and compliance with other laws and regulations. Holding companies that own or control a bank or thrift are subject to Federal Reserve supervision. The Bank Holding Company Act of 1956 and the Home Owners’ Loan Act set forth regulatory frameworks for bank holding companies and thrift holding companies, respectively. The Dodd-Frank Act made the Federal Reserve the regulator of thrift holding companies and amended the Home Owners’ Loan Act and the Bank Holding Company Act to create certain similar requirements for bank and thrift holding companies. The prudential regulators are identified in table 1.

Securities and Futures Regulators

The securities and futures markets are regulated under a combination of self-regulation (subject to oversight by the appropriate federal regulator) and direct oversight by the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC), respectively. SEC regulates the securities markets, including participants such as securities exchanges, broker-dealers, investment companies, corporate issuers, and certain investment advisers and municipal advisors. SEC’s mission is to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation. SEC also oversees self- regulatory organizations—including securities exchanges, clearing agencies, and the Financial Industry Regulatory Authority. These organizations have responsibility for overseeing securities markets and their members; establishing the standards under which their members conduct business; monitoring business conduct; and bringing disciplinary actions against members for violating applicable federal statutes, SEC’s rules, and their own rules.

CFTC is the primary regulator of futures markets, including futures exchanges and intermediaries, such as futures commission merchants. CFTC’s mission is to protect market users and the public from fraud, manipulation, abusive practices, and systemic risk related to derivatives subject to the Commodity Exchange Act, and to foster open, competitive, and financially sound futures markets. CFTC oversees the registration of intermediaries and relies on self-regulatory organizations, including the futures exchanges and the National Futures Association, to establish and enforce rules for member behavior. CFTC and SEC jointly regulate security futures (generally futures on single securities and narrow-based security indexes). In addition, Title VII of the Dodd-Frank Act expands regulatory responsibilities for CFTC and SEC by establishing a new regulatory framework for swaps. The act authorizes CFTC to regulate swaps and SEC to regulate security-based swaps with the goals of reducing risk, increasing transparency, and promoting market integrity in the financial system. CFTC and SEC share authority over mixed swaps— security-based swaps that have a commodity component.

Consumer Financial Protection Bureau

The Dodd-Frank Act transferred consumer protection oversight and other authorities regarding certain consumer financial protection laws and institutions from multiple federal regulators to CFPB, creating a single federal entity to help, among other things, foster consistent enforcement of federal consumer financial laws. The Dodd-Frank Act charged CFPB with the following responsibilities, among others: ensuring that consumers are provided with timely and understandable information to make responsible decisions about financial transactions; ensuring that consumers are protected from unfair, deceptive, or abusive acts and practices, and from discrimination; monitoring compliance with federal consumer financial law and taking appropriate enforcement action to address violations; identifying and addressing outdated, unnecessary, or unduly burdensome regulations; ensuring that federal consumer financial law is enforced consistently, without regard to the status of a person as a depository institution, in order to promote fair competition; ensuring that markets for consumer financial products and services operate transparently and efficiently to facilitate access and innovation; and conducting financial education programs.

Furthermore, the Dodd-Frank Act gave CFPB consumer protection supervisory authority over certain nondepository institutions, including, among others, certain mortgage market participants, private student loan lenders, and payday loan lenders.

Financial Stability Oversight Council

The Dodd-Frank Act also established the FSOC to identify risks to the financial stability of the United States, promote market discipline, and respond to emerging threats to the stability of the U.S. financial system. FSOC consists of 10 voting and 5 nonvoting members and is chaired by the Secretary of the Treasury. The 10 voting members are the heads of Treasury, CFPB, CFTC, Federal Deposit Insurance Corporation (FDIC), the Federal Reserve, the Federal Housing Finance Agency (FHFA), NCUA, Office of the Comptroller of the Currency (OCC), and SEC, and an independent member with insurance expertise. The Dodd-Frank Act also established the Office of Financial Research in Treasury to support FSOC and its member agencies by improving the quality, transparency, and accessibility of financial data and information; conducting and sponsoring research related to financial stability; and promoting best practices in risk management. The director of the Office of Financial Research is a nonvoting member of FSOC, along with the director of the Federal Insurance Office, and designated state insurance, securities, and banking regulators.

Dodd-Frank Act Regulations

The Dodd-Frank Act authorizes certain agencies to adopt regulations to implement the act’s provisions and, in some cases, gives the agencies little or no discretion in deciding how to implement the provisions. However, other rulemaking provisions in the act are discretionary in nature, stating that (1) certain agencies may issue rules to implement particular provisions or that the agencies may issue regulations that they decide are “necessary and appropriate,” or (2) agencies must issue regulations to implement particular provisions but have some level of discretion as to the substance of the regulations. As a result, the agencies may decide to promulgate rules for all, some, or none of the provisions, and often have broad discretion to decide what these rules will contain. Many of the provisions in the Dodd-Frank Act target the largest and most complex financial institutions, and regulators have noted that much of the act is not meant to apply to community banks. As such, the act exempts certain small institutions with $10 billion or less in total assets from a number of its provisions and in other provisions authorizes regulators to provide smaller institutions with relief in a number of areas. However, the act is comprehensive and far-reaching and includes some provisions that impose additional requirements on small insured depository institutions. In our September 2012 report, we identified Dodd-Frank Act provisions expected by federal regulators, state regulatory associations, and industry associations to impact community banks and credit unions. Almost 6,200 (about 98 percent) FDIC-insured banks and thrifts had less than $10 billion in assets in 2015. Of those, almost 61 percent had less than $250 million in total assets. The vast majority of credit unions had less than $10 billion in total assets in 2015. Furthermore, around 75 percent of the credit unions had less than $100 million in total assets.

Requirements for Regulatory Analyses in Rulemaking and Retrospective Review

Several regulatory analysis requirements may apply to independent regulators, including the financial regulators. The regulators are subject to compliance with various requirements as part of their rulemakings, such as those in the Paperwork Reduction Act of 1995 (PRA), the Regulatory Flexibility Act (RFA), as amended by the Small Business Regulatory Enforcement Fairness Act of 1996, and the CRA.

PRA requires agencies to minimize the paperwork burden of their rulemakings and evaluate whether a proposed collection is necessary for the proper performance of the functions of the agency. Under PRA, agencies include this analysis in the notice of proposed rulemaking and obtain approval for an information collection from the OMB.

RFA requires that federal agencies consider the impact on small entities of certain regulations they issue and, in some cases, alternatives to lessen regulatory burden on small entities. Although RFA, through reference to the Small Business Act, generally defines the term “small entity,” the statute also sets forth a procedure that permits agencies to formulate their own definitions. For example, NCUA defines small entities to include federally insured credit unions with less than $100 million in assets as opposed to other agencies’ reliance on the Small Business Administration’s definition of a small depository institution (a commercial bank, thrift, or credit union with $550 million or less in total assets) to define a small depository institution that falls under that RFA asset threshold. In some cases, PRA and RFA also require agencies to assess various impacts and costs, respectively, of their rules. However, RFA, like PRA, does not require the agencies to conduct formal benefit and cost analyses.

The Small Business Regulatory Enforcement Fairness Act of 1996, which amended RFA, generally includes judicial review of compliance with certain provisions of RFA and requires agencies to develop one or more small entity compliance guides for each rule or group of related rules for which the agency must prepare a final regulatory flexibility analysis. In addition, when an initial regulatory flexibility analysis is required in connection with a proposed rule, covered agencies like CFPB must convene a review panel and obtain advice and recommendations from representatives of small entities on the effects of the proposed rule on small entities. The initial regulatory flexibility analyses must describe the number of small entities to which the proposed rule would apply, projected reporting and recordkeeping requirements of the proposed rule, any significant alternatives to the proposed rule which accomplish the stated objectives of applicable statutes and which minimize any significant economic impact of the proposed rule on small entities, and any projected increase in the cost of credit for small entities.

Under CRA, before rules can take effect, agencies must submit their rules to Congress and the Comptroller General, and rules deemed major by OMB generally may not become effective until 60 days after the rules are submitted.

In addition to these requirements, authorizing or other statutes require certain financial regulators to consider specific benefits, costs, and impacts of their rulemakings (see table 2). However, like PRA and RFA, none of these authorizing statutes prescribe a benefit and cost analysis that includes the identification and assessment of alternatives.

In contrast, E.O. 12,866, supplemented by E.O. 13,563, requires executive agencies (which do not include independent regulators such as financial regulators), to the extent permitted by law and where applicable, to provide more formal cost-benefit analyses that (1) assess costs and benefits of available regulatory alternatives and (2) include both quantifiable and qualitative measures of benefits and costs in their analysis, recognizing that some costs and benefits are difficult to quantify. Such analysis, according to OMB, can enable an agency to learn if the benefits of a rule are likely to justify the costs and discover which possible alternatives would yield the greatest net benefit or be most cost-effective.

In 2003, OMB issued Circular A-4 to provide guidance to executive agencies on developing regulatory analysis as required by E.O.12,866. The circular defines good regulatory analysis as including a statement of the need for the proposed regulation, an assessment of alternatives, and an evaluation of the costs and benefits of the proposed regulation and the alternatives. It also standardizes the way costs and benefits of regulatory actions should be measured and reported. FSOC and Treasury are subject to E.O. 12,866 and Circular A-4. However, as we have reported, some independent agencies consult Circular A-4 and some have revised their internal rulemaking guidance to more fully incorporate OMB’s regulatory analysis guidance as we had recommended in our 2011 report on Dodd-Frank Act regulation.

The Economic Growth and Regulatory Paperwork Reduction Act of 1996 (EGRPRA) requires OCC, FDIC, and the Federal Reserve, along with the FFIEC, to review their regulations at least every 10 years to identify outdated, unnecessary, or unduly burdensome regulations and consider how to reduce regulatory burden on insured depository institutions. The report from the first EGRPRA review was submitted to Congress in 2007 and the second review is underway. The agencies anticipate completing the current EGRPRA review by the end of 2016. NCUA conducts a voluntary review of its regulations on the same cycle and in a manner consistent with the EGRPRA review. Additionally, per NCUA’s internal policies, NCUA conducts a review of all of its regulations every 3 years and produces a non-binding memo for its board with suggestions on rules that should be revised or streamlined. In a process separate from EGRPRA, CFPB must conduct an assessment of its significant regulations and publish a report of its review 5 years after the regulations take effect.

Agencies Conducted Required Regulatory Analysis and Reported Coordinating as Required on Dodd- Frank Act Rulemakings

In the Federal Register releases of the 26 Dodd-Frank Act rules that we identified and reviewed, the issuing federal agencies conducted the regulatory analyses required by RFA and PRA. The agencies also addressed key elements in OMB’s Circular A-4 for six of the rules that were identified to be major, that is, they resulted or are likely to result in an annual impact on the economy of $100 million or more, a major increase in costs or prices, or significant adverse effects on competition, employment, investment, productivity, innovation, or on the ability of U.S.- based enterprises to compete with foreign-based enterprises in domestic or export markets. Additionally, federal agencies reported coordinating on 11 of the 26 rules and were not required to coordinate for the remaining 15 rules.

Agencies Conducted Required Regulatory Analyses

Of the 26 Dodd-Frank Act rules in our scope, 15 were substantive— generally subject to public notice and comment under APA—and also required some form of regulatory analysis. These rules were issued individually or jointly by CFPB, CFTC, FDIC, the Federal Reserve, FHFA, Department of Housing and Urban Development (HUD), NCUA, OCC, SEC or Treasury. (See app. II for a list of the regulations in our review).

In examining the regulatory analyses the agencies reported they conducted for the 15 substantive rules, we found the following:

Agencies conducted the required regulatory analyses. All the agencies we reviewed conducted the regulatory analyses pursuant to RFA for their Dodd-Frank Act rules, when required or applicable. For example, in the final regulatory flexibility analysis for its rule on Nationally Recognized Statistical Rating Organizations, SEC identified significant issues raised by public comments and included responses; it further determined that small entities may be affected by the rule and identified actions it took to minimize the effect on small entities. The Federal Reserve conducted the flexibility analysis for two of the final rules it issued, although the agency determined that the rules would not have a significant economic impact on a substantial number of small entities. All of the agencies also conducted the analyses required under PRA when required or applicable.

Agencies issued 6 major rules and addressed key elements in OMB’s Circular A-4 for these rules. Of the 15 substantive rules, OMB identified 6 as major rules under CRA. Specifically, SEC issued 5 major rules, and the Federal Reserve, FDIC, FHFA, HUD, OCC, and SEC jointly issued one major rule. Based on our review of all 6 rulemakings, the regulators identified the problems to be addressed by the rule, the potential benefits and costs, the baseline against which they assessed benefits and costs, and the regulatory alternative approaches they considered. They asked for and received public comments on alternatives for all 6 rulemakings. In 4 rulemakings, the regulators quantified the costs; in the 2 cases in which they did not quantify costs, regulators provided reasons why they did not quantify them. Regulators did not quantify benefits for all 6 major rules because the benefits were qualitative or the economic benefits were difficult to quantify.

Agencies Reported Coordinating as Required on Dodd-Frank Act Rulemakings

The rulemaking agencies coordinated as required by the Dodd-Frank Act for 11 of the 26 regulations we reviewed (see app. III). For the remaining 15 of the 26 rules, the agencies were not required by the Dodd-Frank Act to coordinate. We reviewed the rulemakings to document evidence of required coordination among the agencies and found the following:

On three of SEC’s rulemakings related to swaps, the agency reported that it coordinated with CFTC and the prudential regulators pursuant to Title VII of the Dodd-Frank Act. SEC also reported coordinating with foreign regulators on these rules through bilateral and multilateral discussions.

On five of CFPB’s rulemakings, the agency reported that it consulted, or offered to consult with, the prudential regulators and other agencies pursuant to section 1022 of the Dodd-Frank Act. CFPB staff we spoke with stated that CFPB met with agencies to coordinate on the rules.

Several agencies jointly issued two of the rulemakings as required by the act. OCC, Federal Reserve, FDIC, FHFA, SEC, and HUD jointly issued a rule on credit risk retention. Additionally, CFPB, OCC, and the Federal Reserve jointly issued a rule on appraisals for higher- priced mortgage loans.

The Federal Reserve reported that it consulted with CFTC, FSOC, and SEC for its rule on financial market utilities as required by the act.

Most of the agencies stated that they did not encounter any significant challenges in coordination and that they have continued to consult and coordinate with each other.

Community Banks and Credit Unions Cited a Cumulative Compliance Burden Associated with Dodd-Frank Act Rules

Representatives of community banks and credit unions and industry associations with whom we spoke noted an increased compliance burden associated with implementation of Dodd-Frank Act rules. The Dodd-Frank Act includes numerous reforms to strengthen oversight of financial services firms and consolidate certain consumer protection responsibilities within CFPB. In our September 2012 report, we concluded that some provisions, such as the deposit insurance reforms and CFPB supervision of nonbank providers of financial services products, have benefitted or may benefit community banks and credit unions. However, we noted that other provisions—such as some of the act’s mortgage reforms—could negatively affect them depending in part on how regulators implement such provisions and exercise their exemption authority. Some credit union, community bank, and industry association representatives said several of the mortgage-related rules have increased their overall compliance burden, such as increases in staff and training. Additionally, some said these rules had begun to adversely affect some lending activities, such as mortgage lending to customers not typically served by larger financial institutions, even though CFPB provided exemptions or other provisions to reduce such impacts. The results of surveys conducted by regulators, industry associations, and academics on the impact of the Dodd-Frank Act on small banks suggest that there have been moderate to minimal initial reductions in the availability of credit among those responding to the various surveys, and regulatory data to date have not confirmed a negative impact on mortgage lending. Some community bank, credit union, and industry association representatives also identified the impact of nonmortgage-related requirements on business activities.

Regulators told us that it may be too early to assess the full impact of the Dodd-Frank Act rulemakings and while they have heard concerns about an increase in compliance burden, they have not been able to quantify compliance costs. Regulators also said that they are aware of industry concerns about the potential for unintended impacts from Dodd-Frank Act rulemaking and implementation. Regulators are currently engaged in retrospective reviews of rules. In addition, we developed indicators which, when monitored over time, may be suggestive of impact of the regulations on community banks and credit unions.

Industry Officials Reported Mortgage-Related Rules Generally Increased Compliance Burden

CFPB’s implementation of mortgage-related rules imposes additional requirements on community banks and credit unions. In September 2012, we reported that mortgage reform provisions are expected to impose additional burdens on a large percentage of community banks and credit unions. In particular, some regulators and industry representatives expected the reforms to lead smaller institutions to decrease certain lending activities, or, at the extreme, exit the mortgage business. However, we also concluded that the full burden on the entities would depend on the extent to which CFPB (and other agencies) exercised its authority, where available, to exempt small institutions from any regulations and how it implemented provisions to provide more limited relief to small institutions, particularly those in rural or underserved communities.

Since our 2012 report, CFPB issued mortgage-related rules pursuant to Titles X and XIV of the Dodd-Frank Act that became effective by October 2015. Many of these rules amended Regulation X, which implements the Real Estate Settlement Procedures Act (RESPA) of 1974 and Regulation Z, which implements the Truth in Lending Act (TILA). Representatives from credit unions, community banks, and industry associations we interviewed said several of these new rules have increased their overall compliance burden—training staff, allocating time for regulatory compliance matters, and updating compliance systems—and in some cases, have begun to affect mortgage lending. These rules include new disclosure requirements, minimum standards for mortgage loans, and new requirements related to escrow accounts and appraisals for higher- priced mortgage loans and mortgage servicing (see table 3).

CFPB’s integrated mortgage disclosure rule implementing requirements in the Dodd-Frank Act, known as TILA-RESPA Integrated Disclosures (TRID), combines certain disclosures that consumers receive in connection with applying for and closing on a mortgage loan. The purpose of the integrated disclosure is to facilitate compliance with the disclosure requirements of TILA and RESPA and to help the consumer understand the transaction by using plain language for the disclosures.

Representatives from community banks, credit unions, and industry associations we interviewed and CFPB stated that the compliance costs incurred by community banks and credit unions to implement the new disclosures included costs to revise and test software and compliance systems and costs to train employees. Representatives from two community banks and four credit unions we interviewed stated that they had to work with third-party vendors to update their loan origination and documentation system software. CFPB stated in its analysis of the final rule that the one-time cost of updating software largely would fall on software vendors because a majority of creditors rely on these vendors. The CFPB analysis also stated that many vendor contracts are structured in a way that vendors would not be able to pass through any cost increase due to a regulation-related software update such as this one. However, representatives from one community bank and one credit union indicated that they had to retain a new vendor to comply with the rules. Representatives from one community bank and one credit union also stated that they have to conduct additional due diligence on their vendors to ensure compliance because they are ultimately held liable if the vendors’ systems or disclosures are not compliant with the rule. As part of quality assurance, they have to test the vendors’ new systems prior to implementation. Representatives from ICBA and CUNA stated that some entities would not have adequate time to test the software for compliance before the effective date of the rule due to delays by third-party service providers. CFPB and the other FFIEC member agencies stated in their letters to industry associations that during initial examination for compliance with TRID, the agencies’ examiners will expect the supervised entities to make good faith efforts to comply with the rule’s requirements in a timely manner. The agencies stated that during early examinations, examiners will consider an institution’s implementation plan, including actions taken to update policies, procedures, and processes; its training of appropriate staff; and its handling of early technical problems or other implementation challenges. In October 2015, FDIC and the Federal Reserve issued a Financial Institution Letter and guidance, respectively, on their approach to early supervision. CFPB also issued a press release on the regulators’ approach.

Representatives from several community banks and credit unions also said that they had to train their staff on TRID, including familiarizing them with the new forms. A representative from one community bank association stated that compared with larger institutions, community bank staff have to take on more compliance duties and the community banks may decide to stop offering certain products in order to minimize compliance risk. A representative from a community bank state association stated that community banks may exit the market due to the costs and time allocated to comply. Furthermore, representatives from one community bank and one credit union state association indicated that the new TRID requirements could lengthen the closing process and result in potential closing delays related to meeting these requirements. CFPB also recognized this potential impact in its final rulemaking analysis.

Ability to Repay and Qualified Mortgage Standards

Representatives from credit unions, community banks, and industry associations we spoke with said that CFPB’s Ability to Repay and Qualified Mortgage Standards (ATR/QM) rule could affect mortgage lending activities of credit unions and community banks, particularly lending to customers who otherwise might not be served by larger lenders. However, agency data thus far have not reflected such changes. The Dodd-Frank Act amended TILA to generally prohibit lenders from making mortgage loans unless the lender makes a reasonable and good faith determination based on verified and documented information that the consumer has a reasonable ability to repay the loan. In its final rule, CFPB identified eight underwriting factors a creditor must consider in relation to making the required good faith determination of a borrowers’ ability to repay, such as current employment status and monthly debt-to-income ratio. A creditor presumably satisfies the ability-to-repay requirement by making a qualified mortgage, which meets certain underwriting requirements and restrictions on product features and points and fees. CFPB sets out three main categories of qualified mortgages that are presumed to comply with the ability-to-repay requirements: general, temporary, and small creditor (see table 3). Creditors that make qualified mortgages receive some protection from liability—a safe harbor, or in cases of higher-priced loans, a rebuttable presumption that ability-to-repay requirements have been met.

CFPB included special provisions in the final rule for small creditors, which during our review were defined as those creditors with less than $2 billion in assets (adjusted annually for inflation) that, together with their affiliates, originated no more than 500 first-lien mortgage loans in the preceding year. For loans that are not sold and kept in their portfolios, such creditors must meet some restrictions on qualified mortgages loans, such as points and fees, but are not subject to a specific debt-to-income ratio and are permitted a higher interest rate threshold for a safe harbor. Certain small creditors operating in rural or underserved areas can also originate mortgages with balloon payments, a risky loan feature otherwise not permitted for a qualified mortgage.

Representatives from some community banks and credit unions as well as industry associations we interviewed stated that the ATR/QM rule has negatively affected mortgage lending, particularly for mortgages that do not meet the criteria for qualified mortgages. For example, representatives from some community bank and credit union associations and one credit union said they were unwilling to make loans that are not qualified mortgages because they may not benefit from the liability protection afforded qualified mortgages and borrowers may hold lenders liable for making mortgage loans that they cannot repay. Representatives from two community banks said that many banks have been unwilling to originate loans that cannot be sold on the secondary market. Representatives from one community bank and one credit union we spoke with said that investors will not purchase loans that are not qualified mortgages, such as those that do not meet the debt-to-income requirement. A 2015 survey of community banks conducted by the Conference of State Bank Supervisors and state regulators found that about a third of the 974 state-chartered commercial banks that responded said that they will only make loans that are not qualified mortgages on an “exception” basis; additionally, about a third of the respondents did not intend to make any loans that are not qualified mortgages.

Representatives from several industry associations and community banks told us that those most likely to be affected by community banks originating only qualified mortgages are borrowers on the margins of meeting qualified mortgage standards, or those that would not meet the underwriting standards at large banking institutions because they were self-employed, did not have steady income, or were buying in an area with a lack of comparable sales of similar properties. Representatives from CUNA and one state community bank association told us that CFPB’s current rural or underserved area exemption is too narrow and as a result has limited the ability to lend to those potential borrowers.

Additionally, while survey results cannot be generalized to all banks, an ICBA survey found that about two thirds of the 519 responding community banks in the $500 million to $2 billion asset range made too many loans to qualify as small creditors under CFPB’s current rural and underserved area exemption. Moreover, about half of the banks responding to this survey that serve rural areas did not qualify for the rural exception. In response to concerns expressed by the industry, CFPB amended the regulatory criteria for small creditor in September 2015 to raise the limit for small creditors and their affiliates from 500 first-lien mortgages in the preceding year to 2,000, excluding loans that are held in portfolio, and expanded the definitions of rural and underserved areas. The rule will be effective on January 1, 2016. According to CFPB, the revised small creditor criteria will effectively expand the overall number of creditors that are eligible to extend small creditor portfolio-qualified mortgages. Additionally, CFPB estimated that the number of rural small creditors will increase from about 2,400 to about 4,100. The final rule retains the asset limit used to determine small creditor status, but was updated to generally include the assets of certain affiliates.

In our June 2015 report on mortgage reforms, we found that studies that were conducted or posted after the implementation of the ATR/QM rule anticipated or suggested moderate to minimal initial reductions in the availability of credit and willingness to originate loans that are not qualified mortgages. However, we also found that the ATR/QM rule would have limited initial impacts on mortgage lending activities because most loans originated in recent years largely conformed with qualified mortgage criteria and because not all loans that qualify as qualified mortgages are subject to the same restrictions. According to a November 2015 Federal Reserve report examining 2014 data collected under the Home Mortgage Disclosure Act, there is little indication that the ATR/QM rules significantly curtailed mortgage credit availability in 2014 relative to 2013. For example, despite the ATR/QM rule that caps borrowers’ debt-to-income ratio for many loans, the fraction of high debt- to-income loans does not appear to have declined in 2014 from 2013. However, the report also stated that the results here do not necessarily rule out the possibility that effects may arise in the future. Additionally, FDIC stated that FDIC’s data do not appear to confirm a large negative effect of the rule on small banks. In early 2014, FDIC introduced a new Community Bank Performance section to the FDIC Quarterly Banking Profile that is intended to monitor the health of community banks. In the aggregate, these profiles showed that community banks’ one-to-four family residential mortgage loan balances have grown in 2014 and 2015.

Rules Related to Higher-Priced Mortgage Loans and Mortgage Servicing

Representatives from some community banks, credit unions, and industry associations with whom we spoke noted increased compliance costs associated with CFPB’s new rules related to escrow accounts, appraisals for higher-priced loans, and mortgage servicing.

Escrow Requirements. To enhance consumer protection, the Dodd- Frank Act amended TILA to expand escrow requirements for first-lien higher-priced mortgage loans, including by generally establishing a 5- year minimum for escrow accounts. CFPB’s rule on escrow for higher-priced mortgage loans increases the time for which mandatory escrow accounts established for such loans must be maintained from 1 to 5 years, but provides an exemption for certain small creditors operating in rural or underserved areas and meeting other criteria. Representatives from ICBA and CUNA said that some of their community banks and credit union members had to increase resources to set up and monitor these escrow accounts. Representatives from both national associations stated that setting up and monitoring escrow accounts is burdensome and that some community banks and credit unions do not have adequate technology or staff to support it. CUNA representatives further stated that some credit unions had to outsource these functions. ICBA has advocated for community bank loans held in portfolio to be exempted from the escrow requirement for higher-priced mortgages because they do not hold a huge volume of such mortgages. CUNA representatives stated credit unions that provide low volumes of higher-priced mortgage loans may cease to provide those loans altogether. While the survey results cannot be generalized to all banks, in a 2015 survey conducted by the American Bankers Association, the 182 responding banks in the survey indicated that cost and, a lack of escrow capabilities, or, inadequate staff were the primary reasons that they did not offer escrow services. As discussed earlier, the CFPB expanded the exemption for small creditors operating in rural or underserved areas.

Appraisal Requirements For Higher-Priced Mortgage Loans. CFPB’s joint rule with other federal financial regulators implementing the Dodd-Frank Act appraisal requirements for higher-priced mortgages generally requires lenders to obtain one, or in some limited cases where timing and pricing requirements are triggered, two written appraisals. In addition, the requirement to obtain two appraisals does not apply to a number of transactions, including where the property is in a rural county. One credit union representative said that having to deliver appraisals 3 business days prior to consummation delayed an intended closing (due to its remote location, which makes appraisals complex and turnaround times longer). Representatives from a state community bank association and one community bank we interviewed said the requirement for two appraisals (when timing and pricing requirements are triggered) is a challenge because they have had difficulty finding two independent appraisers who understand the market in their respective areas. ICBA representatives stated that for higher-priced mortgage loans of smaller amounts, the cost of appraisal becomes significant in proportion to the loan. Representatives from CUNA and two state credit union associations stated the rule had a minimal impact on their members because they generally did not make higher-priced loans.

Mortgage Servicing Rules. CFPB issued two mortgage servicing rules under TILA and RESPA, designed in part to provide, among other things, better disclosure to consumers about their loan obligations and loss mitigation options that may be available if they have difficulty with their loan obligations. CFPB, in its final rule analysis, noted that the small servicer thresholds were appropriate in part because it estimated that more than 98 percent of the insured depository institutions and credit unions, with less than $2 billion in assets fall beneath the 5,000 loan threshold, qualifying for the small servicer exemption from many of the rules. Representatives from ICBA and one state credit union association told us that the exemptions available to small servicers are too narrow. Although the rules exempt small servicers from certain provisions, they require all servicers to respond to written notices of errors received from borrowers, and all servicers generally must not make the first notice or filing for foreclosure unless the borrower is more than 120 days delinquent, among other provisions. Representatives from several industry associations we interviewed said that community banks and credit unions had to expand resources to meet these requirements. ICBA representatives said the small servicer threshold should be increased from 5,000 to 20,000 loans. However, representatives from four community banks we interviewed stated the rules had no impact on their mortgage servicing or that they did not provide mortgage servicing. A 2013 survey by the Mercatus Center indicated that less than two-fifths of the approximately 200 small banks participating in their survey currently offered mortgage servicing and less than a tenth discontinued or anticipated discontinuing mortgage servicing as a result of the Dodd-Frank Act. While survey results and interview responses cannot be generalized to all small banks, they suggest that the regulatory requirements would have a small overall impact on mortgage servicing practices at these banks.

Industry Officials Also Said Certain Nonmortgage- Related Rules Had Increased Compliance Burden or Changed Business Practices

Representatives from community banks, credit unions, and industry associations we interviewed also identified the impact of several nonmortgage-related requirements and implementing rules on compliance and related business activities. These included requirements related to credit rating removal, remittance transfers, and debit interchange and routing (see table 4).

The Dodd-Frank Act required each federal agency to review regulations that require the use of an assessment of creditworthiness of a security or money market instrument and any references to, or requirements in, those regulations regarding credit ratings. The act also required the agencies to modify the regulations identified during the review by substituting any references to, or requirements of, reliance on credit ratings with standards of creditworthiness each agency determines to be appropriate. Under the agencies’ revised regulations, to determine whether a security is “investment grade,” insured depository institutions must determine that the probability of default by the issuer is low and the full and timely repayment of principal and interest is expected. To comply with the new standard, banks and credit unions may not rely exclusively on external credit ratings, but may continue to use such ratings as part of their determinations. They must supplement any consideration of external ratings with due diligence processes and additional analyses that are appropriate for the institution’s risk profile and the size and complexity of the investment instrument.

Representatives from two industry associations, three community banks, and one credit union said that the rules increased compliance burden. Representatives from the community banks and credit union said that investing became more complex and they have had to devote more time and resources to research the investment vehicles. Two community bank association representatives we interviewed stated that community banks do not have the internal expertise to evaluate their investments. One community bank association’s representative also stated that the rule required community banks to hire experts and spend additional time to document the due diligence they have conducted. While the results cannot be generalized to all banks, in the Mercatus Center survey, almost half of the approximately 200 community banks responding to the survey said that they altered their credit analysis practices in response to this provision or related guidance, while the other half said they did not. Among those that altered practices, some said they contracted with outside firms or hired additional employees to conduct credit analysis or altered the type of securities they purchased.

Remittance Transfers

The Dodd-Frank Act imposes new requirements on remittance transfer providers. CFPB’s rule on remittance transfers amended Regulation E, which implements the Electronic Fund Transfer Act. It requires companies to provide disclosures to consumers before they pay for the remittance transfers, including about items such as the applicable exchange rate, if any, and certain fees and taxes. In our September 2012 report, representatives from some community banks, credit unions, and associations we interviewed expected the remittance transfer rule to decrease their (or their member institutions) remittance transfer business.

Representatives from four industry associations, as well as two credit unions and one community bank whom we interviewed stated the rule has had a negative impact. ICBA representatives said that some community banks tried to keep the number of remittance transfers each year to below 100 (to avoid having the rules apply to them). Representatives from CUNA and two state credit union associations said that some credit unions have increased fees or left the market. For example, one credit union representative said that it did not have access to the information and services required by the rule and had to contract with a correspondent bank to continue to offer the service. As a result, it increased its remittance fees. One state credit union association representative said that their members stopped the service to avoid the related compliance costs. Although the Mercatus Center conducted its survey of approximately 200 banks prior to the effective date of the rule, it indicated that a small percentage of the respondents had discontinued or anticipated discontinuing offering remittances as a result of the rule. CFPB stated that in response to these concerns, it delayed and amended this rule twice to ease compliance concerns related to the disclosure of foreign fees and taxes. In addition, CFPB officials stated that, based on their analysis of NCUA call report data, about 90 percent of the credit unions do not send over 100 transfers annually and thus are exempt from the remittance rule. CFPB officials additionally stated that the call data indicates virtually no change in the remittance market by credit unions since the rule has been implemented.

Debit Interchange Fee Rule

The Dodd-Frank Act requires the Federal Reserve to prescribe regulations for any interchange transaction fee that an issuer may receive or charge for an electronic debit transaction. In implementing the debit interchange fee rule, the Federal Reserve set a cap on the maximum permissible interchange fee that any issuer may receive for such a transaction. Although issuers, together with their affiliates, that have less than $10 billion in assets are exempt from the cap on interchange fees, all issuers and networks are prohibited from restricting the number of networks over which the debit transaction may be processed to less than two unaffiliated networks. Our September 2012 report on community banks found that the rule had had a limited impact on exempt issuers, but industry officials expressed concerns about the potential for their interchange fees or fee income to decline over the long term.

Representatives from five industry associations, one community bank, and one credit union stated that the rule has led to a decline in interchange revenue, although one credit union said that the decline was minimal. Representatives from one credit union stated that it was hard to measure the impact of the rule because their revenue had increased due to the increase in volume of debit card transactions. Data collected by the Federal Reserve from card networks on the interchange fees showed that exempt issuers have not experienced a significant impact on the amount of average interchange fees. In 2011, these data showed that the average interchange fee received by exempt issuers declined from $0.45 over the first three quarters of 2011 to $0.43 in the fourth quarter of 2011, when the rule took effect. Federal Reserve data from 2014 showed that the average interchange fee remained at $0.43 for exempt issuers.

Regulators Face Challenges Determining the Cumulative Impact of Dodd-Frank Act Rules on Community Banks and Credit Unions

Regulators told us that it is still too early to assess the full impact of Dodd- Frank Act rulemakings on community banks and credit unions, and while they have heard concerns about the increase in compliance burden, they have not been able to quantify compliance costs. Two regulators told us that it was too early to determine the impact of the Dodd-Frank Act rulemakings; NCUA officials stated that there has been little cumulative impact from the rules to date because many have only recently become effective. OCC and FDIC officials also said that it would be difficult to disentangle the impact of Dodd-Frank Act regulations from changes in response to the overall economic environment or other rulemakings.

FDIC, OCC, and Federal Reserve officials stated that the institutions with which they have spoken are concerned about integrating many rules into their business operations and with the increase in compliance costs. For instance, OCC officials stated that even if community banks do not hire new staff, the existing staff would have to be redeployed into compliance areas. FDIC officials stated that the cumulative compliance cost is hard to quantify because these costs are not reported separately in Call Reports. Regulators also said that compliance activities do not appear to have reduced profitability for community banks. For example, Federal Reserve officials said that profitability for community banks has increased. Additionally, FDIC officials said that noninterest expenses have decreased or remained flat since the financial crisis. Further, FDIC officials stated that the Dodd-Frank Act did not appear to have conferred a negative effect. For example, they noted that since 2010, small banks have increased loan growth and their earnings have improved. Officials from OCC said that the benefits of the Dodd-Frank Act would be difficult to quantify, but OCC and CFTC officials stated that having a safer and sounder financial system is a benefit of the Dodd-Frank Act. In our prior work on federal rulemaking, many agency officials told us that monetizing benefits is more difficult than monetizing costs.

OCC, FDIC, and the Federal Reserve have been conducting retrospective reviews of their rules pursuant to EGRPRA, while NCUA and CFPB have been conducting retrospective reviews pursuant to other requirements and internal policies. These reviews include Dodd-Frank Act rules. As part of their review, agencies have requested comments from the public on the impact on the community banks and conducted outreach meetings, including an outreach meeting with those in rural areas. In past work, we have noted the usefulness of retrospective reviews.

CFPB, which is not subject to EGRPRA, conducts its own analyses of regulations that impact financial institutions with $10 billion or less in assets. Section 1022(d) of the Dodd-Frank Act requires CFPB to assess each significant rule it adopts under federal consumer financial law and publish a report of the assessment not later than 5 years after the effective date of such rule. The assessment must address, among other relevant factors, the rule’s effectiveness in meeting the purposes and objectives of Title X of the Dodd-Frank Act, and the specific goals stated by the CFPB. According to CFPB officials, the review conducted for each significant rule is to include broad data analysis. In our June 2015 report on mortgage reforms, we found that CFPB has begun planning for review of the qualified mortgage regulations. Regulators also said they are aware of industry concerns about the potential for unintended impacts from Dodd-Frank Act rulemaking and implementations. Representatives from community banks, credit unions, and industry associations expressed concern about future “trickledown effects” from regulations intended for large banking institutions and one-size-fits-all regulation on community banks and credit unions. For example, representatives from community banks and credit unions we interviewed stated that while CFPB exempts them from certain rules or parts of the rules, their prudential regulators might hold them to regulatory standards for larger institutions as a best practice. Additionally, some industry associations have expressed concerns about a one-size-fits-all approach in regulating community banks and credit unions as well as large banking institutions. FDIC and Federal Reserve officials stated that they have heard similar concerns from the institutions they regulate. FDIC officials stated that the agency has emphasized that best practices are not requirements and that FDIC has been monitoring its examiners to help ensure they are following FDIC policies, which take into consideration the size, complexity, and risk profiles of banks. Federal Reserve officials said that the Federal Reserve has set expectations for its examiners to not examine regional banks using the same requirements as for large banking institutions. Additionally, Federal Reserve officials said the agency has tried to communicate the applicability of rules clearly to smaller institutions.

Indicators Provide Baselines for Monitoring the Future Impact of the Dodd-Frank Act on Small Banks and Credit Unions

We developed indicators that, although imperfect, may shed light on the cumulative impact of Dodd-Frank Act regulations on small banks and credit unions over time. These indicators are likely to capture some of the cost associated with regulatory compliance and include: (1) the number of employees; (2) a measure of labor and other noncapital costs; (3) profitability; and (4) residential mortgage lending. As we have discussed, both mortgage-related rules and certain nonmortgage-related rules may increase the compliance burden for small banks and credit unions. Banks and credit unions may have to hire additional staff to manage compliance with regulations, hire outside counsel or consultants, or take other actions. As a result, the numbers of employees and the total cost of resources other than funding at banks and credit unions are likely to increase and profits are likely to decrease, all else being equal. Also, as discussed earlier, mortgage-related rules may affect mortgage lending by small banks and credit unions. Residential mortgage-related regulations, in particular, may raise the cost of originating loans and result in a shifting of portfolios away from residential lending. All else being equal, residential mortgage lending by small banks and credit unions is likely to decrease as a result.

While these indicators are baselines against which to compare future trends between different sized institutions, they are limited in their ability to assess the regulatory burden associated with the Dodd-Frank Act and care should be used in interpreting the results of this analysis. First, the level of, and trends in, these indicators for the various groups of institutions does not provide evidence on the impact of Dodd-Frank at this time. Going forward, the differences in the trends for each quintile would be the more important indicator to monitor. Second, even when assessed over time and across different size institutions, our analysis cannot rule out other important factors that may influence our indicators, including other regulations, policies, and general macroeconomic conditions, such as the demand for credit. Furthermore, trends in our indicators are generally representative of trends for banks and credit unions of different sizes, but may not reflect the experience of every bank or credit union. Moreover, many of the Dodd-Frank Act regulations that apply to small banks and credit unions have not been implemented or have been implemented only recently. Finally, while we presented similar indicators for banks and credit unions, comparisons between the two types of institutions on the basis of these measures may not be appropriate and certain indicators may be more relevant than others for each type of institution.

Figure 1 summarizes trends in our indicators for banks of different sizes. We used total assets to measure size and grouped banks into five equal- sized groups, or quintiles, based on total assets. The first quintile represents the smallest banks while the fifth quintile represents the largest. We then calculated the median value of each indicator for each quintile for each quarter. Our indicators for banks allow for the following observations:

Smaller banks tend to have more employees per $1 million in assets than larger banks, and employment at banks of all sizes generally has fallen since the third quarter of 2010.

Smaller banks tend to have slightly higher noninterest expenses (e.g., salaries and employee benefits, consulting and advisory expenses) as a percentage of assets than larger banks, and noninterest expenses generally have fallen for banks of all sizes since the third quarter of 2010.

Smaller banks tend to have lower earnings as a percentage of assets than larger banks, at least in recent quarters, and earnings generally have increased for banks of all sizes since the third quarter of 2010.

The smallest banks tend to have fewer residential mortgage loans on their balance sheets as a percentage of assets than larger banks. However, since the third quarter of 2010, residential mortgage loans have grown as a fraction of assets for banks of all sizes.

Figure 2 summarizes trends in our indicators for credit unions of different sizes. As we did with banks, we used total assets to measure size and grouped credit unions into quintiles based on total assets and then calculated the median value of each indicator for each quintile for each quarter. Again, the current level of these indicators and the trends for each quintile are not sufficient for assessing the impact of the Dodd-Frank Act. Nevertheless, our indicators for credit unions allow for the following observations:

Smaller credit unions tend to have more full-time employees per $1 million than larger credit unions with the exception of the smallest, which tend to have no full-time employees at all. Furthermore, smaller credit unions tend to have more part-time employees per $1 million in assets than larger credit unions. However, the numbers of both full- time and part-time employees generally have decreased since the third quarter of 2010.

Noninterest expenses as a percentage of assets are generally the same for credit unions of different sizes and generally have decreased for credit unions of all sizes since the third quarter of 2010.

Smaller credit unions tend to have lower earnings as a percentage of assets than larger credit unions, but earnings at credit unions of all sizes generally have increased since the third quarter of 2010.

Smaller credit unions tend to have fewer residential mortgage loans on their balance sheets as a percentage of assets than larger credit unions, and most of the smallest credit unions have no residential mortgages at all. However, residential mortgages generally have decreased as a percentage of assets for larger credit unions —those in the third, fourth, and fifth quintiles—but have increased for the smaller credit unions in the second quintile.

Possible Impacts of the Dodd-Frank Act on Bank SIFIs, Designated Nonbanks, and Swaps

Financial regulators have continued to implement reforms pursuant to the Dodd-Frank Act, but the full impact of the act remains uncertain. This uncertainty stems from a number of factors, in particular, not all rules have been finalized and taken effect. When the act’s reforms are fully implemented, it will take time for the financial services industry to comply with the array of new regulations—meaning additional time will need to elapse to measure the impact of the rules. Moreover, the evolving nature of implementation makes isolating the Dodd-Frank Act’s effect on the U.S. financial marketplace difficult. This task is confounded by the many factors that can affect the financial marketplace, including factors that could have an even greater impact than the act.

Recognizing these limitations and difficulties, we developed a multipronged approach to analyze current data and trends that might indicate some of the Dodd-Frank Act’s initial impacts. First, using data through the second quarter of 2015, we updated the indicators developed in our December 2012 report to monitor changes in certain characteristics of SIFIs, which are subject to enhanced prudential standards and oversight under the act, and also developed new indicators. Second, we updated our difference-in-difference econometric analysis to infer the act’s impact on funding costs for bank SIFIs and the safety and soundness of bank SIFIs. Third, we developed indicators of designated nonbanks that parallel our bank SIFI indicators. Fourth, using data through the second quarter of 2014, we updated indicators developed in our December 2013 report to monitor the extent to which certain of the act’s swap reforms are consistent with the act’s goals of reducing risk. All of these analyses have limitations, which we discuss below.

Indicators Suggest Large Bank SIFIs Have Become Larger but Less Vulnerable to Financial Distress Since the Dodd- Frank Act

According to its legislative history, the Dodd-Frank Act contains provisions intended to reduce the risk of failure of a large, complex financial institution and the damage that such a failure could do to the economy. Such provisions include (1) authorizing FSOC to designate a nonbank financial company for Federal Reserve supervision if FSOC determines it could pose a threat to U.S. financial stability and (2) directing the Federal Reserve to impose enhanced prudential standards and oversight on bank holding companies with $50 billion or more in total consolidated assets (bank SIFIs) and nonbank financial companies designated by FSOC (designated nonbanks). (See app. IV for a summary of provisions related to SIFIs and their rulemaking status.)

As we first reported in December 2012, the Dodd-Frank Act and its implementing rules may result in adjustments to the size, interconnectedness, complexity, leverage, or liquidity of bank SIFIs over time. We updated the indicators we developed in our December 2012 report and updated in our December 2013 and December 2014 reports to monitor changes in some of these characteristics of SIFIs. In addition, we added indicators of interconnectedness. The size, interconnectedness, and complexity indicators reflect the potential for the financial distress of a single SIFI to affect the financial system and economy (spillover effects). The leverage and liquidity indicators reflect a SIFI’s resilience to shocks or its vulnerability to financial distress.

It is important to note however, that our analysis has limitations. For example, the indicators do not identify causal links between changes in SIFI characteristics and the act. Rather, the indicators track changes in the size, interconnectedness, complexity, leverage, and liquidity of SIFIs since the passage of the act to examine if the changes have been consistent with the goals of the act. However, other factors—including international banking standards agreed upon by the Basel Committee on Banking Supervision (Basel Committee) and monetary policy actions— also affect bank holding companies and, thus, the indicators. These factors may have a greater effect than the Dodd-Frank Act on SIFIs. Furthermore, because a number of rules implementing provisions related to SIFIs have not yet been finalized, our indicators include the effects of these rules only insofar as SIFIs have changed their behavior in response to issued rules or in anticipation of expected rules. In this regard, our indicators provide baselines against which to compare future trends. See appendix VI for additional limitations of our indicators.

Table 5 summarizes the changes in our bank SIFI indicators from the third quarter of 2010 through the second quarter of 2015 and allows for the following observations (see app. VI for more information):

Changes in some size, interconnectedness, and complexity indicators are consistent with increased potential spillover effects for large bank SIFIs (which we define as bank holding companies with $500 billion or more in assets) while changes in others are consistent with decreased potential spillover effects for large bank SIFIs.

Changes in all of the size, interconnectedness, and complexity indicators are consistent with decreased or no change in potential spillover effects for other bank SIFIs (which we define as bank holding companies with at least $50 billion but less than $500 billion in assets).

Changes in all of our leverage and liquidity indicators are consistent with increased resilience for both large bank SIFIs and for other bank SIFIs.

Enhanced Prudential Standards Associated with Some Improvements in Bank SIFI Safety and Soundness but Not with Changes in Funding Costs for Bank SIFIs

The act requires the Federal Reserve to impose a variety of regulatory reforms on SIFIs, including enhanced risk-based capital, leverage, and liquidity requirements. These reforms may affect the safety and soundness of bank SIFIs and the funding costs for bank SIFIs. Specifically, capital and leverage requirements may help reduce the probability of bank failures and promote financial stability. However, by increasing funding costs for banks, the requirements might also cause banks to raise lending rates and limit their ability to provide credit, especially during a crisis. Similarly, while stricter liquidity requirements may help reduce the probability of bank failures and promote financial stability, banks could respond to these requirements by increasing lending spreads to offset lower yields on assets or higher costs associated with liabilities with longer maturities. To the extent that they increase the cost and reduce the availability of credit, these reforms may lead to reduced output and economic growth.

Our analysis shows an association between the Dodd-Frank Act and an increase in some indicators of SIFI safety and soundness. However, we find no evidence of an association between the Dodd-Frank Act and increased funding costs for bank SIFIs. Our econometric analysis leverages the Dodd-Frank Act requirement that bank holding companies with total consolidated assets of $50 billion or more are subject to enhanced regulation by the Federal Reserve but other bank holding companies are not. Specifically, we compare funding costs, capital adequacy, asset quality, earnings, and liquidity for bank SIFIs and non- SIFI bank holding companies before and after enactment of the Dodd- Frank Act. All else being equal, the difference in the comparative differences is the inferred effect of the Dodd-Frank Act’s prudential requirements on bank SIFIs.

Our approach allows us to partially differentiate changes in funding costs, capital adequacy, asset quality, earnings, and liquidity associated with the Dodd-Frank Act from changes due to other factors. However, several factors make isolating and measuring the impact of the act’s new requirements for SIFIs challenging. For example, the effects of the act cannot be differentiated from the effects of simultaneous changes in economic conditions, such as the pace of the recovery from the recent recession; regulations, such as those stemming from Basel III; or other changes, such as changes in credit ratings that differentially may affect bank SIFIs and other bank holding companies. In addition, some of the new requirements for SIFIs have yet to be fully implemented. For example, in August 2015, the Federal Reserve issued a final rule that established risk-based capital surcharges for the largest, most interconnected SIFIs. Nevertheless, our estimates are suggestive of the initial effects of the act on bank SIFIs and provide a baseline against which to compare future trends.

Our analysis suggests that the Dodd-Frank Act has not been associated with a significant change in funding costs for bank SIFIs (see table 6). Our measure of funding cost captures the interest paid on borrowed funds and deposits. To the extent that the cost of credit provided by bank SIFIs is a function of their funding costs, the new requirements for SIFIs appear to have had little effect on the aggregate cost of credit to date via the funding cost channel.

Our estimates also suggest that the Dodd-Frank Act is associated with improvements in some measures of bank SIFIs’ safety and soundness. Bank SIFIs appear to be holding more tangible common equity as a percentage of assets than they otherwise would have held since Dodd- Frank Act enactment (see table 6). The quality of assets on the balance sheets of bank SIFIs seems to have improved since enactment. The act is also associated with improved liquidity as measured by the extent to which a bank holding company is using stable sources of funding and with higher earnings. However, capital adequacy as measured by total bank holding company equity and liquidity as measured by the capacity of a bank holding company’s liquid assets to cover its volatile liabilities have not clearly improved since enactment. Thus, the Dodd-Frank Act appears to be associated with improvements in some indicators of safety and soundness for bank SIFIs (relative to non-SIFI bank holding companies) but not others. See appendix VI for more details on our regression analysis.

Indicators for Designated Nonbanks Provide Baselines for Assessing the Future Impact of Dodd-Frank Act Reforms

We developed indicators associated with size, interconnectedness, leverage, and liquidity for institutions whose material financial distress or activities FSOC determines could pose a threat to U.S. financial stability and therefore should be subject to Federal Reserve supervision and enhanced prudential standards. As of July 2015, FSOC has designated four nonbank financial companies—American International Group, Inc. (AIG) and General Electric Capital Corporation (GECC) in July 2013, Prudential Financial, Inc. (Prudential) in September 2013, and MetLife, Inc. (MetLife) in December 2014. FSOC has determined that each of these institutions was predominately engaged in financial activities (that is, at least 85 percent of their revenues were derived from, or more than 85 percent of their assets were related to, activities that were financial in nature). According to FSOC, at the time of the determinations, AIG was the third-largest insurance company in the United States and one of the largest insurers in the world; GECC was one of the largest holding companies in the United States and a significant source of credit to commercial and consumer customers; Prudential was one of the largest financial services companies in the United States providing a wide array of financial services, including group and individual life insurance, annuities, retirement-related products and services, and asset management; and MetLife was the largest publicly traded U.S. insurance organization and one of the largest financial services companies in the United States.

As we first reported in December 2012, the Dodd-Frank Act and its implementing rules may result in adjustments to size, interconnectedness, leverage, and liquidity characteristics of designated nonbanks over time. Size and interconnectedness reflect the potential for the financial distress of a single designated nonbank to affect the financial system and economy, while leverage and liquidity reflect a designated nonbank’s resilience to shocks or its vulnerability to financial distress. We developed the following indicators based on the characteristics of companies that FSOC reviews as part of its process for designating nonbanks:

Size. Our indicator of size is total consolidated assets.

Interconnectedness. Our indicators of interconnectedness are gross notional amounts of credit default swaps outstanding for which the designated nonbank is the reference entity and total debt outstanding (excluding deposit liabilities).

Leverage. Our indicator of leverage is total equity as a percentage of total consolidated assets (excluding separate account assets).

Liquidity. Our indicator of liquidity is short-term debt (excluding deposit liabilities) as a percentage of total consolidated assets (excluding separate account assets).

We calculated each indicator for each designated nonbank for each quarter from the second quarter of 2012 to the second quarter of 2015. We also calculated the medians of each indicator for publicly traded banks and insurance companies with total consolidated assets of $50 billion or more to provide a frame of reference.

Like our indicators for bank SIFIs, our indicators for designated nonbanks have some limitations. For example, the indicators do not identify causal links between changes in designated nonbanks’ characteristics and the act. Rather, the indicators track changes in the size, interconnectedness, leverage, and liquidity of designated nonbanks since the passage of the act to examine if the changes have been consistent with the goals of the act. However, other factors, such as capital standards for large, internationally active insurance companies may also affect designated nonbanks and, thus, the indicators. Furthermore, to the extent that a number of rules implementing provisions related to designated nonbanks have not yet been finalized, our indicators include the effects of these rules only insofar as designated nonbanks have changed their behavior in response to issued rules or in anticipation of expected rules. In this regard, our indicators provide baselines against which to compare future trends.

Figure 3 below shows the indicators for the period from second quarter 2012 through second quarter 2015. As of July 2015, the Federal Reserve issued specific rules requiring designated nonbank financial companies to conduct resolution planning and stress testing, but additional rules are forthcoming. Thus, the current values of our indicators are baselines against which to compare future trends as more rules for designated nonbanks are implemented. Our indicators allow for the following observations:

Based on their total assets, all four designated nonbanks are relatively large. They are all larger than the median publicly traded bank or insurance company with assets of $50 billion or more.

Gross notional amounts of credit default swaps outstanding (for which designated nonbanks are the reference entities) have decreased since the second quarter of 2012, suggesting that the designated nonbanks are relatively less interconnected and thus have smaller potential spillover effects than in prior years by this measure, all else being equal.

Total debt outstanding for one designated nonbank is relatively high, suggesting that it is more interconnected and thus has larger potential spillover effects than the other three designated nonbanks by this measure, all else being equal.

Total equity as a percentage of nonseparate account assets varies across the four designated nonbanks, ranging from less than 10 percent to almost 25 percent in the second quarter of 2015. This variation in leverage suggests that the designated nonbanks have varying resilience to shocks and financial distress by this measure, all else being equal.

Short-term debt as a percentage of nonseparate account assets for one designated nonbank is relatively high, suggesting that it faces greater liquidity risk and is relatively less resilient than the other three designated nonbanks by this measure, all else being equal.

Indicators Suggest That the Dodd-Frank Act Is Associated with Increased Use of Margin Collateral in Over-the-Counter Derivatives Transactions

As we reported in December 2013, once fully implemented, some provisions in Title VII of the Dodd-Frank Act may help reduce systemic risks to financial markets by increasing margins posted for uncleared swaps. Using data through the second quarter of 2015, we updated the set of indicators that we developed in our December 2013 report and updated in our December 2014 report to measure changes in the use of margin collateral for over-the-counter derivatives. This set of indicators may shed light on changes in the use of margin collateral associated with Dodd-Frank Act swap reforms as they are implemented, but has several key limitations, as described later in this section.

Our margin indicators measure the fair value of collateral pledged by counterparties to secure over-the-counter derivatives contracts as a percentage of net current credit exposure to those counterparties for bank holding companies. To protect itself from the loss it would incur if a counterparty defaulted on a derivative contract, a swap entity could require counterparties to post margin collateral in an amount equal to or greater than its exposure to the contracts. An increase in collateral as a percentage of credit exposure suggests that holding companies have required their counterparties to post a greater amount of collateral against their credit exposure due to derivatives contracts overall, which would be consistent with the purposes of the act’s swap reforms.

Figure 4 shows trends in our margin indicators from the second quarter of 2009 through the second quarter of 2015. The rate of collateralization of net current credit exposure to all counterparties has increased from about 71 percent in the third quarter of 2010 to about 104 percent in the second quarter of 2015, suggesting that holding companies generally required their counterparties to post a greater amount of collateral against their derivatives contracts. However, as discussed later, aggregate measures of collateralization rates can mask differences in collateralization rates for different counterparty types.

Collateral posted by type of counterparty—banks and securities firms, monoline financial guarantors, hedge funds, sovereign governments, and corporate and all other counterparties—has increased (as a percentage of net credit exposure) between the third quarter of 2010 and the second quarter of 2015. However, the rate of collateralization consistently differed by the type of counterparty, with hedge funds consistently posting more collateral as a percentage of credit exposure than other types of counterparties. As we reported in December 2013, according to OCC, the rates differ partly because swap dealers may require certain counterparties to post both initial and variation margin and other counterparties to post only variation margin. Depending on how the margin rules are finalized, the rates of collateralization for some counterparties may increase.

Our margin indicators, while suggestive, are subject to important limitations. First, they do not identify causal links between changes in collateralization and the Dodd-Frank Act, including its regulations. Rather, the set of indicators tracks changes in collateralization since the act’s passage to examine if the changes were consistent with the act’s goals for increasing collateralization. Second, both net current credit exposure and the fair value of collateral are as of a point in time because the fair values of derivatives contracts and collateral can fluctuate over time. Third, an average collateralization of 100 percent does not ensure that all current counterparty exposures have been eliminated, because one counterparty’s credit exposure may be overcollateralized and another’s undercollateralized. Fourth, our indicators measure the fair value of the collateral held against net current credit exposures but do not necessarily measure the risk of uncollateralized losses. The fair value of net current credit exposure does not fully account for the riskiness of any single swap contract. If a party has entered into riskier swaps, it is possible for the rate of collateralization to increase while the risk of uncollateralized losses also increases. Fifth, our indicators are market aggregates that may not reflect the collateralization rate for any single company. Finally, these indicators do not reflect collateralization rates for companies, such as stand-alone broker-dealers, that have credit exposure to counterparties in over-the-counter derivatives contracts but are not affiliated with a bank holding company.

Agency Comments and Our Evaluation

We provided a draft of this report to CFPB, Federal Reserve, FDIC, OCC, NCUA, SEC, CFTC, and Treasury for review and comment. NCUA provided written comments that we have reprinted in appendix VIII. The regulators also provided technical comments, which we have incorporated, as appropriate.

In its comment letter, NCUA concurred with our report and noted it acknowledges the difficulty of clearly identifying the impact of the Dodd- Frank Act regulations on community banks, credit unions and systemically important financial institutions. However, it said that it would like to see a deeper consideration of structure of the credit union industry, which may help to more clearly illustrate the effects of the Dodd-Frank Act on this sector. NCUA suggested using a set of indicators better-calibrated to credit union business models, which may be more helpful in assessing the effects of the Dodd-Frank Act on smaller credit unions. NCUA noted that despite caveats in our report, indicating comparisons between the credit union and community banking sectors may not be appropriate because readers with limited background in these sectors may not be able to judge the extent of the differences between these institutions.

While we maintain that the indicators we developed are reasonable, in the report, we acknowledged that they are imperfect and have limitations. Specifically, as we noted in the report, these indicators developed for various sizes of credit unions do not reflect the experience of every individual credit union. We also stated in the report that while we presented similar indicators for banks and credit unions, comparisons between the two types of institutions may not be appropriate and that certain indicators may be more relevant than others for each type of institution. We also acknowledged in the report that these indicators are baselines against which to compare future trends between different sized credit unions, they are limited in their ability to assess the cumulative impact of Dodd-Frank Act regulations, and that care should be used in interpreting the results of this analysis.

We are sending copies of this report to the appropriate congressional committees and members, federal financial regulators, and the Department of the Treasury. This report will also be available at no charge on our website at http://www.gao.gov.

Should you or your staff have questions concerning this report, please contact me at (202) 512-8678 or evansL@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. Key contributors to this report are listed in appendix IX.

Appendix I: Objectives, Scope, and Methodology

Under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), various federal agencies are directed or have the authority to issue hundreds of regulations to implement the act’s provisions. This report examines regulatory analyses conducted by the federal financial regulators and the Department of the Treasury (Treasury) in their Dodd-Frank Act rulemakings, including their assessments of which rules they considered to be major rules, and coordination between and among federal regulators on these rulemakings; possible impact of promulgated Dodd-Frank Act provisions on community banks and credit unions and their business activities; and possible impact of selected Dodd-Frank Act provisions and their implementing regulations on financial market stability.

The agencies covered in our review are the federal financial regulators, the Financial Stability Oversight Council (FSOC), and the Treasury. We use the term “federal financial regulators” to refer to the Bureau of Consumer Financial Protection (commonly known as the Consumer Financial Protection Bureau, or CFPB), Commodity Futures Trading Commission (CFTC), Federal Deposit Insurance Corporation (FDIC), the Board of Governors of the Federal Reserve System (Federal Reserve), Office of the Comptroller of the Currency (OCC), National Credit Union Administration (NCUA), and Securities and Exchange Commission (SEC).

To examine the regulatory analyses and coordination conducted by the federal financial regulators and Treasury, we focused our analysis on the final rules issued pursuant to the Dodd-Frank Act that became effective from July 23, 2014, through July 22, 2015, a total of 26 rules (see app.

II). We compiled these rules from a website maintained by the Federal Reserve Bank of St. Louis that tracks Dodd-Frank Act regulations. We corroborated this information with staff from CFPB, Federal Reserve, FDIC, OCC, NCUA, SEC, CFTC, and the Treasury. We asked these staff to identify any other rulemaking that should be included. We reviewed federal statutes, regulations, and GAO studies on these rules as well as Federal Register releases that contain information on the regulatory analyses conducted by agencies and their coordination efforts. Using these materials, we identified the regulatory analyses, including benefit- cost analysis, required to be conducted by the agencies as part of their Dodd-Frank Act rulemakings. Of the 26 rules in our scope, 15 were substantive regulations, meaning that they were generally subject to public notice and comment under the Administrative Procedure Act (APA)—and also required the agencies to conduct some form of regulatory analysis. For each of the 15 rules, we reviewed the Federal Register release of the final rule document and summarized the analyses conducted by the regulators and Treasury. Using GAO’s Federal Rules database, we found that 6 of the 15 rules were classified by the Office of Management and Budget as major rules under the Congressional Review Act (CRA). That is, they resulted or are likely to result in an annual impact on the economy of $100 million or more, a major increase in costs or prices, or significant adverse effects on competition, employment, investment, productivity, innovation, or on the ability of U.S.-based enterprises to compete with foreign-based enterprises in domestic or export markets. For agencies subject to Executive Order (E.O.) 12,866, such major rules would be considered significant regulatory actions and subject to formal cost-benefit analysis. We developed a data collection instrument to compare and assess the regulatory analysis conducted for the major rules against the principles outlined in OMB Circular A-4, which provides guidance to federal agencies on the development of regulatory analysis.

We also reviewed the Dodd-Frank Act and Federal Register releases to identify the interagency coordination or consultation requirements as required by the act for the 26 rules in our scope. As a part of this review, an analyst looked for key words relating to coordination in the Federal Register releases and the requirements for coordination in the Dodd- Frank Act and recorded this information in a spreadsheet. An attorney then reviewed related rulemakings and acts and also independently evaluated each determination documented in the spreadsheet to reach concurrence on the assessment.

To assess the possible impact of the Dodd-Frank Act on community banks and credit unions, we used our September 2012 report, which identified provisions expected to affect some or all community banks and credit unions, to identify select final rules that became effective by October 2015. While we started with a larger population of rules, we specifically reviewed nine final rules that were identified by the community banks and credit unions as potentially having an impact for the purpose of this report. We reviewed the Federal Register releases for these final rules and relevant material on the act and the final rules, as well as five studies by federal and state regulators, industry associations, and academics on the potential impact of the final rules on community banks and credit unions. All but one study we reviewed relied on surveys of banks, usually contacted through banking association member lists. The final study consisted of a study of all payment card networks. We identified these studies through electronic searches of Google and Google Scholar using keywords such as the name of the rule and “impact on community banks or credit unions.” Two GAO social science analysts reviewed the quality of each study’s research design and methods and identified related limitations. Because most of the studies relied on surveys of non-probability, convenience samples of banks with low response rates, the study results cannot be used to make inferences about the population of all small banks. However, the results do provide useful insights into the experiences of surveyed banks with Dodd-Frank Act rules.

We conducted semi-structured interviews with federal regulators, the Independent Community Bankers of America (ICBA), the Credit Union National Association (CUNA), the National Federation of Independent Business, the U.S. Chamber of Commerce, and a non-generalizable sample of four state credit union and community bank associations and eight community banks and credit unions about the impact of the final rules on community banks and credit unions. Between July and September 2015, we interviewed representatives from two state community banking and two state credit union associations from Georgia, Illinois, Louisiana, and Pennsylvania. We also interviewed representatives from four community banks and four credit unions that fell in each of the four asset categories: under $250 million, between $250 million and $500 million, between $500 million and $1 billion, and between $1 billion and $10 billion. In determining our sample, we relied to the extent possible on entities interviewed for our September 2012 report for continuity. As two state bank community banking and credit union associations that we previously interviewed declined to be re-interviewed, we used a methodology similar to our September 2012 report to select replacements. Using SNL Financial data on the number and percentage of banks and credit unions in each state within different asset classes, we selected one state banking association and one state credit union association that (1) represented a higher-than-average percentage of institutions within specific asset classes and (2) represented a larger number of institutions within that asset class than other states.

Additionally, we interviewed three community banks and two credit unions that we previously interviewed in our September 2012 report and randomly selected and interviewed one community bank and two credit unions for the remainder. While the information we obtained from the interviews provides useful insights, it cannot be used to make generalizations about the experiences of all community banks and credit unions since the selection of interviewees relied on non-probability sampling methods. Nevertheless, we purposely sought to achieve variety in our sample as a way to gain access to a range of experiences within the target population.

We also analyzed bank quarterly Reports of Condition and Income (Call Reports) data for depository institutions and credit unions obtained from FFIEC and NCUA, respectively, from the first quarter of 2006 through the second quarter of 2015. We used these data to construct indicators of the cumulative costs associated with complying with Dodd-Frank Act regulations, including numbers of employees per $1 million in assets, non-interest expenses as a percentage of assets, and earnings as a percentage of assets. We used the same data to construct indicators associated with business lines that may be affected by Dodd-Frank Act regulations, including residential mortgage lending as a percentage of assets. We assessed the reliability of the FFIEC and NCUA data by reviewing relevant documentation and electronically testing the data for missing values, outliers, and invalid values, and we found the data to be sufficiently reliable for purpose of constructing indicators associated with compliance costs and business lines for banks and credit unions. Although we analyzed the impact of a number of specific Dodd-Frank Act provisions on community banks and credit unions, assessing the extent to which these provisions or their related regulations should apply to such institutions was beyond the scope of our work.

To analyze the impact of the Dodd-Frank Act on financial market stability, we updated several indicators developed in our prior reports with data through the second quarter of 2015. We also created new indicators for banks that are systemically important financial institution (bank SIFI) and nonbank financial institutions designated by the FSOC for supervision by the Federal Reserve (designated nonbanks). We updated indicators to monitor changes in size, complexity, leverage, and liquidity of bank SIFIs and added new indicators of interconnectedness, which captures direct or indirect linkages between financial institutions that may transmit distress from one institution to another. We updated our econometric analysis estimating changes in measures of the (1) funding cost for bank SIFIs and (2) safety and soundness of bank SIFIs. Since we began developing and tracking indicators for bank SIFIs, FSOC has designated four nonbank institutions for enhanced supervision by the Federal Reserve. As such, we added new indicators associated with the size, interconnectedness, leverage, and liquidity of these institutions. Finally, we updated our indicators monitoring the extent to which certain swap reforms are consistent with the act’s goals of reducing risk. For those parts of our methodology that involved the analysis of computer- processed data from Bloomberg, the Federal Reserve Bank of Chicago, the Federal Reserve, the National Information Center, and the Bureau of Economic Analysis, we assessed the reliability of these data by reviewing relevant documentation, and electronically testing the data for missing values, outliers, and invalid values. We also interviewed Federal Reserve staff about Federal Reserve’s data. We determined the data were sufficiently reliable for our purposes—monitoring changes in SIFI characteristics, estimating changes in the cost of credit bank SIFIs provided and their safety and soundness, and assessing the amount of margin collateral that over-the-counter derivatives counterparties used.

We conducted this performance audit from April 2015 to December 2015 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives.

Appendix II: Dodd-Frank Act Rules Effective as of July 22, 2015

The following table lists the 26 Dodd-Frank Act rules that we identified as having effective dates during the scope of our review—from July 23, 2014, through July 22, 2015. Fifteen of the rules were substantive— meaning they are generally subject to the notice and comment requirements of the Administrative Procedure Act (APA)—and, of those, 6 were major.

Appendix III: Coordination for Dodd-Frank Act Rules Effective as of July 22, 2015

The following table lists the 26 Dodd-Frank Act rules that we identified as having effective dates during the scope of our review (from July 23, 2014, through July 22, 2015), whether the Dodd-Frank Act required interagency or international coordination, and the nature of required coordination (if any). The rulemaking agencies coordinated as required by the Dodd- Frank Act for 11 of the 26 regulations we reviewed (see app. III). For the remaining 15 of the 26 rules we reviewed, the agencies were not required by the Dodd-Frank Act to coordinate.

Appendix IV: Summary of Rulemakings Related to Selected Dodd-Frank Act Provisions Applicable to Designated Nonbanks

The Dodd-Frank Act contains several provisions—including designation by the Financial Stability Oversight Council (FSOC) for supervision by the Board of Governors of the Federal Reserve System (Federal Reserve) and enhanced prudential standards—that apply to nonbank financial companies if FSOC determines that material financial distress at the company or the nature, scope, size, scale, concentration, interconnectedness, or mix of activities at the company could pose a threat to U.S. financial stability. Enhanced prudential standards also apply to bank holding companies with $50 billion or more in total consolidated assets. For this report, we refer to those nonbanks financial companies as designated nonbanks and bank holding companies as systemically important banks (bank SIFI), respectively. Table 9 summarizes some of the Dodd-Frank Act provisions and the rulemakings, including their status, to implement those provisions as of July 22, 2015.

Appendix V: Trends in GAO Indicators for Bank Systemically Important Financial Institutions

We developed indicators to monitor changes in the size, interconnectedness, complexity, leverage, and liquidity of bank holding companies with $50 billion or more in total consolidated assets (bank systemically important financial institutions or bank SIFIs). As we first reported in December 2012, some provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and related rules may result in adjustments to the these characteristics of bank SIFIs over time. The size, interconnectedness, and complexity indicators are intended to capture the potential for a bank SIFI’s financial distress to affect the financial system and economy (spillover effects). The leverage and liquidity indicators are intended to capture a bank SIFI’s resilience to shocks or its vulnerability to financial distress.

Data

We used the following data to construct our indicators: quarterly data on the price index for gross domestic product, which we obtained from the Bureau of Economic Analysis for the period from the second quarter of 2006 to the second quarter of 2015. annual data on numbers and locations of legal entities for holding companies obtained from the Board of Governors of the Federal Reserve System for the period from the second quarter of 2010 to the second quarter of 2015. quarterly data on second tier bank holding companies, which we obtained from the Board of Governors of the Federal Reserve System via the National Information Center for the period from the second quarter of 2006 to the second quarter of 2015. quarterly balance sheet and income statement data that bank holding companies report on Form FR Y-9C, which we obtained from the Federal Reserve Bank of Chicago for the period from the second quarter of 2006 to the second quarter of 2015, and quarterly data on gross notional amounts of credit default swaps outstanding by reference entity, which we obtained from Bloomberg for the period from the third quarter of 2010 to the second quarter of 2015.

Sample

Our indicators analysis generally includes all top-tier U.S. bank holding companies with total consolidated assets of $1 billion or more that filed Form FR Y-9C for one or more quarters during the period from the first quarter of 2006 to the second quarter of 2015, including any U.S.-based bank holding company subsidiaries of foreign banking organizations that on their own have total consolidated assets of $1 billion or more and that filed Form FR Y-9C. We chose the threshold of $1 billion in assets to match the threshold for reporting Form FR Y-9C starting in the first quarter of 2015. We defined bank SIFIs as bank holding companies with total assets of $50 billion or more. We defined large bank SIFIs as bank holding companies with total assets of $500 billion or more and we defined other bank SIFIs as bank holding companies with total assets of at least $50 billion but less than $500 billion. We defined non-SIFI bank holding companies as bank holding companies with less than $50 billion in total assets.

Methodology

We calculate each of our indicators for each bank holding company in our sample for each quarter from the first quarter of 2006 to the second quarter of 2015, with the exceptions of our complexity indicators, which we calculate only for bank SIFIs as of the second quarter of each year from 2006 to 2015, and one of our interconnectedness indicators, which we calculate only for bank SIFIs for the period from the third quarter of 2010 to the second quarter of 2015.. We then calculate the median value of each indicator for each group of bank holding companies—large bank SIFIs, other bank SIFIs, all bank SIFIs, non-SIFI bank holding companies, and all bank holding companies, to the extent possible—and track the median values over time. Finally, we assess the changes in the median values of the indicators for large bank SIFIs and other banks SIFIs between the second or third quarter of 2010 and the second quarter of 2015, depending on the indicator. We say that an indicator has increased or decreased if it has changed by 5 percent or more, depending on the direction of the change, and we say that an indicator has remained about the same if it has changed by less than 5 percent.

Limitations

Our indicators analysis has limitations. For example, the indicators do not identify causal links between changes in bank SIFI characteristics and the act. Rather, the indicators track changes in the size, interconnectedness, complexity, leverage, and liquidity of bank SIFIs since the Dodd-Frank Act was passed to examine whether the changes were consistent with the act. However, other factors—including the economic downturn, international banking standards agreed upon by the Basel Committee on Banking Supervision (Basel Committee), and monetary policy actions— also affect bank holding companies and, thus, the indicators. These factors may have a greater effect on bank SIFIs than the Dodd-Frank Act. In addition, some rules implementing bank SIFI-related provisions have not yet been finalized or fully implemented. Thus, changes in our indicators include the effects of these rules only insofar as bank SIFIs have changed their behavior in response to issued rules and in anticipation of expected rules. In this sense, our indicators provide baselines against which to compare future trends. Furthermore, each indicator has its own specific limitations, which we expand on below.

Indicators

Size

An institution’s size is associated with the potential for its financial distress to affect the financial system and the broader economy (spillover effects). We developed three indicators of size—the number of bank holding companies with assets of $50 billion or more, total assets of the consolidated bank holding company as reported on its balance sheet (adjusted for inflation and measured in billions of second quarter 2015 dollars), and the market share of the bank holding company (equal to its total assets as a percentage of the total assets of all of the holding companies we analyzed).

These indicators do not include an institution’s off-balance-sheet activities and thus may understate the amount of financial services or intermediation an institution provides. Furthermore, asset size alone is not an accurate determinant of systemic significance because an institution’s systemic significance also depends on other factors, such as its complexity and interconnectedness. Furthermore, some bank SIFIs are U.S.-based bank holding company subsidiaries of foreign banking organizations, and the size of these bank SIFIs may not reflect the potential for the parent company’s financial distress to affect the financial system and the economy.

We observed the following changes in our size indicators over the period from the third quarter of 2010 to the second quarter of 2015:

The number of bank SIFIs had decreased by three between the third quarter of 2010 and the second quarter of 2015. The number of large bank SIFIs had decreased by one and the number of other bank SIFIs had decreased by two.

Median assets of bank SIFIs had decreased by about 12 percent.

Median assets of large bank SIFIs have increased by about 35 percent, while median assets of other bank SIFIs had decreased by about 9 percent.

Median market shares of bank SIFIs had decreased by about 7 percent. Median market shares of large bank SIFIs had increased by about 42 percent while median market shares of other bank SIFIs had remained about the same.

Interconnectedness reflects direct or indirect linkages between financial institutions that may transmit distress from one financial institution to another (spillover effects). We developed two indicators of interconnectedness based on those that Financial Stability Oversight Council uses in the first stage of its process for designating nonbank SIFIs—gross notional amount of credit default swaps outstanding for which the institution is the reference entity (adjusted for inflation and measured in millions of second quarter 2015 dollars) and total debt outstanding (adjusted for inflation and measured in second quarter 2015 dollars). We measure total debt outstanding as the difference between total liabilities and total deposits.

We observed the following changes in our interconnectedness indicators:

Median credit default swaps gross notional amounts among bank SIFIs that are reference entities have decreased by about 57 percent. Median credit default swaps gross notional amounts for large bank SIFIs that are reference entities have decreased by about 55 percent while median credit default swaps gross notional amounts for other bank SIFIs that are reference entities have decreased by about 75 percent. We note that few bank SIFIs are reference entities—only 6-7 large bank SIFIs are reference entities and only 3-4 other bank SIFIs are reference entities in any one quarter.

Median total debt outstanding for bank SIFIs has decreased by about 32 percent. Median debt outstanding for large bank SIFIs has decreased by about 21 percent, while median debt outstanding for other bank SIFIs has decreased by about 9 percent.

Institutions that are more complex are likely to be more difficult to resolve and therefore cause significantly greater disruption to the wider financial system and economic activity if they fail (spillover effects). Resolution via a bankruptcy or under the backstop orderly liquidation authority in title II of Dodd-Frank Act may be more difficult if a large number of legal entities or legal systems are involved. For example, a SIFI with a large number of legal entities—particularly foreign ones operating in different countries under different regulatory regimes—may be more difficult to resolve than a SIFI with fewer legal entities in fewer countries. We developed three indicators of this type of complexity—the number of a bank SIFI’s legal entities, the number of a bank SIFI’s foreign legal entities, and the number of countries in which a bank SIFI’s foreign legal entities are located.

A key limitation of our indicators is that they may not capture all relevant aspects of the complexity of a SIFI, such as complexity that could result from being a subsidiary of a foreign company.

We observed the following changes in our complexity indicators:

Median numbers of legal entities for bank SIFIs decreased by 25, (about 19 percent). Median numbers of legal entities for large bank SIFIs decreased by 534, (about 19 percent), and median numbers of legal entities for other bank SIFIs decreased by 24, (about 22 percent).

Median numbers of foreign legal entities for bank SIFIs did not change. However, median numbers of foreign legal entities for large bank SIFIs increased by 143, (about 21 percent), and median numbers of foreign legal entities for other bank SIFIs decreased by 2, (about 33 percent).

Median numbers of countries in which foreign legal entities are located for bank SIFIs did not change. Median numbers of countries in which foreign legal entities are located for large bank SIFIs remained about the same and median numbers of countries in which foreign legal entities are located for other bank SIFIs decreased by 1, (about 25 percent).

Leverage generally captures the relationship between an institution’s exposure to risk and capital that can be used to absorb losses from that exposure (resilience). Institutions with more capital to absorb losses are less likely to fail, all else being equal. We track two indicators of leverage—a bank SIFI’s tangible common equity as a percentage of total assets and a bank SIFI’s total bank holding company equity as a percentage of total assets. We measure tangible common equity as bank holding company equity capital minus preferred stock, goodwill, and other intangible assets, plus mortgage servicing rights.

A limitation of both indicators is that they may not fully reflect an institution’s exposure to risk because total assets do not reflect an institution’s risk exposure from off-balance-sheet activities and generally treat all assets as equally risky.

We observed the following changes in our leverage indicators between the third quarter of 2010 and the second quarter of 2015:

Median tangible common equity as a percentage of assets for bank SIFIs has increased by about 29 percent. Median tangible common equity as a percentage of assets for large bank SIFIs has increased by about 21 percent and median tangible common equity as a percentage of assets for other bank SIFIs has increased by about 26 percent.

Median total equity as a percentage of assets for bank SIFIs has increased by about 13 percent. Median total equity as a percentage of assets for large bank SIFIs has increased by about 29 percent and median total equity as a percentage of assets for other bank SIFIs has increased by about 9 percent.

Liquidity represents the ability to fund assets and meet obligations as they become due, and liquidity risk is the risk of not being able to obtain funds at a reasonable price within a reasonable time period to meet obligations as they become due. Institutions with more liquidity (and less liquidity risk), are less likely to fail, all else being equal (resilience). We developed two indicators of liquidity—short-term liabilities as a percentage of total liabilities and liquid assets as a percentage of short-term liabilities. Short- term liabilities reflect an institution’s potential need for liquidity in the short-term. We measure short-term liabilities as the sum of federal funds purchased and repurchase agreements, trading liabilities (less derivatives with negative fair value), other borrowed funds, deposits held in foreign offices, and jumbo time deposits (deposits of $100,000 or more) held in domestic offices. Liquid assets are assets that can be sold easily without affecting their price and, thus, can be converted easily to cash to cover debts that come due. Accordingly, liquid assets as a percentage of an institution’s short-term liabilities are a measure of an institution’s capacity to meet potential upcoming obligations. We measure liquid assets as the sum of cash and balances due from depository institutions, securities (less pledged securities), federal funds sold and reverse repurchases, and trading assets.

A limitation of both indicators is that they do not include off balance sheet liabilities, such as callable derivatives or other potential derivatives- related obligations. The second indicator also does not include off- balance-sheet liquid assets, such as short-term income from derivative contracts. Because these limitations affect both the numerator and the denominator of our indicators, we cannot determine whether the exclusion of off-balance-sheet items results in an under or an overstatement of an institution’s liquidity need and access.

We observed the following changes in our liquidity indicators between the third quarter of 2010 and the second quarter of 2015:

Median short-term liabilities as a percentage of total liabilities for bank SIFIs have decreased by about 15 percent. Median short-term liabilities as a percentage of total liabilities for large bank SIFIs have decreased by about 20 percent, and median short-term liabilities as a percentage of total liabilities for other bank SIFIs have decreased by about 31 percent.

Median liquid assets as a percentage of short-term liabilities for bank SIFIs have increased by about 70 percent. Median liquid assets as a percentage of short-term liabilities for large bank SIFIs have increased by about 51 percent, and median liquid assets as a percentage of short-term liabilities for other bank SIFIs have increased by about 60 percent.

Appendix VI: Econometric Analyses of the Impact of Enhanced Regulation and Oversight on Systemically Important Financial Institutions

We updated our econometric analysis assessing the impacts of new requirements in the Dodd- Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) for bank holding companies with total consolidated assets of $50 billion or more—bank systemically important financial institutions or bank SIFIs—as they relate to (1) the funding costs for bank SIFIs and (2) indicators of their safety and soundness.

Methodology

Our multivariate econometric model uses a difference-in-difference design that exploits the fact that the Dodd-Frank Act subjects bank SIFIs to enhanced regulation by the Board of Governors of the Federal Reserve System (Federal Reserve) but not other holding companies, so we can view bank SIFIs as the treatment group and other bank holding companies as the control group. We compared the changes in the characteristics of bank SIFIs over time with changes in the characteristics of other bank holding companies over time. All else being equal, the difference in the differences is the impact of new requirements for bank SIFIs primarily tied to enhanced regulation and oversight under the Federal Reserve.

Our general econometric specification is the following: ybq = α + β + γSIFIbq + X’bqF + εbq, where b denotes the bank holding company, q denotes the quarter, ybq is the dependent variable, α is a bank holding company-specific intercept, β is a quarter-specific intercept, SIFIbq is an indicator variable that equals 1 if bank holding company b is a SIFI in quarter q and 0 otherwise, Xbq is a list of other independent variables, and εbq is an error term. We estimated the parameters of the model using quarterly data on top-tier bank holding companies that filed Form FR Y-9C from the first quarter of 2006 through the second quarter of 2015.

The parameter of interest is γ, the coefficient on the SIFI indicator, which is equal to 1 for bank holding companies with consolidated assets of $50 billion or more in the quarters starting with the treatment start date and is equal to zero otherwise. The Dodd-Frank Act was enacted in July 2010, so the treatment start date is the third quarter of 2010. Thus, the parameter γ measures the average difference in the difference in dependent variable between bank SIFIs and other bank holding companies before and after the Dodd-Frank Act was enacted.

We use different dependent variables (ybq) to estimate the impacts of the new requirements for SIFIs on the cost of credit provided by bank SIFIs and on various aspects of bank SIFIs’ safety and soundness, including capital adequacy, asset quality, earnings, and liquidity.

Funding cost. A bank holding company’s funding cost is the cost of deposits or liabilities that it then uses to make loans or otherwise acquire assets. More specifically, a bank holding company’s funding cost is the interest rate it pays when it borrows funds. All else being equal, the greater a bank holding company’s funding cost, the greater the interest rate it charges when it makes loans. We measure funding cost as an institution’s interest expense as a percent of interest- bearing liabilities.

Capital adequacy. Capital absorbs losses, promotes public confidence, helps restrict excessive asset growth, and provides protection to creditors. We use two alternative measures of capital adequacy: tangible common equity as a percentage of total assets and total bank holding company equity as a percent of total assets.

Asset quality. Asset quality reflects the quantity of existing and potential credit risk associated with the institution’s loan and investment portfolios and other assets, as well as off-balance sheet transactions. Asset quality also reflects the ability of management to identify and manage credit risk. We measure asset quality as performing assets as a percent of total assets, where performing assets are equal to total assets less assets 90 days or more past due and still accruing interest and assets in non-accrual status.

Earnings. Earnings are the initial safeguard against the risks of engaging in the banking business and represent the first line of defense against capital depletion that can result from declining asset values. We measure earnings as net income as a percent of total assets.

Liquidity. Liquidity represents the ability to fund assets and meet obligations as they become due, and liquidity risk is the risk of not being able to obtain funds at a reasonable price within a reasonable time period to meet obligations as they become due. We use two different variables to measure liquidity. The first variable is liquid assets as a percent of volatile liabilities. This variable is similar in spirit to the liquidity coverage ratio introduced by the Basel Committee on Banking Supervision (Basel Committee) and measures a bank holding company’s capacity to meet its liquidity needs under a significantly severe liquidity stress scenario. We measure liquid assets as the sum of cash and balances due from depository institutions, securities (less pledged securities), federal funds sold and reverse repurchases, and trading assets. We measure volatile (short-term) liabilities as the sum of federal funds purchased and repurchase agreements, trading liabilities (less derivatives with negative fair value), other borrowed funds, deposits held in foreign offices, and jumbo time deposits (deposits of $100,000 or more) held in domestic offices.

The second liquidity variable is stable liabilities as a percent of total liabilities. This variable measures the extent to which a bank holding company relies on stable funding sources to finance its assets and activities. This variable is related in spirit to the net stable funding ratio introduced by the Basel Committee, which measures the amount of stable funding based on the liquidity characteristics of an institution’s assets and activities over a 1-year horizon. We measure stable funding as total liabilities minus volatile liabilities as described earlier.

Finally, we include a limited number of independent variables (Xbq) to control for factors that may differentially affect SIFIs and non-SIFIs in the quarters since the Dodd-Frank Act was enacted. We include these variables to reduce the likelihood that our estimates are reflecting something other than the impact of the new Dodd-Frank Act requirements for SIFIs.

Securitization income. Bank holding companies with more income from securitization are likely to have different business models than those with more income from traditional banking associated with an originate-to-hold strategy for loans. Changes in the market for securitized products since enactment of the Dodd-Frank Act thus may have had a greater effect on bank holding companies with more securitization income. If bank SIFIs typically have more securitization income than other bank holding companies, then changes in the market for securitized products since enactment may have differentially affected the two groups. We measure securitization income as the sum of net servicing fees, net securitization income, and interest and dividend income on mortgage-backed securities minus associated interest expense, and express securitization as a percent of operating revenue. Operating revenue is the sum of interest income and noninterest income less interest expense and loan loss provisions.

Nontraditional income. Nontraditional income generally captures income from capital market activities. Bank holding companies with more nontraditional income are likely to have different business models than those with more income from traditional banking activities. Changes in capital markets since enactment of the Dodd- Frank Act may have had a greater effect on bank holding companies with more nontraditional income. If bank SIFIs typically have more nontraditional income than other bank holding companies, then changes in capital markets since enactment may have differentially affected the two groups. We measure nontraditional income as the sum of trading revenue; investment banking, advisory, brokerage, and underwriting fees and commissions; venture capital revenue; insurance commissions and fees; and interest income from trading assets less associated interest expense, and we express nontraditional income as a percent of operating revenue.

Foreign exposure. Changes in other countries, such as the sovereign debt crisis in Europe, may have a larger effect on bank holding companies with more foreign exposure. If bank SIFIs typically have more foreign exposure than other bank holding companies, then changes in foreign markets may have differentially affected the two groups. We measure foreign exposure as the sum of foreign debt securities (held-to-maturity and available-for-sale), foreign bank loans, commercial and industrial loans to non-U.S. addresses, and foreign government loans and we express foreign exposure as a percent of total assets.

Size. We include size because bank SIFIs tend to be larger than other bank holding companies, and market pressures or other forces not otherwise accounted for may have differentially affected large and small bank holding companies in the time since enactment of the Dodd-Frank Act. We measure the size of a bank holding company as the natural logarithm of its total assets.

Capital Purchase Program participation. We control for whether or not a bank holding company participated in the Capital Purchase Program component of the Troubled Asset Relief Program to differentiate any impact that this program may have had from the impact of the Dodd- Frank Act.

We also conducted several sets of robustness checks:

We restricted our sample to the set of institutions with assets that are “close” to the $50 billion cutoff for enhanced prudential regulation for bank SIFIs. Specifically, we analyzed two restricted samples of bank holding companies: (1) bank holding companies with assets between $25 billion and $75 billion and (2) bank holding companies with assets between $1 billion and $100 billion.

We examined different treatment start dates. Specifically, we allowed the Dodd-Frank Act’s new requirements for SIFIs to have an impact in the third quarter of 2009, 1 year before the passage of the act. We did so to allow for the possibility that institutions began to react to the act’s requirements in anticipation of the act being passed.

We allowed the effect of the treatment to vary by quarter to allow for the possibility that the impact of the act varied over time.

Data

We conducted our analysis using quarterly data on top-tier U.S. bank holding companies that filed Form FR Y-9C, including top-tier U.S.-based bank holding company subsidiaries of foreign banking organizations. We analyzed these companies for the period from the first quarter of 2006 through the second quarter of 2015. We obtained these data from the Federal Reserve Bank of Chicago and the Board of Governors of the Federal Reserve System.

Results

While some of the SIFI-related rulemakings have yet to be implemented, our estimates are suggestive of the initial effects of the Dodd-Frank Act on bank SIFIs and provide a baseline against which to compare future results. Our baseline estimates suggest that the Dodd-Frank Act has not been associated with a significant change in funding costs of bank SIFIs (see table 15). To the extent that the cost of credit provided by bank SIFIs is a function of their funding costs, the new requirements for SIFIs are likely to have had little effect on the cost of credit to date through the funding cost channel.

Our estimates also suggest that the Dodd-Frank Act is associated with improvements in some measures of bank SIFIs’ safety and soundness. Bank SIFIs appear to be holding more tangible common equity as a percentage of assets than they otherwise would have held since Dodd- Frank Act enactment (see panel 1 in table 15). The quality of assets on the balance sheets of bank SIFIs seems to have improved since enactment. The act is also associated with improved liquidity as measured by the extent to which a bank holding company is using stable sources of funding and with higher earnings. However, capital adequacy as measured by total bank holding company equity and liquidity as measured by the capacity of a bank holding company’s liquid assets to cover its volatile liabilities have not clearly improved since enactment. Thus, the Dodd-Frank Act appears to be associated with improvements in some indicators of safety and soundness for bank SIFIs (relative to non- SIFI bank holding companies) but not others.

Our approach allows us to partially differentiate changes in funding costs, capital adequacy, asset quality, earnings, and liquidity associated with the Dodd-Frank Act from changes due to other factors. However, several factors make isolating and measuring the impact of the Dodd-Frank Act requirements for SIFIs challenging. The effects of the act cannot be differentiated from the effects of simultaneous changes in economic conditions, such as the pace of the recovery from the recent recession, or regulations, such as those stemming from Basel III, or other changes, such as in credit ratings that differentially may affect bank SIFIs and other bank holding companies. In addition, some of the new requirements for SIFIs may not yet be fully implemented. Nevertheless, our estimates are suggestive of the initial effects of the Dodd-Frank Act on bank SIFIs and provide a baseline against which to compare future trends.

The results of our robustness checks are as follows:

Our results for funding costs, capital adequacy as measured by total bank holding company equity as a percentage of assets, asset quality, earnings, and liquidity as measured by long-term liabilities as a percentage of total liabilities are generally robust to restricting the set of bank holding companies we analyze to those with assets of $25 billion to $75 billion, but our results for capital adequacy as measured by tangible common equity as a percentage of assets and liquidity as measured by liquid assets as a percentage of short-term liabilities are not.

Our results are generally robust to restricting the set of bank holding companies we analyze to those with assets of $1 billion to $100 billion.

Our results are generally robust to starting the treatment in the third quarter of 2009, 1 year before the passage of the Dodd-Frank Act. This finding is consistent with the idea that bank holding companies began to change their behavior in anticipation of the act’s requirements, perhaps as information about the content of the act became available and the likelihood of its passage increased. However, there may be other explanations, including anticipation of Basel III requirements, reactions to stress tests, and market pressures to improve capital adequacy and liquidity.

Our results for funding costs, capital adequacy, and liquidity are generally robust to allowing the treatment effect to vary by quarter (see table 16). However, our results for asset quality and earnings suggest that the Dodd-Frank Act may not be associated with improvements in asset quality and earnings in every quarter.

Appendix VII: Dodd-Frank Act Rules Implementing Central Clearing, Capital, and Margin Swap Reforms

The following table lists select rules that implement sections of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd- Frank Act) related to central clearing requirements for swaps and security-based swaps, and margin and capital requirements for swaps entities, as of July 22, 2015.

Appendix VIII: Comments from the National Credit Union Administration

Appendix IX: GAO Contact and Acknowledgments

GAO Contact

Staff Acknowledgments

In addition to the contact named above, Stefanie Jonkman (Assistant Director), Akiko Ohnuma (Analyst-in-Charge), Bethany Benitez, Pamela Davidson, Courtney LaFountain, Marc Molino, Barbara Roesmann, and Weifei Zheng made key contributions to this report.