Dodd-Frank Act: Agencies' Efforts to Analyze and Coordinate Their Rules
Released: 2012-12-18T00:00:00

Letter

Background

Financial Services Regulation

The U.S. financial regulatory structure is a complex system of multiple federal and state regulators as well as self-regulatory organizations (SRO) that operate largely along functional lines. That is, financial products or activities generally are regulated according to their function, no matter who offers the product or participates in the activity. The functional regulator approach is intended to provide consistency in regulation, focus regulatory restrictions on the relevant functional areas, and avoid the potential need for regulatory agencies to develop expertise in all aspects of financial regulation.

In the banking industry, the specific regulatory configuration depends on the type of charter the banking institution chooses. Charter types for depository institutions include commercial banks, thrifts, and credit unions. These charters may be obtained at the state or federal level. The federal prudential banking regulators—all of which generally may issue regulations and take enforcement actions against industry participants within their jurisdiction—are identified in table 1.

In addition, the Dodd-Frank Act created CFPB as an independent bureau within the Federal Reserve System that is responsible for regulating the offering and provision of consumer financial products and services under the federal consumer financial laws. Under the Dodd-Frank Act, at the designated transfer date, certain authority vested in the prudential regulators transferred to CFPB.

The securities and futures industries are regulated under a combination of self-regulation (subject to oversight by the appropriate federal regulator) and direct oversight by SEC and CFTC, respectively. SEC oversees the securities industry SROs, and the securities industry as a whole, and is responsible for administering federal securities laws and developing regulations for the industry. SEC’s overall mission includes protecting investors; maintaining fair, orderly, and efficient markets; and facilitating capital formation. CFTC oversees the futures industry and its SROs. Under the Dodd-Frank Act, CFTC also has extensive responsibilities for the regulation of swaps and certain entities involved in the swaps markets. CFTC has responsibility for administering federal legislation and developing comprehensive regulations to protect the public from fraud and manipulation, to insure the financial integrity of transactions, and to reduce systemic risk in the marketplace.

In addition, the Dodd-Frank Act created FSOC. FSOC’s three primary purposes are 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 members and 5 nonvoting members and is chaired by the Secretary of the Treasury. In consultation with the other FSOC members, the Secretary is responsible for regular consultation with the financial regulatory entities and other appropriate organizations of foreign governments or international organizations.

Regulations and Federal Rulemaking

The federal government uses regulation to implement public policy. Section 553 of APA contains requirements for the most common type of federal rulemaking—informal rulemaking or “notice and comment” rulemaking. While there are inter- and intra-agency variations in the informal rulemaking process, federal financial regulators generally share three basic rulemaking steps or phases: Initiation of rulemaking action. During initiation, agencies gather information that would allow them to determine whether rulemaking is needed and identify potential regulatory options. To gather information on the need for rulemaking and potential regulatory options, agencies may hold meetings with interested parties or issue an advanced notice of proposed rulemaking. At this time, the agencies also will identify the resources needed for the rulemaking and may draft concept documents for agency management that summarize the issues, present the regulatory options, and identify needed resources.

Development of proposed rule. During this phase of the rulemaking process, an agency will draft the notice of proposed rulemaking, including the preamble (which is the portion of the rule that informs the public of the supporting reasons and purpose of the rule) and the rule language. The agency will begin to address analytical and procedural requirements in this phase. The agency provides “interested persons” with an opportunity to comment on the proposed rule, generally for a period of at least 30 days.

Development of final rule. In the third phase, the agency repeats, as needed, the steps used during development of the proposed rule. Once the comment period closes for the proposed rule, the agency either would modify the proposed rule to incorporate comments or address the comments in the final rule release. This phase also includes opportunities for internal and external review. As published in the Federal Register, the final rule includes the date on which it becomes effective.

APA’s notice and comment procedures exclude certain categories of rules, including interpretative rules; general statements of policy; rules that deal with agency organization, procedure, or practice; or rules for which the agency finds (for good cause) that notice and public comment procedures are impracticable, unnecessary or contrary to the public interest.

Dodd-Frank Act Regulations

Under the Dodd-Frank Act, federal financial regulatory agencies are directed or have the authority to issue hundreds of regulations to implement the act’s provisions. In some cases, the act gives the agencies little or no discretion in deciding how to implement the provisions. For instance, the Dodd-Frank Act made permanent a temporary increase in the FDIC deposit insurance coverage amount ($100,000 to $250,000); therefore, FDIC revised its implementing regulation to conform to the change. However, other rulemaking provisions in the act appear to be 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 over the substance of the regulations. As a result, for these rulemaking provisions, the agencies may decide to promulgate rules for some or all of the provisions, and may have broad discretion to decide what these rules will contain and what exemptions, if any, will apply.

In many instances, exemptions to Dodd-Frank Act provisions are encompassed in definitions of certain terms that are broadly established in statute and require clarification through regulation. Persons or entities that meet the regulatory definitions are subject to the provision, and those that do not meet the definitions are not. For example, CFTC and SEC promulgated a regulation that defined the terms ‘‘swap dealer,’’ ‘‘security- based swap dealer,’’ ‘‘major swap participant,’’ ‘‘major security-based swap participant,’’ and ‘‘eligible contract participant.’’ Persons that do not meet the definitions of these terms may not be subject to the Dodd- Frank Act provisions concerning swaps and security-based swaps, including registration, margin, capital, business conduct, and other requirements. Similarly, FSOC promulgated a regulation and interpretive guidance regarding the specific criteria and analytic framework FSOC would apply in determining whether a nonbank financial company could pose a threat to the financial stability of the United States. Financial firms that are not designated by FSOC, acting pursuant to the statutory standards, would not be subject to enhanced prudential supervision by the Federal Reserve.

Regulatory Analyses Provide Limited Information about Benefits and Costs of Chosen or Alternative Approaches

Federal agencies conducted the regulatory analyses required by various federal statutes for all 54 Dodd-Frank Act regulations that we reviewed. As part of their analyses, the agencies generally considered, but typically did not quantify or monetize, the benefits and costs of these regulations. As independent regulatory agencies, the federal financial regulators are not subject to executive orders that require comprehensive benefit-cost analysis in accordance with guidance issued by OMB. While most financial regulators said that they attempt to follow OMB’s guidance in principle or spirit, we found that they did not consistently follow key elements of the guidance in their regulatory analyses. We previously recommended that regulators should more fully incorporate the OMB guidance into their rulemaking policies.

Regulators Were Not Required to Assess Benefits and Costs of Regulatory Alternatives

As part of their rulemakings, federal agencies generally must conduct regulatory analysis pursuant to the Paperwork Reduction Act (PRA) and the Regulatory Flexibility Act (RFA), among other statutes.RFA require federal agencies to assess various impacts and costs of their rules, but do not require the agencies to formally assess the benefits and costs of alternative regulatory approaches or the reason for selecting one alternative over another. In addition to these requirements, authorizing or other statutes require certain federal financial regulators to consider PRA and specific benefits, costs, and impacts of their rulemakings, as the following describes.

CFTC, under section 15(a) of the Commodity Exchange Act, is required to consider the benefits and costs of its action before promulgating a regulation under the Commodity Exchange Act or issuing certain orders. Section 15(a) further specifies that the benefits and costs shall be evaluated in light of the following five broad areas of market and public concern: (1) protection of market participants and the public; (2) efficiency, competitiveness, and financial integrity of futures markets; (3) price discovery; (4) sound risk-management practices; and (5) other public interest considerations.

Under the Consumer Financial Protection Act (Title X of the Dodd- Frank Act), CFPB must consider the potential benefits and costs of its rules for consumers and entities that offer or provide consumer financial products and services. These include potential reductions in consumer access to products or services, the impacts on depository institutions with $10 billion or less in assets, as directed by 12 U.S.C. § 5516, and the impacts on consumers in rural areas. RFA analysis, CFPB also must describe any projected increase in the cost of credit for small entities and any significant alternatives that would minimize such increases for small entities. In addition to the protection of investors, SEC must consider whether a rule will promote efficiency, competition, and capital formation whenever it is engaged in rulemaking and is required to consider or determine whether an action is necessary or appropriate in the public interest. SEC also must consider the impact that any rule promulgated under the Securities Exchange Act would have on competition. This provision states that a rule should not be adopted if it would impose a burden on competition that is not necessary or appropriate to the act’s purposes.

12 U.S.C. § 5481(6).

The Electronic Funds Transfer Act (EFTA), as amended by the Dodd- Frank Act, requires the Federal Reserve to prepare an analysis of the economic impact of a specific regulation that considers the costs and benefits to financial institutions, consumers, and other users of electronic fund transfers. The analysis must address the extent to which additional paperwork would be required, the effect upon competition in the provision of electronic banking services among large and small financial institutions, and the availability of such services to different classes of consumers, particularly low-income consumers.

However, like PRA and RFA, none of these authorizing statutes prescribe formal, comprehensive benefit and cost analyses that require the identification and assessment of alternatives.

In contrast, Executive Order 12,866 (E.O. 12,866), supplemented by Executive Order 13,563 (E.O. 13,563), requires covered federal agencies, to the extent permitted by law and where applicable, to (1) assess benefits and costs of available regulatory alternatives and (2) include both quantifiable and qualitative measures of benefits and costs in their analysis, recognizing that some benefits and costs are difficult to quantify. According to OMB, such analysis can enable an agency to learn if the benefits of a rule are likely to justify the costs and discover which of the possible alternatives would yield the greatest net benefit or be the most cost-effective. In 2003, OMB issued Circular A-4 to provide guidance to federal executive agencies on the development of regulatory analysis as required by E.O. 12,866. The guidance defines good regulatory analysis as including a statement of the need for the proposed regulation, an assessment of alternatives, and an evaluation of the benefits and costs of the proposed regulation and the alternatives. It also standardizes the way benefits and costs of federal regulatory actions should be measured and reported. Of the federal agencies included in our review, only FSOC and Treasury are subject to E.O. 12,866. As independent regulatory agencies, the federal financial regulators—CFPB, CFTC, FDIC, the Federal Reserve, OCC, the National Credit Union Administration (NCUA), and SEC—are not subject to E.O. 12,866 and OMB’s Circular A-4.

Of the 66 Dodd-Frank Act rules within our scope, 54 regulations were substantive—generally subject to public notice and comment under APA—and required the agencies to conduct regulatory analysis. These rules were issued individually or jointly by CFTC, FDIC, the Federal Reserve, FSOC, NCUA, OCC, SEC, or Treasury. (See app. II for a list of the regulations within the scope of our review.) In examining the regulatory analyses conducted for these 54 regulations, we found the following.

Agencies conducted the required regulatory analyses. The agencies conducted regulatory analysis pursuant to PRA and RFA for all 54 regulations. Agencies also conducted the analyses required under their authorizing statutes. Specifically, CFTC and SEC individually or jointly issued 39 regulations and considered their potential impact, including their benefits and costs in light of each agency’s respective public interest considerations.

Agencies issued 19 major rules. Of the 54 regulations that were issued and became effective between July 21, 2011, and July 23, 2012, the agencies identified 19 as being major rules—that is, resulting in or likely to result in a $100 million annual impact on the economy. Specifically, CFTC issued 10 major rules; SEC issued 5 major rules; CFTC and SEC jointly issued 2 major rules; the Federal Reserve issued 1 major rule; and Treasury issued 1 major rule.

One of the 19 major rules was subject to E.O. 12866 and its benefit-cost analysis requirement. Of the agencies that issued major rules, only Treasury is subject to E.O. 12,866, which requires a formal assessment of the benefits and costs of an economically significant rule. Thus, as required, Treasury analyzed the benefits and costs of its proposed major rule.

Agencies considered the benefits and/or costs in the majority of their rules, but did not generally quantify them. As part of their regulatory analyses or in response to public comments received on their proposed rules, the agencies frequently discussed the potential benefits and costs of their rules. For instance, CFTC and SEC asked for public comments and data on the benefits and costs in all of their proposed rules, and the other regulators generally asked for public comments on the costs and, in many cases, benefits of their proposed rules. For the 54 substantive Dodd-Frank Act regulations that we reviewed, 49 regulations included discussions of potential benefits or costs. The cost discussions primarily were qualitative except for the PRA analysis, which typically included quantitative data (such as hours or dollars spent to comply with paperwork-related requirements). Other potential costs, however, were less frequently quantified. In comparison, the benefit discussions largely were qualitative and framed in terms of the objectives of the rules.

Regulators Generally Developed Selected Major Rules in Ways Consistent with the Principles, but not Certain Key Elements, of the OMB Guidance

Although independent federal financial regulators are not required to follow OMB’s Circular A-4 when developing regulations, they told us that they try to follow this guidance in principle or spirit. As discussed in more detail below, we previously found that the policies and procedures of these agencies did not fully reflect OMB guidance and recommended that they incorporate the guidance more fully in their rulemaking policies and procedures. To assess the extent to which the regulators follow Circular A-4, we examined four major rules (see table 2). Specifically, we examined whether the regulators (1) identified the problem to be addressed by the regulation and the significance of the problem; (2) considered alternatives reflecting the range of statutory discretion; and (3) assessed the benefits and costs of the regulation.

While the regulators identified the problem to be addressed in their rule proposals, CFTC, the Federal Reserve, and SEC did not present benefit- cost information in ways consistent with certain key elements of OMB’s Circular A-4. For example, CFTC and SEC did not evaluate the benefits and costs of regulatory alternatives they considered for key provisions compared to their chosen approach. Also, because of the lack of data and for other reasons, the agencies generally did not quantitatively analyze the benefits and, to a lesser degree, costs in their rules. Agencies’ approaches for calculating a baseline against which to compare benefits and costs of regulatory alternatives in their analysis varied, and agency staffs told us that the lack of data complicated such efforts.

Two of the major rules we reviewed did not evaluate alternative approaches for key provisions in their rule proposals, but the final rule releases did evaluate alternatives considered by the agencies. In implementing the Dodd-Frank provisions, the agencies exercised discretion in designing the various requirements that composed their rules, such as defining key terms and determining who will be subject to the regulations and how. In their rule proposals, CFTC and SEC identified alternative approaches for key provisions of their rule proposals. For example, CFTC identified the consolidated tape approach—which is used in the U.S. securities markets to publicly report data on securities—as an alternative method for distributing swap transaction data in real time. SEC considered requiring potential whistleblowers to use in-house complaint and reporting procedures before they make a whistleblower submission to SEC. However, CFTC and SEC generally did not evaluate the benefits and costs of their proposed rules’ requirements compared to such alternative requirements. Instead, their rule proposals only presented the proposed set of requirements composing their rules and discussed the potential benefits and costs of their overall regulatory approaches. As part of their proposed rules, CFTC and SEC asked the public for comments on a number of questions, including about possible alternatives to proposed requirements. In their final rules, CFTC and SEC noted that they considered alternatives provided by commenters on the proposed rules and revised their rules, so as to reduce regulatory burden or improve the effectiveness of the rules. This approach generally is consistent with each agency’s guidance on regulatory analysis. However, OMB guidance notes that good regulatory analysis is designed to inform the public and other parts of the government of the effects of alternative actions. Without information about the agency’s evaluation of the benefits and costs of alternatives for key provisions, interested parties may not have a clear understanding of the assumptions underlying the rule’s requirements, which could hinder their ability to comment on proposed rules.

One of the rules we reviewed identified the alternative approaches but did not describe the reasons for choosing one alternative over another in its rule proposal. The Federal Reserve identified several alternative approaches for key provisions in the rule proposal for implementing the interchange fee rule and some of their potential benefits and costs. However, it did not determine which of the alternatives would produce greater net benefits or be more cost-effective. Instead, the Federal Reserve asked the public to comment on which alternatives might be preferable to the others based on several factors, including benefits and costs. Federal Reserve staff told us that they took this approach because it was difficult to predict how market participants would respond to the rule. They said that they had discussions with senior management about alternative approaches and analyzed the costs and benefits of the alternatives, including how alternatives could have different impacts on different market participants, but this information was not contained in the proposed rule. In the final rule, responding to public comments, the Federal Reserve selected one alternative over the other alternatives and provided reasons for the selection. Without information about the rationale for selecting one alternative over another in the proposed rule, interested parties may not know how to effectively gauge the magnitude of the potential effects, which could hinder their ability to comment on the proposed rule.

Only one rule that we reviewed identified and evaluated alternative regulatory approaches. In its rule proposal, Treasury determined that the fee assessment rule was a significant regulatory action under E.O. 12,866 and, thus, conducted a regulatory impact assessment. In its proposal, Treasury identified, evaluated, and discussed several alternative regulatory approaches. Treasury evaluated the impact of alternative approaches on interested parties and selected the approach it viewed as equitable and cost-effective, consistent with the OMB guidance.

The regulators generally did not quantitatively analyze the benefits and, to a lesser degree, costs of the rules we reviewed. CFTC, the Federal Reserve, and SEC did not quantitatively analyze the benefits of these rules. CFTC and SEC monetized and quantified paperwork-related costs under PRA, but did not quantify any other costs. Federal Reserve staff told us that they monetized some of the direct costs of the debit card interchange fee rule. Specifically, they conducted a survey to determine an average debit card interchange fee in 2009 and used that data to help establish the debit card interchange fee cap under the rule. However, while the debit card interchange fee cap information was included in the proposed rule, measures of revenue loss that could result from the rule were not included. In contrast to the other rules we reviewed, Treasury monetized and quantified some costs of the rule beyond paperwork- related costs. Specifically, Treasury provided a range of estimated assessment amounts that described the approximate size of the transfer from assessed companies to the government.

As we have reported, the difficulty of reliably estimating the costs of regulations to the financial services industry and the nation has long been recognized, and the benefits of regulation generally are regarded as even more difficult to measure. Similarly, Circular A-4 recognizes that some important benefits and costs may be inherently too difficult to quantify or monetize given current data and methods and recommends a careful evaluation of qualitative benefits and costs. All of the rules we reviewed included qualitative descriptions of the potential benefits and costs associated with the rules. The agencies also generally included qualitative information on the nature, timing, likelihood, location, and distribution of the benefits and costs. For instance, in discussing the benefits of the reporting and public dissemination requirements, CFTC stated that it anticipates that the real-time reporting rule “will generate several overarching, if presently unquantifiable, benefits to swaps market participants and the public generally. These include: mprovements in market quality; price discovery; improved risk management; economies of scale and greater efficiencies; and improved regulatory oversight.” CFTC then went on to describe the ways in which these benefits might accrue to market participants. However, some of the agencies did not discuss the strengths and limitations of the qualitative information and did not discuss key reasons why the benefits and costs could not be quantified.

Also, the regulators did not consistently present analysis of any important uncertainties connected with their regulatory decisions. For instance, the Federal Reserve stated that the potential impacts of the debit card interchange fee rule depended in large part on the reaction of certain market actors to the rule. In contrast, we did not find a discussion of any important uncertainties associated with SEC’s whistleblower rules, but SEC staff told us that the inherent uncertainties in making predictions about human behavior was a key reason why it was not possible to engage in a quantitative analysis of the rule. However, we found that the agencies generally based their analyses on the best reasonably available, peer-reviewed economic information. Treasury described certain direct costs associated with complying with the fee assessment rule. Treasury used economic reasoning to identify some benefits or types of benefits associated with the rule, particularly in considering the choice of assessment methodology, which was the area of discretion left by Congress to the agency.

We also found the regulators’ approaches for calculating a baseline against which to compare benefits and costs of regulatory approaches varied. OMB’s Circular A-4 states that the baseline should be the best assessment of the way the world would look absent the proposed action. In cases where substantial portions of the rule may simply restate statutory requirements that would be self-implementing, Circular A-4 provides for use of a prestatute baseline—that is, the baseline should reflect the status quo before the statute was enacted. However, the guidance further states that if the agency is able to determine where it has discretion in implementing a statute, it can use a post-statute baseline to evaluate the discretionary elements of the action. CFTC and SEC both did not establish post-statute baselines and instead evaluated the benefits and costs of the discretionary elements of their rules in terms of statutory objectives. Specifically, CFTC evaluated each discretionary element of the real-time reporting rule based on whether it met the statutory objectives to reduce risk, increase transparency, and promote market integrity. Similarly, SEC evaluated each discretionary element of the whistleblower protection rule according to four broad objectives based on statutory goals and the nature of public comments. We found that the Federal Reserve generally took this approach in developing the debit card interchange fee rule. In contrast, Treasury, which is subject to E.O. 12,866, used a post-statute baseline to evaluate the discretionary elements of the fee assessment rule. SEC staff said they would have described the analysis somewhat differently under their new economic analysis guidance (discussed below), which directs staff to consider the overall economic impacts, including both those attributable to congressional mandates and those that result from an exercise of discretion. SEC’s guidance states that this approach often will allow for a more complete picture of a rule’s economic effects, particularly because there are many situations in which it is difficult to distinguish between the mandatory and discretionary components of a rule.

Agency staffs told us developing a baseline from which to assess the benefits and costs of what would have happened in the absence of a regulation was complicated by the lack of reliable data to quantify the benefits and costs. For example, CFTC staff told us that they were challenged because little public data were available about the opaque swaps market. Moreover, because the rule created a new regulatory regime, CFTC did not have the data needed for the analysis. Instead, CFTC had to rely on market participants to voluntarily provide it with proprietary data. CFTC staff said that they did receive some proprietary data but that they were incomplete. Similarly, for the whistleblower protection rule, SEC staff said that they asked the public for data in their draft rule but did not receive any. In the absence of data, SEC cited related research in its rule release, but staff noted that they were reluctant to weigh this research too heavily because the programs covered in the research differed in important respects from SEC’s program. In addition, Federal Reserve staff said that quantifying the effects of the debit card interchange fee rule was a major challenge because of the lack of data.

Some Agencies’ Guidance on Regulatory Analysis Continues to Omit Key Elements of OMB’s Regulatory Guidance

Although not subject to E.O. 12,866 and, in turn, OMB Circular A-4, most of the federal regulators told us that they try to follow Circular A-4 in principle or spirit. In our previous review, we found that the policies and procedures of these regulators did not fully reflect OMB guidance and recommended that they incorporate the guidance more fully in their rulemaking policies and procedures. For example, each federal regulator has issued guidance generally explaining how its staff should analyze the benefits and costs of the regulatory approach selected, but unlike the OMB guidance, such guidance generally does not encourage staff to identify and analyze the benefits and costs of available alternative approaches. Since we issued our report, OCC and SEC have revised their guidance, but the other agencies have not yet done so. CFTC last revised its guidance in May 2011, and in May 2012 it signed a Memorandum of Understanding with OMB that allows OMB staff to provide technical assistance to CFTC staff as they consider the benefits and costs of proposed and final rules.

Issued in March 2012, SEC guidance on economic analysis for rulemakings closely follows E.O. 12,866 and Circular A-4. Specifically, SEC’s guidance defines the basic elements of good regulatory economic analysis in a manner that closely parallels the elements listed in Circular A-4: (1) a statement of the need for the proposed action; (2) the definition of a baseline against which to measure the likely economic consequences of the proposed regulation; (3) the identification of alternative regulatory approaches; and (4) an evaluation of the benefits and costs—both quantitative and qualitative—of the proposed action and the main alternatives. In addition, the guidance explains these elements and describes the ways rulemaking teams can satisfy each of the elements borrowing directly from Circular A-4. OCC guidance on economic analysis defines the elements included in a full cost-benefit analysis in a similar fashion and includes citations to specific sections of Circular A-4 to guide staff through the application of each element.

For other federal financial regulators, by continuing to omit core elements of OMB Circular A-4, their regulatory guidance may cause staff to overlook or omit such best practices in their regulatory analysis. In turn, the analyses produced may lack information that interested parties (including consumers, investors, and other market participants) could use to make more informed comments on proposed rules. For example, in our review of four major rules, we found that most of the agencies did not consistently discuss how they selected one regulatory alternative over another or assess the potential benefits and costs of available alternatives. Without information about the benefits and costs of alternatives that agencies considered, interested parties may not know which alternatives were considered and the effects of such alternatives, which could hinder their ability to comment on proposed rules. More fully incorporating OMB’s guidance into their rulemaking guidance, as we previously recommended, could help agencies produce more robust and transparent rulemakings.

Regulators Continue to Coordinate Informally on Rulemakings, but Differences among Related Rules Still Exist

Federal financial regulators have continued to coordinate on rulemakings informally, but coordination may not eliminate the potential for differences in related rules. Regulators have coordinated on 19 of the 54 substantive regulations that we reviewed, in some cases voluntarily coordinating their activities and also extending coordination internationally. According to agency staff, most interagency coordination during rulemaking largely was informal and conducted at the staff level. Differences in rules could remain after interagency coordination, because the rules reflected differences in factors such as regulatory jurisdiction or market or product type. While a few regulators have made progress on developing guidance for interagency coordination during rulemaking, most have not.

Dodd-Frank Act and Regulators Recognize the Importance of Interagency Coordination

Both the Dodd-Frank Act and the federal financial regulators whom we interviewed recognize the importance of interagency coordination during the rulemaking process. In general, coordination during the rulemaking process occurs when two or more regulators jointly engage in activities to reduce duplication and overlap in regulations. Effective coordination could help regulators minimize or eliminate staff and industry burden, administrative costs, conflicting regulations, unintended consequences, and uncertainty among consumers and markets.

Recognizing the importance of coordination, the act imposes specific interagency coordination and consultation requirements and responsibilities on regulators or certain rules. For instance, section 171 (referred to as the Collins Amendment) requires that the appropriate federal banking agencies establish a risk-based capital floor on a consolidated basis. In addition, while section 619 (referred to as the Volcker Rule) does not require the federal banking agencies (FDIC, the Federal Reserve, and OCC) to issue a joint rule together with CFTC and SEC, it requires that they consult and coordinate with each other, in part to better ensure that their regulations are comparable. Further, the act broadly requires some regulators to coordinate when promulgating rules for a particular regulatory area. For example, under Title VII, SEC and CFTC must coordinate and consult with each other and prudential regulators before starting rulemaking or issuing an order on swaps or swap-related subjects—for the express purpose of assuring regulatory consistency and comparability across the rules or orders. The act also includes specific requirements for CFPB. Title X requires CFPB to consult with the appropriate prudential regulators or other federal agencies, both before proposing a rule and during the comment process, regarding consistency with prudential, market, or systemic objectives administered by such agencies.

Federal financial regulators also have highlighted the importance of coordination during the rulemaking process. For example, in testifying about the need to coordinate agency rulemakings, FSOC’s chairperson commented on the importance of coordinating both domestically and internationally to prevent risks from migrating to regulatory gaps—as they did before the 2007-2009 financial crisis—and to reduce U.S. vulnerability to another financial crisis. At the same time, we noted in a recent report that the FSOC chairperson has recognized the challenges of coordinating on the Dodd-Frank Act rulemakings assigned to specific FSOC members. He noted that the coordination in the rulemaking process represented a challenge because the Dodd-Frank Act left in place a financial system with multiple, independent agencies with overlapping jurisdictions and different responsibilities. However, the chairperson also noted that certain agencies were working much more closely together than they did before the creation of FSOC. This observation has been repeated by other regulators, whose staffs have told us that interagency coordination in rulemaking has increased since the passage of the Dodd- Frank Act.

Regulators Coordinated as Required, and Such Coordination Involved Around One-Third of Their Dodd-Frank Regulations

We found documentation of coordination among the rulemaking agency and other domestic or international regulators for 19 of the 54 substantive regulations that were issued and became effective between July 21, 2011, and July 23, 2012. The act required coordination in 16 of the 19 rulemakings. Specifically, 6 of the 19 regulations were jointly issued by two or more regulators and, thus, inherently required interagency coordination (see table 3). The act stipulated coordination for 10 other regulations. In the Federal Register rule releases, we found evidence documenting the coordination required by the act as well as voluntary coordination with additional regulators. For example, FDIC’s regulation on “Certain Orderly Liquidation Authority Provisions” described voluntary coordination with the Federal Reserve. Similarly, CFTC was required to coordinate with SEC on six swaps regulations it issued, but the agency also coordinated with other regulators on two of those regulations. Further, CFTC coordinated with foreign regulators on all six swaps regulations. The act did not require coordination for the other three regulations for which we found documentation of coordination, indicating that the agencies voluntarily coordinated. For the remaining 35 regulations that we reviewed, which did not require interagency coordination, we did not find any documentation of coordination among the agencies.

Of the 19 regulations that we identified as having interagency coordination, we selected three regulations to review in depth and sought to cover as many regulators as possible that were required to coordinate under the Dodd-Frank Act (see table 4). We examined when, how, and the extent to which federal financial regulators coordinated. We also examined efforts undertaken by the regulators to avoid conflicts in the rulemakings.

The regulators held some formal interagency meetings early on in the rulemaking process; however, coordination was mostly informal and conducted through e-mail, telephone conversations, and one-on-one conversations between staff. For example, at the initiation stage of the risk-based capital rulemaking, FDIC, OCC, and the Federal Reserve held a principal-level meeting to discuss the major issues relating to the interpretation of the statutory requirement. After this meeting, staffs formed an interagency working group, comprised of staff from each agency who, according to Federal Reserve staff, continually have worked together on numerous capital rules and therefore have a very close working relationship. Likewise, agency staffs said that after the initial formal meetings on the other rulemakings that we reviewed, coordination revolved around informal staff-level discussions. Coordination during the proposed rule drafting stage typically was characterized by staff-level conversations primarily through telephone calls or e-mails and some face- to-face meetings. Staffs would contact each other as issues arose to work out conflicts or differences in agency viewpoints. When issues could not be resolved at the staff level, they were escalated to senior management, but most issues were resolved and most coordination occurred at the staff level throughout the drafting of the proposed rules, according to agency staffs. For all three rulemakings reviewed, agency staffs coordinated at least weekly through the proposal stage with the frequency of coordination escalating as the proposed rule neared issuance.

After receiving public comments and while preparing the final rule, agency staffs told us that they continued to coordinate with each other, but the need for and level of interagency coordination varied by rule. For instance, OCC, Federal Reserve, and FDIC staffs said that by the time they reached the stage of drafting the final risk-based capital rule, meetings were less frequent because the group already had worked out most of the details. Coordination between CFTC and SEC also decreased during this stage of the real-time reporting rulemaking. Conversely, CFTC and SEC staffs said that interagency coordination continued to be frequent while drafting the final swaps entities rule because after the proposed rule was issued some differences in underlying definitions remained, such as the definition for “highly leveraged.” The commissions used public comments to the proposed rule to help them interpret and come to consensus on the definitions. CFTC and SEC staffs met regularly in this period to refine drafts, resolve issues, and convene an industry roundtable.

The extent to which agencies coordinated with international regulators varied in the three rulemakings that we reviewed. For example, CFTC and SEC coordinated with international regulators on swap rulemakings. For the real-time reporting rule, CFTC coordinated with foreign regulators, such as the Financial Services Authority and the European Commission, which provided ideas on data reporting. On the swap entities rule, CFTC and SEC staffs said that they participated in numerous conference calls and meetings with various international regulators.

In contrast, the banking regulators did not meet with any international regulators on the risk-based capital rule. The agency staffs said that they were implementing a straightforward statutory provision that required little interpretation and little amendment to the existing rules; therefore, staffs said they did not need to seek input from international regulators as to how to implement U.S. law. Staffs said that for less narrowly scoped rules, where regulators have more discretion, they are more proactive in reaching out to international regulators. FDIC staff cited, as an example, the risk retention rule, for which they reached out to the European Union to understand their approach.

Regulators who were responsible for the three rulemakings that we reviewed said that they tried to identify potential areas of duplication or conflict involving the rules. For the risk-based capital rule, the banking regulators held discussions on regulatory conflict and duplication and concluded that none would be created by this rule. For the swap entity rule and the real-time reporting rule, CFTC and SEC identified potential areas of conflict, which they were able to address through coordination. For example, when developing the real-time reporting rule, CFTC and SEC initially had different approaches about what type of entity would be in charge of disseminating swap transaction data. SEC proposed that only swap data repositories would be required to disseminate real-time data, and CFTC initially proposed to require several different entities to do so. SEC’s proposal, deciding that only swap data repositories would be required to disseminate real-time swap data. Agency staffs said that this harmonization should help to minimize the compliance cost burden placed on market participants and allow for more efficient operation of systems for the public dissemination of swap and security-based swap market data.

Swap data repositories are new entities created by the Dodd-Frank Act in order to provide a central facility for swap data reporting and recordkeeping. Under the act, all swaps, whether cleared or uncleared, are required to be reported to registered swap data repositories. Pub. L. No. 111-203, § 727, 124 Stat. 1696 (2010) (codified at 7 U.S.C. 2(a)(13)(G)).

In some areas, differences in rules remained after interagency coordination, due to differences in regulatory jurisdiction. In particular, while CFTC and SEC reached consensus on the text for the jointly issued swap entities rule, the regulators outlined different approaches in certain parts of the rule as a result of their regulatory jurisdiction over different product sets. For example, some of the language of the definitions for “major swap participant” and “major security-based swap participant” differs because the agencies each have jurisdiction over different products and some of these products have different histories, markets, and market sizes, according to CFTC and SEC staff. Also, in the real-time reporting rule, CFTC, in its final rule, defined specific data fields to be reported, while SEC, in its proposed rule, outlined broad data categories and required swap data repositories to develop specific reporting protocols. Agency staffs stated that while the approaches were different, they were not inconsistent. The key factors the regulators considered were whether the rules achieved the policy objectives and whether the regulated entities could comply with both agencies’ rules given their differences. It was determined that swap data repositories could develop data reporting protocols that would comply with both agencies’ rules.

To document and communicate preliminary staff views on certain issues to senior management, regulators use term sheets throughout the rulemaking process. Although term sheets are primarily internal documents, they were shared with staff at other regulators to communicate views and elicit comments. These term sheets serve as a formal mechanism to help initiate discussions of differences in the regulators’ positions. Term sheets generally are drafted internally by staff at each agency, shared between or among agency staff, and shared with agency principals or senior management. CFTC and SEC created term sheets for both the swap entities rule and the real-time reporting rule. Conversely, for the risk-based capital rule, the banking regulators did not create a term sheet because, according to OCC staff, the statutory requirements for this rule were explicit and therefore a term sheet was not required. However, staff noted that this was different from a standard rulemaking where they typically would draft and share a term sheet.

Most Agencies Continue to Lack Formal Policies and Procedures to Guide Interagency Coordination

While a few agencies have made progress on developing policies for interagency coordination for their rulemaking, most have not. In November 2011, we reported that most of the federal financial agencies lacked formal policies or procedures to guide their interagency coordination in the rulemaking process. Federal financial regulators informally coordinated on some of the final rules that we reviewed, but most of the agencies lacked written policies and procedures to guide their interagency coordination. Specifically, seven of nine agencies did not have written policies and procedures to facilitate coordination on rulemaking. The written policies and procedures that existed were limited in their scope or applicability. The remaining two regulators, FDIC and OCC, had rulemaking policies that include guidance on developing interagency rules. As we previously reported, documented policies can help ensure that adequate coordination takes place, help to improve interagency relationships, and prevent the duplication of efforts at a time when resources are extremely limited.

Since our November 2011 report, we found that OCC and CFPB have further developed guidance on interagency coordination, but the other agencies have not. CFPB has developed guidance that outlines the agency’s approach to interagency consultation in rulemaking. The document generally describes two rounds of consultation when drafting the proposed rule and two rounds when addressing comments and drafting the final rule. The guidance highlights the points in a rulemaking at which staff should reach out to other regulators, the purpose of consultation, and the length of time to allow for responses from regulators. Similarly, OCC updated its rulemaking policy to include more detail on what steps should be taken in coordination and who should be involved.

In our November 2011 report, we recommended that FSOC work with the federal financial regulators to establish formal coordination policies for rulemaking that clarify issues, such as when coordination should occur, the process that will be used to solicit and address comments, and what role FSOC should play in facilitating coordination. While FSOC has not implemented this recommendation, staff told us that they have developed coordination processes around specific areas of the Dodd-Frank Act. For example, FSOC staff said that they have coordinated closely with FDIC on all rulemakings under Title II. In addition, FSOC developed written guidance for coordination on rulemakings for enhanced prudential standards for bank holding companies with $50 billion or more in total consolidated assets and nonbank financial companies designated by FSOC for Federal Reserve supervision under sections 165 and 166 of the act. However, in a September 2012 report, we noted that a number of industry representatives questioned why FSOC could not play a greater In that report, role in coordinating member agencies’ rulemaking efforts.we further noted that the FSOC chairperson, in consultation with the other FSOC members, is responsible for regular consultation with the financial regulatory entities and other appropriate organizations of foreign governments or international organizations. We also reiterated our previous recommendation by stating that FSOC should establish formal collaboration and coordination policies for rulemaking.

Impacts of the Dodd- Frank Act Have Not Yet Fully Materialized and Remain Uncertain

The full impact of the Dodd-Frank Act remains uncertain. Although federal agencies continue to implement the act through rulemakings, much work remains. For example, according to one estimate, regulators have finalized less than half of the total rules that may be needed to implement the act. Furthermore, sufficient time has not elapsed to measure the impact of those rules that are final and effective. As we previously noted, even 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.

The evolving nature of implementation makes isolating the effects of the Dodd-Frank Act on the U.S. financial marketplace difficult. This task is made more difficult 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 be indicative of some of the Dodd-Frank Act’s initial impacts, as institutions react to issued and expected rules. First, the act contains provisions that serve to enhance the resilience of certain bank and nonbank financial companies and reduce the potential for financial distress in any one of these companies to affect the financial system and economy. Specifically, the Dodd-Frank Act requires the Federal Reserve to impose enhanced prudential standards and oversight on bank holding companies with $50 billion or more in total consolidated assets and nonbank financial We developed indicators to monitor companies designated by FSOC.changes in certain SIFI characteristics. Although the indicators may be suggestive of the act’s impact, our indicators do not identify causal links between their changes and the act. Further, many other factors can affect SIFIs and, thus, the indicators. As new data become available, we expect to update and, as warranted, revise our indicators and create additional ones to cover other provisions. Second, we used difference-in-difference analysis to infer the act’s impact on the provision of credit by and the safety and soundness of bank SIFIs. The analysis is subject to limitations, in part because factors other than the act could be affecting these entities. Third, we analyzed the impact of several major rules that were issued pursuant to the Dodd-Frank Act and have been final for around a year or more.

Indicators Suggest Increased SIFI Resiliency and Provide Baselines for Future Analysis

The 2007-2009 financial crisis demonstrated that some financial institutions, including some nonbank financial companies (e.g., AIG), had grown so large, interconnected, complex, and leveraged, that their failure could threaten the stability of the U.S. financial system and the global economy. Financial institutions, markets, and infrastructure that make up the U.S. financial system provide services to the U.S. and global economies, such as helping to allocate funds, allowing households and businesses to manage their risks, and facilitating financial transactions that support economic activity. The sudden collapses and near-collapses of major financial institutions, including major nonbank financial institutions, were among the most destabilizing events of the 2007-2009 financial crisis. In addition, large, complex financial institutions that are perceived to be “too big to fail” can increase uncertainty in periods of market turmoil and reinforce destabilizing reactions within the financial system.

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) establishing FSOC to identify and respond to emerging threats to the stability of the U.S. financial system; (2) authorizing FSOC to designate a nonbank financial company for Federal Reserve supervision if FSOC determines it could pose a threat to the financial stability of the United States based on the company’s size, leverage, interconnectedness, or other factors; and (3) directing the Federal Reserve to impose enhanced prudential standards and oversight on bank holding companies with $50 billion or more in total consolidated assets (referred to as bank SIFIs in this report) and nonbank financial companies designated by FSOC (referred to as nonbank SIFIs in this report). The Dodd-Frank Act also is intended to reduce market expectations of future federal rescues of large, interconnected, and complex firms using taxpayer dollars. Under the act, bank holding companies with $50 billion or more in total consolidated assets and nonbank financial companies designated by FSOC for Federal Reserve supervision are required to develop plans for their rapid and orderly resolution. Additionally, FDIC is given new orderly liquidation authority to act as a receiver of a troubled financial firm whose failure could threaten financial stability so as to protect the U.S. financial system and the wider economy.

Some Dodd-Frank Act provisions may result in adjustments to SIFIs’ size, interconnectedness, complexity, leverage, or liquidity over time. We developed indicators to monitor changes in some of these SIFI characteristics. The size and complexity indicators reflect the potential for a single company’s financial distress to affect the financial system and economy. The leverage and liquidity indicators reflect a SIFI’s resilience to shocks or its vulnerability to financial distress. FSOC has not yet designated any nonbank financial firms for Federal Reserve supervision. As a result, we focus our analysis on U.S. bank SIFIs. Our indicators have limitations. For example, the indicators do not identify causal links between changes in SIFI characteristics and the act. Rather, the indicators track or begin to track changes in the size, complexity, leverage, and liquidity of SIFIs over the period since the Dodd-Frank Act was passed to examine whether the changes are 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), European debt crisis, 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. In addition, some rules implementing SIFI-related provisions have not yet been proposed or finalized. Thus, trends in our indicators include the effects of these rules only insofar as SIFIs have changed their behavior in response to issued rules and in anticipation of expected rules. In this sense, our indicators provide a baseline against which to compare future trends.

Table 5 summarizes the changes in our bank SIFI indicators. The size indicators do not provide a clear trend between the third quarter of 2010 and the second quarter of 2012. Additionally, we have only one data point in the complexity indicator, but our data suggest that the largest bank SIFIs generally were more complex organizationally than other bank SIFIs. Lastly, the indicators suggest that bank SIFIs, on average, have become less leveraged since the third quarter of 2010, and their liquidity also appears to have improved. Trends in our leverage and liquidity indicators appear to be consistent with an improvement in SIFIs’ resilience to shocks.

Ben S. Bernanke, “Financial Reform to Address Systemic Risk,” (Speech to the Council on Foreign Relations, Washington, D.C., Mar. 10, 2009). size of a financial institution may prevent the institution from growing so large that it is perceived by the market as too big to fail, such limits also may prevent the institution from achieving economies of scale and benefiting from diversification.

We developed three indicators of size. The first indicator tracks the number of bank SIFIs. The second indicator measures a SIFI’s size based on the total assets on its balance sheet. The third indicator measures the extent to which industry assets are concentrated among the individual SIFIs, reflecting a SIFI’s size relative to the size of the industry. A limitation of these indicators is that they 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 risk, as an institution’s systemic risk significance also depends on other factors, such as its complexity and interconnectedness.

As shown in figure 1, seven U.S. bank SIFIs had more than $500 billion in total consolidated assets (referred to as large bank SIFIs in this report) in the third quarter of 2010 and in the second quarter of 2012.bank SIFIs were considerably larger than the other bank SIFIs.

Agency Comments and Our Evaluation

We provided a draft of this report to CFPB, CFTC, FDIC, the Federal Reserve Board, FSOC, NCUA, OCC, OFR, SEC, and Treasury for review and comment. SEC and Treasury provided written comments that we have reprinted in appendixes VII and VIII, respectively. All of the agencies also provided technical comments, which we have incorporated, as appropriate.

In their comments, the agencies neither agreed nor disagreed with the report’s findings. In its letter, Treasury noted that FSOC agrees that successful implementation of the Dodd-Frank Act rulemakings will require member agencies to work together, even if such coordination is not specifically required under the Dodd-Frank Act. Treasury also noted that FSOC has served as a forum for discussion among members and member agencies, through various FSOC meetings, committee meetings, and subcommittee meetings. Finally, the letter describes FSOC’s effort to continue monitor potential risks to the financial stability and implement other statutory requirements.

In its letter, SEC noted that it revised its guidance on economic analysis in March 2012, in part in response to a recommendation in our 2011 report that federal financial regulators more fully incorporate OMB’s regulatory analysis guidance into their rulemaking policies. SEC’s letter stated that the revised guidance already has improved the quality of economic analysis in its rulemakings and internal rule-writing processes. SEC also noted that FSOC has fostered a healthy and positive sense of collaboration among the financial regulators. SEC remains amenable to working with FSOC on formal coordination policies, as GAO previously recommended, but noted that FSOC's efforts should fully respect the independence of the respective member agencies regarding the substance of the rules for which they are responsible and the mission of FSOC itself.

We are sending copies of this report to CFPB, CFTC, FDIC, the Federal Reserve Board, FSOC, NCUA, OCC, OFR, SEC, Treasury, interested congressional committees, members, and others. 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 clowersa@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: Scope and Methodology

Our objectives in this report were to examine (1) the regulatory analyses, including benefit-cost analyses, federal financial regulators have performed to assess the potential impact of selected final rules issued pursuant to the Dodd-Frank Act; (2) how federal financial regulators consulted with each other in implementing selected final rules issued pursuant to the Dodd-Frank Act to avoid duplication or conflicts; and (3) what is known about the impact of the final Dodd-Frank Act regulations on the financial markets.

To address the first two objectives, we limited our analysis to the final rules issued pursuant to the Dodd-Frank Act that were effective between July 21, 2011, and July 23, 2012, a total of 66 rules (see app. II). To identify these rules, we used a website maintained by the Federal Reserve Bank of St. Louis that tracks Dodd-Frank Act regulations. We corroborated the data with information on Dodd-Frank Act rulemaking compiled by the law firm Davis Polk & Wardwell LLP.

To address our first objective, we reviewed statutes, regulations, GAO studies, and other documentation to identify the benefit-cost or similar analyses federal financial regulators are required to conduct in conjunction with rulemaking. For each of the 66 rules within our scope, we prepared individual summaries using a data collection instrument (DCI). The criteria used in the DCI were generally developed based on the regulatory analyses required of federal financial regulators and Office of Management and Budget (OMB) Circular A-4, which is considered best practice for regulatory analysis. We used the completed summaries to develop a table showing the extent to which the federal financial regulators addressed the criteria for each of the Dodd-Frank Act regulations. We selected 4 of the 66 rules for in-depth review, comparing the benefit-cost or similar analyses to specific principles in OMB Circular A-4. We selected the rules for in-depth review based on whether the rule was deemed a major rule (i.e., whether it is anticipated to have an annual effect on the economy of $100 million or more) by the responsible agency and OMB. We generally found that the financial regulators do not state in the Federal Register notice whether the rule is major. However, we learned that regulators are required to submit major rules to GAO under the Congressional Review Act (CRA) for the purpose of ensuring that the regulators followed certain requirements in conducting the rulemaking, and GAO maintains a database of major rules. Our search of the CRA database showed that federal financial regulators issued 19 major Dodd- Frank Act rules within our scope. To further narrow the list of rules for in- depth review, we determined to include at least one rule from each of the federal financial regulators. We identified major rules issued by only three financial regulators: the Commodity Futures Trading Commission (CFTC), the Board of Governors of the Federal Reserve (Federal Reserve), and the Securities and Exchange Commission (SEC). In addition, the Department of the Treasury (Treasury) issued a major rule during the scope period. The Federal Reserve and Treasury each issued only one major rule during our scope period—the Debit Card Interchange Fee rule and the Assessment of Fees on Large Bank Holding Companies to Cover the Expenses of the Financial Research Fund, respectively. SEC and CFTC issued multiple major rules during the period. To further narrow the list of rules for in-depth review, we determined to include only rules implementing a new regulatory authority rather than amending a preexisting regulatory authority. For SEC, only one rule met this criterion—the Securities Whistleblower Incentives and Protections rule. CFTC issued several major rules that met this criterion so to further narrow the list of rules for in-depth review, we consulted with a former CFTC economist and solicited his opinion whether it would be appropriate for GAO to assess the Real-Time Public Reporting of Swap Transaction Data rule, and he agreed. To compare these rules to the principles in Circular A-4, we developed a DCI with the principles and applied the DCI to all four rules. In conducting each individual analysis, we reviewed the Federal Register notices prepared by the agencies during the course of the rulemaking. We also interviewed officials from CFTC, the Federal Reserve, SEC, and Treasury to determine the extent to which benefit-cost or similar analyses were conducted.

To address our second objective, we reviewed the Dodd-Frank Act, regulations, and studies, including GAO reports, to identify the coordination and consultation requirements federal financial regulators are required to conduct in conjunction with rulemaking. For each of the 66 rules in our scope, we reviewed the rule releases to determine the rules on which agencies coordinated with other federal financial regulators and international financial regulators. From our review of the rule releases, we developed a table that shows the rules that involved coordination, agencies involved, nature of coordination, whether coordination was required or voluntary, and whether the agencies coordinated with international regulators. Rules that may have involved interagency coordination in the rulemaking but did not expressly mention such coordination in the rule release are not included in this table. Of the 19 rules that we determined involved interagency coordination, we selected 3 rules to review in depth to assess how and the extent to which federal financial regulators coordinated, focusing on actions they took to avoid conflict and duplication in rulemakings. In selecting rules to review in depth, we sought to include at least one rule that was jointly issued and therefore implicitly required coordination and at least one rule that was issued by a single agency and involved coordination with another agency. We also sought broad coverage of agencies issuing substantive Dodd- Frank Act rules. We ultimately selected two joint rules and one rule issued by a single agency, including rules issued by FDIC, OCC, Federal Reserve, CFTC, and SEC. In reviewing each rule, we reviewed the Federal Register notices for each rule, and we interviewed officials from each agency to determine how and the extent to which coordination took place to avoid duplication and conflict. We also interviewed officials at FSOC and CFPB to get an understanding of their role in interagency coordination for Dodd-Frank Act rulemakings.

To address our third objective, we took a multipronged approach to analyze what is known about the impact of the Dodd-Frank Act on the financial marketplace. First, the act contains provisions that serve to enhance the resilience of certain bank and nonbank financial companies and reduce the potential for any one of these companies to affect the financial system and economy. Specifically, the Dodd-Frank Act requires the Federal Reserve to impose enhanced prudential standards and oversight on bank holding companies with $50 billion or more in total consolidated assets and nonbank financial companies designated by FSOC. For purposes of this report, we refer to these bank and nonbank financial companies as bank systemically important financial institutions (bank SIFI) and nonbank systemically important financial institutions (nonbank SIFI), respectively, or collectively as SIFIs. We developed indicators to monitor changes in certain characteristics of SIFIs that may be suggestive of the impact of these reforms. FSOC has not yet designated any nonbank financial firms for Federal Reserve enhanced To supervision. As a result, we focus our analysis on U.S. bank SIFIs.understand the rationale behind the act’s focus on enhanced SIFI regulation and oversight, we reviewed the legislative history of the act, the act itself, related regulations, academic studies, GAO and agency reports, and other relevant documentation. To inform our choice of indicators, we analyzed the provisions and related rulemakings most relevant to bank SIFIs. Our analysis and indicators for this report focus on bank SIFIs’ asset size, interconnectedness, complexity, leverage, and liquidity. We developed our indicators of bank SIFIs’ size, leverage, and liquidity using quarterly data for bank holding companies from SNL Financial and quarterly data on the gross domestic product (GDP) deflator from the Bureau of Economic Analysis, both for the period from 2006 quarter 1 to 2012 quarter 2. We developed our indicators of bank SIFIs’ complexity using data from the Federal Reserve Board’s National Information Center as of October 2012. As new data become available, we expect to update and, as warranted, revise our indicators and create additional indicators to cover other provisions.

Second, we use difference-in-difference regression analysis to infer the act’s impact on the provision of credit by and the safety and soundness of U.S. bank SIFIs. The key element of our analysis is that the Dodd-Frank Act subjects some bank holding companies to enhanced oversight and regulation but not other bank holding companies. Specifically, the act requires the Federal Reserve to impose a number of enhanced prudential standards on bank holding companies with total consolidated assets of $50 billion or more (bank SIFI) , while bank holding companies with assets less than $50 billion (non-SIFI banks) are not subject to such enhanced oversight and regulation. As a result, we were able to compare funding costs, capital adequacy, asset quality, earnings, and liquidity for bank SIFIs and non-SIFI banks before and after the Dodd-Frank Act. All else being equal, the difference in the differences is the inferred effect of the Dodd-Frank Act on bank SIFIs. For our analysis, we used quarterly data on bank holding companies from SNL Financial and quarterly data on commercial banks and savings banks from FDIC and the Federal Financial Institutions Examinations Council, all for the period from 2006 quarter 1 to 2012 quarter 2 (see app. IV for details). Lastly, for all of our indicators, we obtained and addressed high-level comments and suggestions from FSOC staff and two other market experts.

Third, we analyze the impact of several major rules that were issued pursuant to the Dodd-Frank Act and have been final for around a year or more. There were 44 final rules as of July 21, 2011, 7 of which were major rules. We judgmentally selected 4 out of those 7 rules for impact analyses, based largely on data availability. Our selected rules implement provisions that serve specific investor or consumer protection purposes. We first analyzed the Federal Reserve’s Debit Interchange Fees and Routing Rule (Regulation II). As part of that work, we reviewed selected statutes and regulations, analyzed available data and documents from the Federal Reserve, GAO, and market participants and experts, and interviewed agency officials and market experts. Additionally, we analyzed two SEC rules on asset-backed securities (ABS): Issuer Review of Assets in Offerings of ABS and Disclosure for ABS Required by Section 945 and 943 of the Act, respectively. To do this, we reviewed selected statutes and regulations and analyzed data on ABS issuances obtained from the Securities Industry and Financial Markets Association (SIFMA). Lastly, we analyzed SEC’s rule on Shareholder Approval of Executive Compensation and Golden Parachute Compensation. As part of that analysis, we reviewed selected regulations and analyzed available data on shareholder votes on executive compensation that we obtained from Institutional Shareholder Services, Inc., a proxy advisory firm that advises institutional investors on how to vote proxies and provides consulting services to corporations seeking to improve their corporate governance. For all of the data described above, we assessed the reliability of the data and found it to be reliable for our purposes.

We conducted this performance audit from December 2011 to December 2012 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: Tables Listing Dodd-Frank Act Rules Effective as of July 23, 2012

The following table lists the Dodd-Frank Act rules that we identified as final and effective during the scope period for this review—July 21, 2011, and July 23, 2012 The following table lists the Dodd-Frank Act rules that we identified as final and effective during the scope period for our first review—July 21, 2010, and July 21, 2011.

Appendix III: Summary of Rulemakings Related to the Dodd-Frank Act Provisions Applicable to Systemically Important Financial Institutions

The Dodd-Frank Act contains several provisions that apply to nonbank financial companies designated by the Financial Stability Oversight Council for Federal Reserve supervision and enhanced prudential standards (nonbank SIFI) and bank holding companies with $50 billion or more in total consolidated assets (bank SIFI). Table 12 summarizes those provisions and the rulemakings, including their status, to implement those provisions.

Appendix IV: Econometric Analyses of the Impact of Enhanced Regulation and Oversight on SIFIs

Methodology

We conducted an econometric analysis to assess the impact of the Dodd- Frank Act’s new requirements for bank SIFIs on (1) the cost of credit they provide and (2) their safety and soundness. Our multivariate econometric model used a difference-in-difference design that exploits the fact that the Dodd-Frank Act subjects bank holding companies with total consolidated assets of $50 billion or more to enhanced regulation by the Federal Reserve but not others, so we can view bank holding companies with total consolidated assets of $50 billion or more (bank SIFIs) as the treatment group and other bank holding companies as the control group. We compared the changes in the characteristics of U.S. bank SIFIs over time to changes in the characteristics of other U.S. 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 regression specification is the following: ybq = α + β + γSIFIbq + X’bqΘ + 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 for the period from the first quarter of 2006 to the second quarter of 2012.

The parameters of interest are the γ, the coefficients on the SIFI indicators in the quarters starting with the treatment start date of the third quarter of 2010 through the second quarter of 2012. The Dodd-Frank Act was enacted in July 2010 (the third quarter of 2010), so the SIFI indicator is equal to zero for all bank holding companies for all quarters from the first quarter of 2006 to the second quarter of 2010. The SIFI indicator is equal to 1 for all bank holding companies with assets of $50 billion or more for the third quarter of 2010 through the second quarter of 2012 and the SIFI indicator is equal to zero for all other bank holding companies for those quarters. Thus, for quarters from the third of 2010 to the second of 2012, the parameter γ measures the average difference in the dependent variable between bank SIFIs and other bank holding companies in those quarters relative to the base quarter.

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 percent of total assets and tangible common equity as a percent of risk-weighted 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, assets in non-accrual status, and other real estate owned.

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 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 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 large time deposits held in domestic offices. Large time deposits are defined as time deposits greater than $100,000 prior to March 2010 and as time deposits greater than $250,000 in and after March 2010.

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 on Banking Supervision, 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 things 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 of the impact of new requirements for SIFIs are reflecting something other than the impact of the Dodd-Frank Act’s new requirements for SIFIs.

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 in the period since the Dodd- Frank Act was enacted 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 in the time since the Dodd-Frank Act was enacted 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.

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 in the period since the Dodd-Frank Act was enacted may thus 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 in the time since the Dodd-Frank Act was enacted 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 we 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.

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. 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 the Dodd-Frank Act was enacted. We measure the size of a bank holding company as the natural logarithm of its total assets.

TARP participation. We control for whether or not a bank holding company participated in the Troubled Asset Relief Program (TARP) 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 $1 billion and $100 billion and (2) bank holding companies with assets between $25 billion and $75 billion.

We examined different treatment start dates. Specifically, we allowed the Dodd-Frank Act’s new requirements for SIFIs to have an impact in 2009q3, 1 year prior to 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 analyzed alternative measures of capital adequacy, including equity capital as a percent of total assets and Tier 1 capital as a percent of risk-weighted assets.

We analyzed commercial banks and savings banks (banks). In this case, we identified a bank as a SIFI if it is a subsidiary of a SIFI bank holding company.

Data

We conducted our analysis using quarterly data on bank holding companies from the Federal Reserve Board and SNL Financial for the period from the first quarter of 2006 to the second quarter of 2012. We also used quarterly data on commercial banks and savings banks from the Federal Deposit Insurance Corporation (FDIC), Federal Financial Institutions Exanimation Council (FFIEC), and SNL Financial for the same time period for one of our robustness checks.

Results

The Dodd-Frank Act appears to be associated with an increase in bank SIFIs’ funding costs in the second quarter of 2012, but not in other quarters (see table 13). Over the period from the third quarter of 2010 to the second quarter of 2012, bank SIFIs’ funding costs ranged from about 0.02 percentage points lower to about 0.05 percentage points higher than they otherwise would have been since the Dodd-Frank Act. As a group, the estimates are jointly significant. However, the individual estimates are not significantly different from zero for quarters other than the second quarter of 2012. These estimates suggest that the Dodd-Frank Act’s new requirements for SIFIs have had little effect on bank SIFIs’ funding costs. To the extent that borrowing costs are a function of funding costs, the new requirements for SIFIs likely have had little effect on the cost of credit thus far.

Our results suggest that the Dodd-Frank Act is associated with improvements in most aspects of bank SIFIs’ safety and soundness. Bank SIFIs appear to be holding more capital than they otherwise would have held since the Dodd-Frank Act was enacted. The quality of assets on the balance sheets of bank SIFIs also seems to have improved since enactment. The act is associated with higher earnings for bank SIFIs in the first four quarters after enactment. It is also associated with improved liquidity as measured by the extent to which a bank holding company is using stable sources of funding. Only liquidity measured by the capacity of a bank holding company’s liquid assets to cover its volatile liabilities has not clearly improved since the enactment of the act. Thus, the Dodd- Frank Act appears to be broadly associated with improvements in most indicators of safety and soundness for 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 Dodd-Frank Act’s new requirements for SIFIs challenging. The effects of the Dodd-Frank Act cannot be differentiated from 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, that may differentially affect bank SIFIs and other bank holding companies. In addition, many of the new requirements for SIFIs have yet to be implemented. For example, the Federal Reserve has indicated that it will impose a capital surcharge and liquidity ratios on at least some SIFIs, but the exact form and scope of these requirements is not yet known. 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 are generally robust to restricting the set of bank holding companies we analyze to those with assets of $1 billion-$100 billion.

Our results are not generally robust to restricting the set of bank holding companies we analyze to those with assets of $25 billion-$75 billion, but this is likely to be a result of the small number of bank holding companies (29) that fit this criteria.

Our results are generally robust to starting the “treatment” in 2009 Q3, 1 year prior to the passage of the Dodd-Frank Act. In addition, our estimates suggest that the impact of new requirements for SIFIs of the Dodd-Frank Act may have preceded the enactment of the act itself. This finding is consistent with the theory 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 the impact on capital adequacy are generally similar for alternative measures of capital adequacy.

Our results for banks’ funding costs, asset quality, earnings, and liquidity as measured by liquid assets as a percent of volatile liabilities were generally similar to our baseline results for bank holding companies, but our results for capital adequacy and liquidity as measured by stable liabilities as a percent of total liabilities were not. The differences may reflect the impact of nonbank subsidiaries on bank holding companies or a number of other factors.

Appendix V: Impact Analysis of the Debit Card Interchange Fees and Routing Rule

The Federal Reserve’s adoption of Regulation II (Debit Card Interchange Fees and Routing), which implements section 1075 of the Dodd-Frank Act, generally has reduced debit card interchange fees. However, debit card issuers, payment card networks, and merchants are continuing to adjust strategically to the rule; thus, the rule’s impact has not yet been fully realized. Typically, consumers use debit cards as a cashless form of payment that electronically accesses funds from a cardholder’s bank account. A consumer using a debit card authenticates and completes a transaction by entering a personal identification number (PIN) or a signature. The parties involved in a debit card transaction are (1) the customer or debit cardholder; (2) the bank that issued the debit card to the customer (issuer bank); (3) the merchant; (4) the merchant’s bank (called the acquirer bank); and (4) the payment card network that processes the transaction between the merchant acquirer bank and the issuer bank. In a debit transaction, the merchant receives the amount of the purchase minus a fee that it must pay to its acquirer bank. This fee includes the debit interchange fee that the acquirer bank pays to the issuer bank. Interchange fees generally combine an ad-valorem component, which depends on the amount of the transaction, and a fixed- fee component. Additionally, before Regulation II was implemented, fees varied more widely based on, among other things, the type of merchant.

Although payment card networks do not receive the debit interchange fees, they set the fees. Debit cards represent a two-sided market that involves cardholders and merchants. Cardholders benefit if their cards are accepted by a wide range of merchants, and merchants benefit if their ability to accept cards results in higher sales. In theory, a card network sets its interchange fees to balance the demand on the two sides of the market. It sets interchange fees high enough to attract issuers to issue debit cards processed by the network but low enough for merchants to be willing to accept the debit cards. Before the enactment of section 1075 of the Dodd-Frank Act, debit interchange fees had been increasing, creating controversy in the industry about the appropriate level of debit interchange fees in the United States, which some have stated were among the highest in the world. For example, some merchants stated that network competition led to higher, not lower, interchange fees as networks strived to attract issuer banks (who ultimately receive interchange fee revenue).

Section 1075 amends the Electronic Fund Transfer Act (EFTA) by adding a new section 920 regarding interchange transaction fees and rules for payment card transactions. As required by EFTA section 920, Regulation II establishes standards for assessing whether debit card interchange fees received by issuers are reasonable and proportional to the costs incurred by issuers for electronic debit transactions. The rule sets a cap on the maximum permissible interchange fee that an issuer may receive for an electronic debit transaction at $0.21 per transaction, plus 5 basis points multiplied by the transaction’s value. An issuer bank that complies with Regulation II’s fraud-prevention standards may receive no more than an additional 1 cent per transaction. The fee cap became effective on October 1, 2011. However, as required by EFTA section 920, the rule exempts from the fee cap issuers that have, together with their affiliates, less than $10 billion in assets, and transactions made using debit cards issued pursuant to government-administered payment programs or certain reloadable prepaid cards. In addition, Regulation II prohibits issuers and card networks from restricting the number of networks over which electronic debit transactions may be processed to less than two unaffiliated networks. This prohibition became effective on April 1, 2012. The rule further prohibits issuers and networks from inhibiting a merchant from directing the routing of an electronic debit transaction over any network allowed by the issuer.October 1, 2011.

Initial Impact on Large and Small Banks

Thus far, large banks that issue debit cards have experienced a decline in their debit interchange fees as a result of Regulation II, but small banks generally have not. As noted above, issuers that, together with their affiliates, have $10 billion or more in assets are subject to the debit card interchange fee cap. According to the Federal Reserve, 568 banks were Issuers below the $10 subject to the fee cap in 2012 (covered issuers).billion asset threshold are exempt from the fee cap (exempt issuers). According to the Federal Reserve, over 14,300 banks, credit unions, savings and loans, and savings banks were exempt from the fee cap in 2012.

Initial data collected by the Federal Reserve indicate that covered issuers have experienced a significant decline in their debit interchange fees and fee income as a result of Regulation II. Data published by the Federal Reserve show that 15 of 16 card networks provided a lower interchange fee, on average, to covered issuers after the rule took effect.Specifically, the data show that the average interchange fee received by covered issuers declined 52 percent, from $0.50 in the first three quarters of 2011 to $0.24 in the fourth quarter. During the same period, the interchange fee as a percentage of the average transaction value for covered issuers declined from 1.29 percent to 0.60 percent.

Our own analysis also suggests that the fee cap is associated with reduced interchange fee income for covered banks. To further assess the impact of the fee cap on covered banks, we conducted an econometric analysis of debit and credit card interchange fee income earned by banks from the first quarter of 2008 through the second quarter of 2012. As discussed, Regulation II subjects covered issuers but not exempt issuers to the fee cap. This allows us to compare the incomes earned by covered and exempt banks before and after the fee cap’s effective date in the fourth quarter of 2011. All else being equal, the post- cap changes in income among the two groups can be inferred as the effect of the fee cap on interchange fee income earned by covered banks. Our estimates suggest that interchange fees collected by covered banks, as a percent of their assets, were about 0.007 to 0.008 percentage points lower than they otherwise would have been in the absence of the fee cap. For a bank with assets of $50 billion, this amounts to $3.5 million to $4 million in reduced interchange fee income.

In comparison, Regulation II’s fee cap appears initially to have had a limited impact on exempt issuers. As we recently reported, initial data collected by the Federal Reserve indicate that card networks largely have adopted a two-tiered interchange fee structure after the implementation of Regulation II, to the benefit of exempt issuers. Data published by the Federal Reserve from 16 card networks show 15 of 16 card networks provided a higher interchange fee, on average, to exempt issuers than covered issuers after the rule took effect. The data further showed that the average interchange fee received by exempt issuers declined by $0.02, or around 5 percent, after the rule took effect—declining from $0.45 over the first three quarters of 2011 to $0.43 in the fourth quarter of 2011. Over the same period, the interchange fee as a percentage of the average transaction value for exempt issuers declined from 1.16 to 1.10 percent.

Although the fee cap appeared to have a limited impact on exempt issuers, such issuers remain concerned about the potential for their interchange fee income to decline over the long term. For example, some have noted that (1) the prohibition on network exclusivity and routing restrictions may lead networks to lower their interchange fees, in part to encourage merchants to route debit card transactions through their networks; or (2) economic forces may cause networks not to maintain a two-tiered fee structure that provides a meaningful differential between fees for exempt and covered issuers. However, some merchants and others have noted that major card networks have adopted a two-tiered fee structure and have an incentive to maintain that structure to attract exempt issuers.

Impact on Merchants and Consumers

Regulation II’s fee cap generally has reduced debit card interchange fees, which likely has resulted or will result in savings for merchants. According to the Federal Reserve and industry experts, the merchant acquirer market is competitive. Thus, the decrease in interchange fees likely has translated or will translate into lower merchant acquirer fees. Some noted that large merchants likely reaped immediate benefits from the fee cap, because their acquirer fees probably were reduced when interchange fees declined. In contrast, they noted that smaller merchants often opt for blended fee structures under which, for example, the merchants may be charged a flat fee per electronic payment transaction and, thus, not immediately receive the benefit of decreases in interchange fees because merchants may still be locked into contracts that have these fee structures.is expected to cause acquirer banks to adjust the fees they charge to merchants and pass on any savings to avoid losing merchant business.

In either case, competition in the supply of acquirer services In its final rule, the Federal Reserve noted that merchants could be negatively affected if large issuers were able to persuade their customers to pay with credit cards rather than debit cards, since credit cards generally have higher interchange fees. While issuers can take this strategy, merchants also can provide incentives to consumers to encourage them to use debit cards instead of credit cards. The Dodd- Frank Act requires networks to allow merchants to offer discounts to consumers based on whether they pay by cash, check, debit card, or credit card. In addition, a recent report stated that an antitrust settlement between the Department of Justice and VISA and MasterCard requires the networks to loosen past restrictions on merchants’ ability to offer discounts to consumers based on the payment method, brand, and product. This allows merchants accepting cards by those networks to provide incentives to encourage customers to complete their debit transactions using their PIN rather than signature.data on whether issuers or merchants are engaging in such strategies.

Some types of merchants may be adversely affected by Regulation II. As mentioned earlier, the fee cap generally led payment card networks to set their debit interchange fees at the level of the cap for covered issuers. However, the interchange fee for small-ticket transactions, or transactions that are generally under $15, was sometimes below the fee cap before Regulation II became effective. For example, according to the International Franchise Association and the National Council of Chain Restaurants, before Regulation II a $5 transaction could incur 11.75 cents in debit interchange fees. Under the current fee cap of 21 cents plus 0.05 percent of the transaction value, the interchange fee for a $5 covered transaction is 21.25 cents, about 80 percent higher. As a result, merchants that have a high volume of small value transactions, such as quick serving restaurants, transit authorities, and self-service and vending operators, could be worse off after the adoption of Regulation II.

It is not practical to measure the extent to which consumers in the many markets where debit transactions are possible have been affected by Regulation II. First, one probable outcome is that at least a fraction of the merchants have passed some of their cost savings onto consumers. As noted by the Federal Reserve, whether merchants reduce their prices as a result of lower interchange fees will depend on the competitiveness of the various retail markets. In a competitive market with low margins, merchants likely have to pass on at least part of their cost savings to consumers. On the other hand, the loss in debit interchange fee income by large banks may lead them to seek ways to recover that lost income. As mentioned by the Federal Reserve, banks may try to recoup lost interchange fee income by introducing new bank service and product fees, possibly making banking services too costly for at least some customers. Our analysis (discussed previously) suggests that covered banks have recovered some of their lost interchange fee revenue, such as through increased revenue from service charges on deposit accounts.

Impact on Competition and Interchange Fees

Historically, issuers have determined which and how many signature and PIN networks may process their debit card transactions. Before and after Regulation II, issuers generally use only one signature network (e.g., VISA or MasterCard) to process their debit card transactions that are completed using a signature. Additionally, as stated in the final rule, before Regulation II issuer banks, or in some cases, networks controlled the merchant routing of debit transactions. For example, an issuer bank could require a PIN transaction to be routed over a particular network, even if other PIN networks were available to route the transaction. The rule also states that, prior to Regulation II, issuer banks were able to limit the networks enabled on their cards through exclusive contracts with networks. For example, some issuers had agreed to restrict their cards’ signature debit functionality to a single signature debit network and their PIN debit functionality to the signature network’s affiliated PIN network. According to the Federal Reserve’s 2009 survey data of large issuers, most debit cards from large bank issuers carried only one PIN network, and the cards’ PIN and signature networks typically were affiliated with each other.

Regulation II contains two provisions that serve to provide merchants with the option of selecting the network to process their debit card transactions and a greater number of network options. First, the rule prohibits all issuers and networks from inhibiting a merchant from directing the routing of a transaction over any network allowed by the issuer. This provision became effective on October 1, 2011. For example, if an issuer’s debit card has two or more PIN networks, the merchant rather than the issuer can chose which network processes a PIN transaction, such as the one charging the lowest interchange fee. Second, the rule prohibits all issuers and networks from restricting the number of networks over which debit transactions may be processed to fewer than two unaffiliated networks. This provision became effective on April 1, 2012. As a result, issuers no longer may allow only VISA’s or MasterCard’s signature and affiliated PIN networks to process their debit card transactions. Instead, such issuers would need to add an unaffiliated signature or PIN network if they do not already have an unaffiliated network.

Regulation II’s prohibitions may have a limited impact on increasing competition and, in turn, lowering interchange fees, because issuers largely control which networks may process their debit card transactions. For example, issuers did not likely comply with Regulation II by adding a second unaffiliated signature network because, according to the final rule, networks and issuers stated it would be too costly to reconfigure cards and merchant equipment to enable the processing of two signature networks associated with one card.have only one network option for transactions completed by signature. Additionally, issuers can comply by having an unaffiliated signature network and PIN network, which means that merchants may have only one network routing choice once a customer decides to use her signature or her PIN. Therefore, even though Regulation II provides merchants with the authority to choose the network over which to route debit card transactions, merchants may not have a choice about which network to route the debit card transaction.

Going forward, issuers may be able to act strategically to limit competition over debit card interchange fees through their control over which networks may process their debit card transactions. First, for covered transactions subject to the fee cap, both signature and PIN networks have an incentive to set their interchange fees at the fee cap. If a network lowered its fees below the cap, such as to attract merchant routing business, issuers using that network could replace it with a network that sets its fees at the cap. With networks charging similar interchange fees for covered transactions, merchants may not be able to use their network routing decisions to put downward pressure on such fees. Second, for exempt PIN transactions, merchants may be able to exert downward pressure on fees when issuers use two or more PIN networks to process their transactions. In this case, merchants can choose the network with the lowest fees and possibly induce the other networks to lower their fees. However, exempt issuers may be able to counter such pressure by dropping a network whose fees are too low or allowing only the PIN network (along with an unaffiliated signature network) with the highest fees to process their transactions. As discussed, merchants may be able to provide incentives to customers using cards issued by exempt banks to conduct a PIN rather than a signature transaction, so as to allow themselves more routing options.

Impact on Networks

In response to Regulation II, VISA is undertaking strategies intended to attract merchant routing. First, VISA recently imposed a new monthly fixed acquirer fee that merchants must pay to accept VISA debit and credit cards. VISA also plans to reduce merchants’ variable fees so that merchants’ total fees associated with VISA transactions likely would be lower after the new fee structure’s implementation. Under its new fee structure, VISA could, for example, lower the interchange fees for VISA’s PIN network, Interlink, to attract merchant routing and make up at least some of its lost revenue by collecting the fixed fees. However, the extent to which VISA will be able to lower PIN debit interchange fees and gain transaction volume is limited. As with any network, if Interlink reduces its interchange fees too much, issuers could replace Interlink with another PIN network that offers higher fees.

Second, according to VISA representatives, VISA’s signature network also is able to process PIN transactions, in essence automatically offering an additional PIN routing choice to merchants for cards that carry VISA For example, in the past, a debit card that carried the VISA signature.signature and two other PIN networks usually would process a PIN transaction through one of the PIN networks. Now, the VISA check card signature network can continue to be the only option for routing signature debit transactions on that card but also become a third option for routing PIN debit transactions. For VISA to gain PIN transaction volume through VISA check cards, however, it must set the associated interchange fees at or below the fees set by the other available PIN networks. However, the extent to which VISA can do this is not yet clear. If issuers experienced declining interchange fee revenue from their use of VISA, they could switch signature networks, for example, to MasterCard.

Appendix VI: Econometric Analysis of the Impact the Debit Interchange Fee Standard on Issuer Banks’ Income

Methodology

We conducted an econometric analysis to assess the impact of the Dodd- Frank Act’s debit interchange fee standard on covered banks. Our multivariate econometric model used a difference-in-difference design that exploits the fact that some banks are automatically covered by the debit interchange fee requirements but others are not, so we can view covered banks as the treatment group and exempt banks as the control group. We then compared changes in various types of income earned by covered banks over time to changes in those types of income earned by exempt banks over time. All else being equal, the difference in the differences is the impact of the new debit interchange fee requirements.

Our regression specification is the following: ybq = α + β + γCOVEREDbq + X’bqΘ + εbq, where b denotes the bank, q denotes the quarter, ybq is the dependent variable, α is an institution-specific intercept, β is a quarter-specific intercept, COVEREDbq is an indicator variable that equals 1 if bank b is covered by the debit interchange standard in quarter q and 0 otherwise, Xbq is a list of other independent variables, and εbq is an error term. We estimate the parameters of the model using quarterly data for banks for the period from the first quarter of 2008 to the second quarter of 2012.

The parameters of interest are the γ, the coefficients on the covered bank indicators in the quarters after the treatment start date of the fourth quarter of 2011. The debit interchange standard was effective October 1, 2011, (the fourth quarter of 2011), so the covered bank indicator is equal to zero for all banks for all quarters from the first quarter of 2008 to the third quarter of 2011. For all quarters from the fourth quarter of 2011 to the second quarter of 2012, the covered bank indicator is equal to one for all covered banks and equal to zero for all exempt banks. Thus, for quarters from the fourth of 2011 to the second of 2012, all else being equal, the parameter γ measures the average difference in the dependent variable between covered and exempt banks in that quarter relative to the base quarter.

We used lists of covered institutions provided by the Federal Reserve to identify which banks in our sample are required to comply with debit card interchange fee standards in each quarter and which are not. We assumed that any institution not explicitly identified as a covered institution was exempt.

We used different dependent variables (ybq) in order to estimate the impacts of the debit interchange standard on various sources of income earned by covered banks, including bank card and credit card interchange fees, service charges on deposit accounts in domestic offices, total non-interest income, total interest income, and total income.

Finally, we included size as an independent variable (Xbq) to control for factors correlated with size that may differentially affect exempt and covered banks in the quarters since debit interchange standard went into effect. We measured the size of a bank as the natural logarithm of its total assets. We included this variable to reduce the likelihood that our estimates of the impact of the debit interchange standard are reflecting something else.

Data

To assess the impact of debit interchange fee regulation on covered institutions, we analyzed commercial banks and savings banks (banks) for the period from the first quarter of 2008 to the second quarter of 2012 using data from the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the Federal Financial Institutions Examination Council (FFIEC). We excluded savings associations and credit unions from our analysis, even though they are subject to the debit card interchange fee standards. For much of the period we analyzed, savings associations filed quarterly Thrift Financial Reports, but these filings did not include the information we required for our analysis, such as income earned from bank card and credit card interchange fees, for every quarter. Similarly, credit union filings also do not include the information we required for our analysis.

Results

Table 14 shows the estimated differences in fees and income as a percent of assets for covered banks relative to what they would have earned in the absence of the debit interchange fee standard, all else being equal.

Our estimates suggest that the debit interchange fee standard is associated with:

Lower bank card and credit card interchange fees collected by covered banks. After the effective date, interchange fees collected by covered banks, as a percent of assets, were about 0.007-0.008 percentage points lower than they otherwise would have been. For a bank with assets of $50 billion, this amounts to $3.5 million-4 million in reduced bank card and credit card interchange fees.

Higher service charges on deposit accounts in domestic offices for covered banks. After the effective date, service charges collected by covered banks, as a percent of assets, were about 0.004-0.007 percentage points higher than they otherwise would have been. For a bank with assets of $50 billion, this amounts to $2 million-3.5 million in additional service charges.

No significant change in overall non-interest income for covered banks. Non-interest income—of which both interchange fees and service charges are components—earned by covered banks was about 0.09-0.13 percentage points lower as a percent of assets than it would have been in the first two quarters after the effective date and about 0.03 percentage points higher in the third quarter after the effective date. However, these estimates are not statistically significant at the 5-percent level. Increased interest income in the first two quarters after the effective date but no significant increase since. Interest income earned by covered banks, as a percent of assets, was about 0.03 percentage points higher than it would have been in the first two quarters after the effective date. It was 0.02 percentage points higher in the third quarter after the effective date, but this estimate is not statistically significant at the 5-percent level.

No significant change in total income. Total income—which is composed of interest and non-interest income—earned by covered banks after the effective date, as a percent of assets, ranges from 0.10 percentage points lower to 0.05 percentage points higher, but these estimates are not statistically significant at the 5-percent level.

To assess the robustness of our estimates, we examined different treatment start dates. Specifically, we allowed the debit fee standard to have an impact starting in the fourth quarter of 2010—1 year prior to the rule’s effective date—on banks that were covered in the fourth quarter of 2011. We did so to allow for the possibility that institutions began to react to the debit fee standard in anticipation of the rule being passed. Our estimates suggest that changes in covered banks’ interchange fee income and service charge income generally did not occur until after the effective date and also that significant changes in non-interest income, interest income, and total income for covered banks generally did not precede the rule’s effective date.

Our approach allows us to partially differentiate changes in various types of income earned by covered banks associated with the debit interchange fee cap from changes due to other factors. However, several factors make isolating and measuring the impact of the cap for covered banks challenging. In particular, the effects of the cap cannot be differentiated from simultaneous changes in economic conditions, regulations, or other changes that may differentially affect covered banks. Nevertheless, our estimates are suggestive of the initial effects of the cap on covered banks and provide a baseline against which to compare future trends.

Appendix VII: Comments from the Securities and Exchange Commission

Appendix VIII: Comments from the Department of the Treasury

Appendix IX: GAO Contact and Staff Acknowledgments

GAO Contact

Staff Acknowledgments

In addition to the contact named above, Richard Tsuhara (Assistant Director), Silvia Arbelaez-Ellis, Bethany Benitez, William R. Chatlos, Philip Curtin, Rachel DeMarcus, Timothy Guinane, Courtney LaFountain, Thomas McCool, Marc Molino, Patricia Moye, Susan Offutt, Robert Pollard, Christopher Ross, Jessica Sandler, and Joseph Weston, made key contributions to this report.