The federal banking regulators recently took their first official Dodd-Frank rulemaking step, inviting public comments in advance of proposed rulemaking on the use of credit ratings in the formulation of risk-based capital standards.  The reality is that years of such rulemaking and interpretation by regulators will determine the true impact of the law.

More important to community banks, the FDIC announced the establishment of a department—the Division of Depositor and Consumer Protection (DCP) —that will soon become a household name for smaller insured state nonmember banks.  This unit will be dedicated to the enforcement of consumer protection rules promulgated by the new Consumer Financial Protection Bureau (CFPB) as to banks exempt from that agency’s oversight.

The New Community Bank “Regulator”—FDIC’s DCP

On August 10, 2010, the FDIC Board created two new offices specifically for the purpose of implementing Dodd-Frank:  the Office of Complex Financial Institutions (CFI) and Division of Depositor and Consumer Protection (DCP).  The first will be the FDIC vehicle for carrying out the agency’s role in overseeing systemic and large bank holding company and non-bank financial firms.  The DCP, on the other hand, is in a sense a community bank regulator.  According to the FDIC, this body will be charged with enforcing consumer protection rules promulgated by the CFPB as against banks outside its purview:  those with $10 billion or less in total assets.  In the words of Chairman Bair:

Our depositor protection and compliance examination and enforcement responsibilities are integral to our unique responsibilities as deposit insurer and supervisor of thousands of community banks. The creation of this new division emphasizes the importance we place on these responsibilities and is directly responsive to Congress’s intent in the new legislation.  DCP will also complement the activities of the new Consumer Financial Protection Bureau that is being established within the Federal Reserve. The FDIC supports the CFPB, and we are committed to doing our part in carrying out the consumer responsibilities Congress has entrusted to us.

The CFPB will enforce consumer financial protection laws as to insured depository institutions with more than $10 billion in total assets.  Below that threshold, the CFPB may require related reporting of smaller banks, but Dodd-Frank tasks each institution’s primary federal regulator with this enforcement and supervision authority.  In many cases, these regulators already serve this function—the “consumer financial laws” are vast and include the Electronic Funds Transfer Act and the Equal Credit Opportunity Act—but many enforcement roles will be new (e.g., RESPA and TILA).  What’s even more novel, though, is that the CFPB is authorized to be the primary rulemaker on these laws, and the prudential regulators, in turn, are empowered to enforce “any rule or order” prescribed by the CFPB under any of these laws.  The other bank regulators are directed to coordinate with the CFPB on enforcement, and the CFPB may even “include examiners on a sampling basis” of consumer protection exams conducted of these banks by their federal regulator.  That is why the DCP will soon become a “household name” for most community banks.  Under Dodd-Frank, the CFPB can initiate rulemaking as soon as January of next year.

Dodd-Frank Rulemaking Begins

On August 10, 2010, the four federal banking regulators also issued a joint advance notice of proposed rulemaking (ANPR) regarding alternatives to the use of credit ratings—specifically, those ratings generated by Moody’s and the like—in the formulation of risk-based capital guidelines.  These rules are to be promulgated pursuant to Section 939A of Dodd-Frank, a section which essentially eliminates regulatory reliance on the “big three” rating agencies in developing capital standards. An ANPR is an optional rulemaking step through which a promulgating agency can solicit information and comment on its deliberative process in advance of an actual rule proposal.  Its use is consistent with the agencies’ stated intent to make Dodd-Frank implementation transparent, reiterated this week by the FDIC.

Chairman Bair explained in plain terms why this is the first rulemaking required by Dodd-Frank on which the FDIC has acted:  “Every study of the root causes of the financial crisis highlights the role of credit ratings as a key contributing factor to the problems the led to virtual collapse of the financial sector.”  She also indicated that the agencies’ ongoing work on capital standards will be halted pending feedback on credit rating alternatives.

This ANPR is in a sense the first step in implementing the heightened capital standards required by Dodd-Frank pursuant to the much-publicized Collins amendment.  We have discussed the proposal’s transition periods, grandfathering, and exemptions in the final bill.   The agencies had previously proposed risk-based capital guidelines that integrated the 2004 Basel II standardized approach to calculating credit risk, which relies extensively on credit ratings to assign risk weight to various exposures.   In this week’s ANPR, available in full text here, the agencies indicate that U.S. implementation of the pending Basel III Accord, which also relies heavily on credit ratings, “would be significantly affected by the need for the agencies to comply with section 939A” of Dodd-Frank.  In general, through this ANPR the agencies solicit feedback on alternatives to the use of credit ratings, including the use of broad “risk buckets” assigning exposure risk by category (e.g., corporate versus sovereign debt) or more  sophisticated assignments based on financial metrics (e.g., debt-to-equity ratios).  For community banks, this is a signal that while Dodd-Frank preserved tier 1 capital treatment for certain trust-preferred and other hybrid securities, the international call for financial reform may impact this treatment in the long run.