Dodd Frank Act and Impact on Us Industry

Impact on US Banks

The overall theme of the Act has been to grant more powers to regulators, especially to the Fed, in order to identify any systemic risks and prevent another financial crisis. Increased supervision, higher requirements of capital and stricter limitations on businesses would add costs of conducting business to banks. While these costs are expected to be higher for larger banks, even the smaller banks will have to budget for these changes.

Further, the Act allows various regulators to create rules to support the provisions in the Act. These rules are expected to formulated and implemented over the next two years and exact extent of their impact will be known only over time.

Following paragraphs provide analysis on the key aspects of the Act under the expectations that the market participants have on future developments.

Higher Capital Charges

The Collins amendment in the act significantly limits the amount of Tier 1 capital available to a bank. Cumulative Preferred Stock and Trust Preferred Stock (Trups) will not be available as Tier 1 capital under the new provisions which are expected to be implemented in a staggered manner over 2012-2016. This would lead to a decrease in the banks’ capital ratios which will further adversely affect their cost of capital.

As a response to this measure, some banks have already retired some of their hybrid capital. For example, recently Capital Bancorp announced an offer to exchange its common stock for outstanding Trups (Capital Bancorp, 2011, January 11). Standard & Poors (2010, November 2) has estimated that the stricter capital requirements could add up to as much as $85 billion in reduced Tier I capital for banks, which they will need to refinance to maintain current Tier 1 ratios. According to Moody’s (2010, as cited by Guerrera and Baer, 2010), US banks had almost $118bn of Trups outstanding as of August 2010.

Further, these changes need to be considered keeping in mind the impending Basel III...