In July the second anniversary of the signing of the Dodd-Frank Act passed, giving community bankers an opportunity to consider where things stand. For some banking institutions, particularly larger ones, it has been an active two years even though at least half of the regulatory requirements of the Act remain to be finalized. For smaller institutions, as will become clear, the action appears to be just beginning.

The sweeping overall scope of the Act is underscored when one considers there have been significant delays to much of the parts and pieces of the regulatory actions required under the Act. Yet much has been done.  According to various reports, there have been more than 100 finalized regulations under the Act and, there has been public comment requested on nearly as many significant proposals. 

The most critical regulations for smaller financial institutions are those proposed in recent months: new regulations on capital adequacy and new consumer lending regulations from the Consumer Financial Protection Bureau, the formation of which is thought to be one of central accomplishments of the Act.

One of the other centerpieces of the Act, the Financial Stability Oversight Council has, like the CFPB, been slow in developing over the past two years, considering the importance of the FSOC to the overall goals of the Act. That is not likely to continue; in 2013, after the presidential election, it is likely there will be a period in which the regulatory tempo will increase and that smaller institutions will feel much of the impact.

The financial crisis that led to the Act is most reflected in Title I of the Act, which sets out legal framework for the establishment of the Council to monitor and limit systemic risk in the financial system. This title does this by, among other things, giving the FSOC the power to instruct the Federal Reserve to impose additional regulation on systemically important financial institutions. This includes bank holding companies with at least $50 billion in assets and nonbank entities that have been designated as SIFIs. Such designations remain one of many undone regulatory tasks. The scope of the additional regulation emitting from Title I and related provisions of the Act includes among other things, enhanced requirements for capital, liquidity, resolution planning, credit exposure, asset concentration, stress testing and public disclosures.

Some specific progress toward these regulatory goals of the Act for the largest financial institution has been made in the last two years. For example, nine of the largest banks in the country submitted resolutions plans on July 1, 2012, and earlier in 2012, the Federal Reserve proposed rules for SIFIs to enhance prudential standards, covering among other topics single-party credit limits, enterprise-wide risk management, overall leverage limits and required stress testing. Designations of nonbank SIFIs are likely to be made in 2013, along with the finalization of a number of these regulations that are intended generally speaking, to limit and provide oversight of enterprise risk for these large institutions.

Two of these rules, which pertain to capital adequacy, are of particular interest to smaller institutions. These regulations, known as the Basel III capital requirements, were surprising to smaller institutions because they expected to be exempt from them as they are from various aspects of the Act. The regulations as proposed by the Federal Reserve on June 7, 2012 (with comments due on October 22, 2012) will directly impact smaller institutions as well as larger ones. The regulations will be phased in beginning on January 1, 2013, and, generally speaking, will impose on community banks the following: higher capital requirements in the form of new regulatory capital categories including a new capital conservation buffer concept, an overall requirement for reduced capital leverage, generally higher risked-based capital requirements, a likelihood of increased volatility in regulatory capital accounts in times of increasing interest rates, and further limits on dividends and executive bonuses. For example, for purposes of the prompt corrective action regulatory scheme, the well-capitalized category as amended will require tier 1 risk-weight capital of 8%, up from 6%.

It is the initiatives of the CFPB however that will almost certainly have the most significant impact on smaller banking institutions in the coming weeks and months, even though the CFPB does not have direct regulatory authority over such institutions with less than $10 billion in assets. During the two years since enactment of Dodd-Frank, the CFPB largely has been focused either on its internal issues like staffing and developing a framework for administration of the agency or on external issues such as integration with other federal and state banking regulatory agencies (because the CFPB has become the primary regulator with respect to most existing consumer regulations). 

The controversial recess appointment of the CFPB’s first director in January 2012 began the agency’s working life in earnest however. Even though the CFPB does not have direct examination authority over institutions with less than $10 billion in assets, its supervision and examination manual was published in early 2012 and will be a touchstone for all institutions and their regulators, and the CFPB's rulemakings regarding key issues such as the definition of “unfair, deceptive and abusive” practices also will be closely followed by institutions of all sizes.

That the CFPB now has begun to function as a financial institution regulator can’t be over emphasized. The CFPB consumer response center became operational earlier this year for example and it remains to be seen whether industry fears that this will become a permanent database of frivolous or unsubstantiated complaints will materialize. It also has begun to define its authority over nonbanks such as credit reporting agencies. The CFPB has imposed its first regulatory fine this year (in connection with credit card marketing) and it has begun to include enforcement counsel to its routine visitations and examinations, a distinct departure from the past practice of the Federal Reserve and the other regulatory agencies that previously enforced consumer financial regulation.

Earlier this summer, in what is likely to be the first of a number of substantive proposals, the CFPB proposed two regulations intended, among other things, to revamp the disclosure requirements imposed on the home residential mortgage industry which has for many years been a source of complaints from both consumers and bankers. The new disclosure regime is an attempt to shorten the transaction disclosures required under Truth In Lending and related regulations.

So even though two years have passed since the Dodd-Frank Act was passed, much remains undone and uncertain. And the uncertainty was increased somewhat by the filing in June of a lawsuit by a small community bank (State National Bank of Big Spring, Texas) and two public interest organizations in Washington, D.C., challenging the constitutionality of the Act. Among other things, the suit focuses particularly on the powers of the FSOC and the CFPB, arguing that they offend the Constitution's separation of powers.

If the outcome of the lawsuit is uncertain, it is certain that the next steps under the Act for the nation's bank regulators will be the hundreds of regulations that remain un-finalized. For smaller institutions, the key areas to watch will be developments in bank regulation, particularly capital adequacy requirements, and developments regarding increased consumer protection requirements, including in particular the developing reform of the residential mortgage industry. And they might also keep an eye on the lawsuit.