Financial Product Safety and Banks

I recently posted a lovely reference that Elizabeth Warren had regarding a Consumer Financial Protection Administration (CFPA). The goal would create an agency whose sole purpose was to regulate the safety of financial products. The idea is something I have supported. A mortgage or credit card can actually do more damage to your home or health than a toaster, and yet, we regulate the toaster more tightly.

However, community banks are in strong opposition to this. Felix Salmon actually discussed why they should not have such concerns. Quoting his post:

1. Small community banks are good at boring, simple banking — think the Bailey Building & Loan. That kind of activity should pass a CFPA audit without
   breaking a sweat. Conversely, a CFPA audit is akin to a tax on size and complexity — the more opaque a bank and its products, the harder it will be to persuade the CFPA that what it’s doing is good for consumers.


2. Small community banks compete with predatory lenders, and in extremis are forced into the gutter with them. The CFPA, by severely curtailing predatory activity, moves the battleground back onto the community lenders’ own turf. More generally, the CFPA will turn formerly-unregulated lenders into regulated financial institutions, which will help level the competitive playing field.


3. The CFPA is rightly prejudiced against yield spread premiums and other hidden ways of gouging consumers, such as putting prime customers into subprime loans. Small community banks don’t engage in such shenanigans. Meanwhile, community banks are really good at old-fashioned know-your-customer underwriting, which the big financial institutions find more or less impossible.

Now, James Kwak that sort of complexifies the first point. He states that community banks did get involved in some of these dangerous products. That said, they do have boring products for the most part, and would likely not have a problem.

The real concern most people have cited is the matter of regulatory capture. The small banks fear that the agency will become captured like many other agencies and thus favor the interests of the big banks they are supposed to police. Capture is a major concern, and it is often difficult to avoid. Large businesses have greater resources to spend. Large businesses are often better connected. Large businesses usually provide the information on the market to the regulator. Caputre is inherenlty hard to avoid, but a well-designed agency, as both Kwak and Salmon point to, definitely could help.

The other concern too arises from compliance costs. If the regulations are too difficult to meet, banks with just boring products could have trouble meeting the new requirements. It takes administrative resources to comply with these matters. This issue is often linked toward capture, as compliance costs are often used by larger players to keep out the smaller ones.

However, agian, design and careful oversight by Congress and people at large, plus an initial agent who understands these issues and sets up an institutional culture that balances these matters would help. Again, this is not some sort of weird luxury here. I do think that this needs to be done. We have to consider these concerns, but small banks should really join on the train here.