The Impact of Dodd-Frank Nearly Five Years Later

It is hard to believe, but this summer we will be hitting the five-year anniversary of the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  This was the legislation spurred by the risky behavior of banks and financial institutions as well as the “no problem, we’ll pay it down later” attitude of consumers for financial products like loans and mortgages. This risky behavior came to a head when the economy collapsed into a recession, and nearly the next Great Depression, almost seven years ago this summer.


The Dodd-Frank legislation aimed for a number of reforms. One example was to require banks to keep more capital reserves on hand in case sudden or unexpected losses occur that could destabilize the bank (and so the government would not necessarily have to jump in with more bailout money). The necessary level of capital is typically tied to the volume of loans and trades made by the bank. Another was to require a shareholder vote on executive pay (“Say on Pay”) which would not be binding on the company, but could perhaps cause boards of directors to re-think executive pay. There has also been the controversial Volcker Rule that restricts proprietary trading by banks in which they make investments using their own money (among other restrictions on banks’ activities with hedge funds and private equity firms), and other restrictions on trading in derivatives (although those were recently stripped away). The Act also created a Consumer Financial Protection Bureau to regulate the provision of financial products and services by banks to consumers (e.g. depositors at a regional bank).

Effects Being Felt More and More

In spite of the challenges of implementing Dodd-Frank, there have been signs that in the nearly five years since the laws passed, as the New York Times Dealbook recently profiled, they are having their intended effects. Banks are eliminating or selling off certain units, bonuses have leveled off or even decreased at some banks. As the article indicates, the rules on minimum capital have had much to do with this, as do restrictions on certain types of trading, among other aspects. Companies are likely more reticent to make loans or trades since the minimum capital reserves are tied to that trade volume, thus requiring banks to counter certain risky moves with reserves to back them up if they fail. It also may spur them into less risky business decisions in order to forego setting aside significant sums for their capital reserves.

While many may see this as a stifling of the economy, it may also be seen as the intended effect of legislation meant to curb risky behavior in the economy. After all, these laws were enacted to prevent “too big to fail” banks which we now know can fail. While these changes have made balance sheets smaller and reduced the previous free culture of wheeling and dealing with less focus on risk, many of these banks are still incredibly profitable (in part due to their cost cutting to account for extra capital reserves), and some more are more profitable than ever. They benefit from a generally rebounding economy, and still do business day-to-day, just in a different and still changing paradigm. For example, banks have changed much of their business models by trading less, and some may even break up into pieces over time, though that is not a certainty.

There are still years ahead before history can judge the legislative reaction to the market crash, and other changes may be necessary on a domestic and international scale. But, as we now know “too big” can fail, we may very well have learned our lesson.