Small Enough to Fail: The 2018 Amendments to the Dodd-Frank Act, Regulatory Stress Tests, and Post-Pandemic Bank Failures

Jacob R. Bourgault & Edwards Adams

As a result of the 2008 financial crisis, the United States lost 8.7 million jobs and U.S. households lost approximately $19 trillion in net worth. The unemployment rate doubled, gross domestic product (“GDP”) fell 4.3%, and the country saw its deepest and longest recession since World War II. In order to prevent the situation from getting worse, nearly $498 billion in taxpayer money was given to, primarily, the large unsecured creditors of large financial institutions. As a result, the hardships fell “disproportionately on low income, working class families.” It again became clear that the banking world was not going to regulate itself—there was too much money to be made and not enough disincentives to prevent large financial institutions from taking advantage of the American public.

Contemporary banking regulations prior to the 2008 collapse had their roots in regulatory responses to bank failures during the Great Depression. As these proved insufficient after the 2008 crisis, one of Congress’s responses to the crash was the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). These changes had significant opposition from various members of Congress and most Wall Street executives due to their restrictive burden on banks, which, they alleged, could potentially stifle business. This opposition did not dispel over time, with political leaders pledging significant changes to the Dodd-Frank Act. This opposition would bear fruit in 2018, when subsequent legislation modifying provisions of the Dodd-Frank Act was enacted.

In 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act (“2018 Amendments”) was signed into law. While this did not dismantle the Dodd-Frank Act, the 2018 Amendments narrowed some of its applications. One of the changes was the development of a new categorization for banks with between $100 billion and $250 billion in assets, which reduced the frequency of supervisory stress tests for these banks from annually to every other year and eliminated the requirement for internal capital stress tests. The alteration of these requirements excluded First Republic Bank ($212 billion), Silicon Valley Bank ($209 billion), and Signature Bank ($110 billion) from being subject to the enhanced prudential standards, and may have failed to prevent the second-, third-, and fourth-largest bank failures in U.S. history. This Article examines the failures of First Republic Bank, Silicon Valley Bank, and Signature Bank to consider whether the regulatory framework prior to the 2018 Amendments could have prevented or foreseen their collapse. By looking at historical and contemporary financial regulations, paired with their effects on bank stability, this Article argues that Congress should implement various regulatory and legislative changes to prevent future bank failures. This Article also delineates the history of banking regulations and their correlation to financial catastrophes, with the conclusion that the collapses of these banks should have been foreseeable, but were not accounted for in the current regulatory framework. Since there is a historical pattern between decreased regulation and financial catastrophes, it is evident that Congress should use its constitutional authority to protect consumers and safeguard macroeconomic stability. As this Article argues, Congress can accomplish this by strengthening the financial sector’s regulatory framework, particularly regarding stress tests. This Article ultimately calls for the incentivization of financial institutions to conduct comprehensive stress testing internally, regulations that account for more variables, such as interest rate risk and deposit beta assumption, returning to pre-2018 Amendment capital requirements, and moving the regulatory oversight responsibilities away from the Federal Reserve.