ECONOMIC REPORT OF THE PRESIDENT

Risk Taking
The Dodd-Frank Act took a number of steps to limit risky behavior
by financial firms. One component dubbed “the Volcker Rule” is named for
Former Federal Reserve Chair Paul Volcker. As required by Dodd-Frank,
the SEC, CFTC and banking regulators finalized the Volcker Rule in 2013
to restrict federally insured banking entities from engaging in proprietary
trading or investing in or sponsoring private equity or hedge funds. As seen
in Figure 6-11, activities related to trading and securities contributed to
significant losses during the crisis. The Volcker Rule is meant to mitigate
the moral hazard inherent in access to federally insured deposits by limiting
high-risk-taking activities. Banks have until July 2017 to conform investments
in, and relationships with, covered funds. In the meantime, banks are
recording and reporting certain quantitative measurements to regulators,
and divesting their proprietary positions, including those in hedge funds.
Banking regulations typically require firms to meet a minimum ratio
of capital to risk-weighted assets. A risk-weighting system assigns a weight
to each asset or category of assets that reflects its relative risk. Figure 6-12
shows a general decline in risk-weighted assets as a fraction of total assets,
reflecting declining relative risk of bank assets over time. Both Basel 2.5,
effective in January 2013, and Basel III, effective in January 2016, revised
the risk-weighting methodology and are reflected in the Figure as discrete
increases on these dates.
The Dodd-Frank Act included several reforms of the Federal Deposit
Insurance Corporation (FDIC) to better protect depositors and stabilize the
financial system. First, it permanently raised the level of deposits insured for
each depositor from $100,000 to $250,000 for each insured bank. Second, it
altered the operation of deposit insurance. Since its founding in 1934, the
FDIC has maintained a Deposit Insurance Fund, a pool of assets meant to
prevent bank runs by insuring the deposits of member banks and finance
the resolution of failed banks. The FDIC maintains funds in the Deposit
Insurance Fund by charging insurance premiums, or assessments, to banks
whose depositors it insures. Specifically, Dodd-Frank required two changes
in the methodology for calculating these premiums that provided direct
relief to small banks with more traditional business models by making large
banks bear more of the costs of deposit insurance.
The first change required by the Dodd-Frank Act expanded the
deposit insurance assessment base. When this change took effect in spring
2011, total assessments for small banks with less than $10 billion in assets
fell by a third — an annualized decrease of almost $1.4 billion. The second
change required by Dodd-Frank raised the minimum Designated Reserve
Ratio—the Deposit Insurance Fund balance over total estimated insured
Strengthening the Financial System | 379