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What Is Dodd-Frank and How Does It Affect Small Business?

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In recent years, financial regulations have frequently been in the spotlight, prompting many to ask, “What is Dodd-Frank?” Though it was during President Donald Trump’s early tenure that significant attention was drawn to this legislation, its implications and effects remain relevant.

Back in his initial weeks in office, Trump quickly took action on several of his key campaign promises, issuing numerous executive orders and memoranda on various issues, including the review of the Dodd-Frank financial regulatory law.

But one of the important ones in terms of business ramifications has been to direct the Treasury to review Barack Obama’s 2010 Dodd-Frank financial regulatory law. Opinions appear to be split over the impact some of these policies have on small business. But what exactly is Dodd-Frank all about and what are its implications?

What is Dodd-Frank?

The Dodd-Frank Wall Street Reform and Consumer Protection Act was an important piece of legislation to emerge from the ashes of the global financial crisis of 2008. Named after its sponsors, Senator Christopher J. Dodd and U.S. Representative Barney Frank, the 2,300 page law was passed by the Obama administration in 2010 in a bid to eliminate various risks across America’s wider financial system.

Dodd-Frank includes a range of 225 regulations, and sets up several new government agencies, including the Financial Stability Oversight Council and the Consumer Financial Protection Bureau (CFPB). The latter has since been tasked with preventing predatory mortgage lending. Meanwhile, Dodd-Frank’s key Volcker Rule restricts the ways big banks are allowed to invest and eliminates proprietary trading.

Likewise, one of Dodd-Frank’s more widely known provisions has been its so-called “too big to fail” clause, which has put new regulatory burdens on big financial institutions that have the ability to spark financial contagion if they become insolvent.

Key Components of Dodd-Frank

Originated from the 2008 global financial crisis.
Sponsored by Senator Christopher J. Dodd and U.S. Representative Barney Frank.
Comprises 2,300 pages, passed in 2010.
Introduced 225 regulations and established several government agencies.
Created the Financial Stability Oversight Council and the Consumer Financial Protection Bureau (CFPB).
Introduced the Volcker Rule restricting bank investments and eliminating proprietary trading.
Implemented the “too big to fail” clause placing regulatory burdens on large financial institutions.

Why is Dodd-Frank Controversial?

On the surface, the Dodd-Frank Act might not appear contentious. To many, it presents as a safeguard — a series of rules designed to ensure that banks maintain responsible lending practices.

However, beneath this straightforward veneer lies a myriad of concerns and debates about the legislation’s wider implications and unintended consequences.

One of the primary arguments against Dodd-Frank stems from economic perspectives. A significant number of economists emphasize that while the act’s intent is to shield taxpayers from the potential fallout of risky financial decisions, it inadvertently hampers the profitability of these institutions.

By introducing more stringent regulations on how financial firms can invest their assets, Dodd-Frank has inadvertently reshaped the financial landscape.

Detractors believe that these constraints have diminished the United States’ stature as a leading global financial powerhouse, making it less attractive for investments and financial activities.

Another often-discussed aspect is the impact on liquidity, especially concerning trading bonds and securities.

With the new limitations set by Dodd-Frank, there’s a marked decrease in the liquidity available in the markets, which in turn can affect the ease and efficiency with which these financial instruments are traded.

Yet, perhaps one of the most contentious parts of Dodd-Frank, especially among business proprietors, is the elevation in reserve requirements.

This stipulation necessitates banks to retain a substantially larger portion of their assets in liquid form compared to what was expected before the 2008 financial crisis. While on the one hand, this might seem like a prudent measure to ensure banks’ stability, it has its drawbacks.

High reserve requirements naturally curtail a bank’s capacity to engage in other financial activities, such as holding marketable securities or facilitating connections between businesses and potential investors.

This reserve-related restraint is particularly concerning for the entrepreneurial ecosystem, as it is perceived to make banks more apprehensive about extending credit to fledgling enterprises and small businesses, especially those without significant assets to pledge as collateral.

This has sparked worries about stifled innovation and potential hindrances to economic growth.

Dodd-Frank: Benefits vs. Criticisms

The Dodd-Frank Act has been both lauded for its consumer protections and criticized for its potential impact on economic growth. Here’s a comparison of the perceived benefits and criticisms:

Benefits of Dodd-FrankCriticisms of Dodd-Frank

Aims to eliminate risks in America’s financial system.Can decrease the ability of financial firms to turn a profit.

Prevents predatory mortgage lending through the CFPB.Might impact America’s status as a global financial center.

Regulates big banks’ investment activities with the Volcker Rule.Causes potential liquidity issues in bonds and securities trading.

Too big to fail” clause safeguards against major financial crises.Bigger reserve requirements can limit bank lending abilities.

Looking Ahead

While President Trump had initiated a review of Dodd-Frank during his term, the lasting effects and potential modifications to the legislation remain subjects of debate and uncertainty. The directive he issued early in his presidency sought a comprehensive review of the bill by the U.S. Treasury.

As discussions continue, it’s imperative that any findings or recommendations provide clear evidence of Dodd-Frank’s impact on America’s economic landscape.

Equally crucial is ensuring that both the public and policymakers are well-informed about the trade-offs between financial security and potential economic hindrances introduced by the law.

Chris Dodd and Barney Frank Photos via Shutterstock

This article, “What Is Dodd-Frank and How Does It Affect Small Business?” was first published on Small Business Trends

What is Dodd-Frank and why are many small business owners applauding a recent decision by President Trump to scale the legislation back?Read MoreEconomySmall Business Trends

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