The too-big-to-fail problem is getting even bigger

The too big to fail problem on Wall Street may now be even bigger.

The Dodd-Frank Act was implemented in the aftermath of the financial crisis to make sure that a bank failure didn’t risk bringing down the entire system.

According to Craig Donohue, the executive chairman of The Options Clearing Corporation and former CEO of the Chicago Mercantile Exchange, it may have made things worse.

“One of the unfortunate things that I think is happening as a result of Dodd-Frank is they were trying to solve too-big-to-fail problems, but, in some sense, I think they have made things even bigger, certainly from the bank perspective,” Donohue told Business Insider in a recent interview.

Specifically, Donohue says Dodd-Frank has caused the industry to become a “very, very capital-intensive business,” and that operating expenses are “between two and three times what they have been historically.”

Dodd-Frank called for the designation of systemically important financial institutions, or companies that could pose a threat to the stability of the US financial system. Aside from the designation of financial institutions as systemically important, financial utilities were also included.

The introduction of Dodd Frank, and other rules such as Basel III Capital Accord, has also exchange trading central counterparty clearing much more expensive.

During the crisis, centrally cleared markets, or those that are cleared by a single entity, functioned as normal, in part because people had faith they would be made whole on their trades. On the other hand, over-the-counter markets seized up because nobody knew if their counterparty was going to survive.

Craig DonohueOptions Clearing CorporationOptions Clearing Corporation Chief Executive Craig Donohue

The unfortunate thing, according to Donohue, is that now it’s “
more expensive to clear through a central counterparty than it may be to maintain a bilateral credit exposure between two financial institutions.” And that could be a danger to the financial system.
“I’m actually pro-regulation, and I think some of these create scrutiny and regulation of central counterparties is actually good for us, but not to the extent that we’ve basically subverted the policy goals of the international regulatory community and the outcome is sort of upside in the way that I’ve described,” Donohue said.

The two global regulators who oversee the derivatives market earlier this week sounded the alarm on the industry responsible for clearing derivatives, saying that some have no guidebook to follow if they get into financial trouble.

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