McGladrey & Pullen, LLPCertified Public Accountants

McGladrey is the brand under which RSM McGladrey, Inc. and McGladrey & Pullen, LLP serve clients’ business needs. The two firms operate as separate legal entities in analternative practice structure. McGladrey & Pullen is a licensed CPA firm providing assurance services. RSM McGladrey provides tax and consulting services.

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The Impact of the Financial Reform Act on Banksand Other Financial Institutions

By Markus Veith

Partner, McGladrey & Pullen New York

July 1, 2010

The Dodd-Frank Wall Street Reform andConsumer Protection Act (the “Act”) was passedby the Senate on July 15, 2010 by a 60-38 margin,introducing a higher level of oversight andregulation designed to promote stability amongfinancial institutions.

Since the Act was first introduced to the U.S.House of Representatives, a great amount ofdeliberation has ensued over how this legislationwill affect banks, the American public and theeconomy.

A heated debate led to a last minute rewriteeliminating the proposed bank tax portion of theAct, which was intended to raise $19 billion bylevying fees on banks and hedge funds with $50billion and $10 billion in assets, respectively.

Following Senate passage, highlights of the Actinclude:

Changes to regulatory oversight

Under the Act, federal regulators will havenew and expanded authority to seize andbreak up large institutions that werepreviously deemed “too large to fail.”

The Office of Thrift Supervision will beeliminated, but the Thrift charter will remainintact.

A new financial stability council will monitorsystem-wide risks and have the ability torecommend stricter regulatory capital,leverage and other rules to the FederalReserve. In extreme cases, the council willeven have the power to break up institutionsdeemed unstable.

Hedge and private equity funds will berequired to register with the Securities andExchange Commission as investmentadvisers and regularly provide reports to aidregulators in monitoring systemic risks.

Trading and investing restrictions

The so-called “Volcker Rule” was preservedin the final version of the Act. This rule willcurb proprietary trading by banks. Bankswould be able to continue to invest up to 3

percent of their respective Tier-1 capital inhedge and private equity funds. However,banks would be barred from bailing outfunds in which they are invested.

Derivatives

Most derivative transactions, with theexception of customized swaps, would haveto be traded on exchanges and clearedthrough clearinghouses, thus guaranteeingboth liquidity and transparency in thesystem. This is also expected to increase thereporting and compliance burden.

Banks will be further required to transfer theirriskiest derivative trading operations intoaffiliates. They will be able to retainoperations in-house for interest-rate, f/x andprecious metals swaps. However, trading incommodities derivatives will have to beconducted through affiliates.

Regulatory capital

The regulatory capital rules and minimumrequirements will be overhauled and largebanks will no longer be able to treat trust-preferred securities as Tier-1 capital.However, banks with less than $15 billion inassets will be grandfathered from thatprovision for existing trust-preferredsecurities.

Mortgage lending

The Act will establish new minimumunderwriting standards for home mortgages.Banks will be required to verify a borrower’sincome, credit history and employmentstatus. Also, the Act will ban commissionpayments to mortgage brokers that steerborrowers to high-priced loans.

Sarbanes-Oxley 404(b) exemption

An exemption from compliance with Section404(b) of the Sarbanes-Oxley Act of 2002has been included in the Act for smallerinstitutions with less than $75 million inmarket capitalization. The proposedexemption would eliminate responsibility forthe auditor attestation of internal controls

McGladrey & Pullen, LLPCertified Public Accountants

McGladrey is the brand under which RSM McGladrey, Inc. and McGladrey & Pullen, LLP serve clients’ business needs. The two firms operate as separate legal entities in analternative practice structure. McGladrey & Pullen is a licensed CPA firm providing assurance services. RSM McGladrey provides tax and consulting services.

© 2010 RSM McGladrey Inc. All rights reserved

over financial reporting requirement foreligible smaller institutions. However,disclosure of management assessment oninternal control over financial reporting underSection 404(a) would still be required.

What is the expected impact on banks andother financial services firms?

Profit margin decline

One of the effects the Act will have on allfinancial institutions is that profit margins willdecline. For example, larger institutions willno longer be able to generate profits fromrisky bets using their own money and willhave to rely more on traditional low-marginbanking business.

Smaller banks forced to expand

On the other end of the spectrum, smallerbanks will be required to increase staff levelsin their credit departments and compliancefunctions as the rules will apply to the sameextent to both large and small institutions.Many experts already foresee the end ofcommunity banking as we know it. Theincrease in cost and profit pressures will leadto a further consolidation in the industry withmany of the smaller community banks beingunable, or unwilling, to shoulder the costburden on their own.

Credit crunch and scarce loans

With the threat of regulatory scrutiny andmonetary penalties over lending decisions,many banks and — in particular — smallercommunity banks, will think twice beforegranting new loans.

Additionally, stricter capital requirements andincreased scrutiny over credit decisions willdrain credit available to borrowers. Thiscould have a negative impact on overallgrowth and hit mid-market companiesparticularly hard that will have to look foralternative higher-cost financing.

Trading strategies shift to unregulatedniches

Another fear is that many of the activitiesthat were previously housed within banksand were subject to oversight by bankingregulators will move into unregulated orlightly-regulated niches of the financialsystem. The financial performance of theseniche players may only affect theirstakeholders, whom are generally wealthierinvestors. Nevertheless, the impact oftrading strategies could impact a wider

audience, as was just evidenced in the caseof the Greek debt crisis and the other recentEurozone troubles.

A bright side

It would be unfair to only point out thenegative aspects of the Act. The legislationis not perfect, as it is subject to a democraticconsensus-finding process that requires aconsideration of input from various parts ofour society.

The Act is a step in the right direction andshould curb the excessive risk takingmentality that some bankers have displayed.It also sends a clear signal that iforganizations fail to properly managefinances, they will not be rescued by thetaxpayer in the future.

The improved risk monitoring and capitalrequirements also serve to build a cushionand offer assurance that another severefinancial crisis may be subdued ahead oftime.

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services meet the needs of diverse local and globalreal estate clients. Our dedicated financialinstitutions practice serves public and privatelyheld banks with a focus on community basedbanks, finance and investment companies and hasexperience with public mortgage REITs as well assecurities broker-dealers and commodity traders.

McGladrey is the brand under which RSMMcGladrey, Inc. and McGladrey & Pullen, LLPserve clients’ business needs. The two firmsoperate as separate legal entities in an alternativepractice structure. Together, the companies rankas the fifth largest U.S. provider of assurance, taxand consulting services (source: AccountingToday), with 7,000 professionals and associates innearly 90 offices. Both firms are members of RSMInternational, the sixth largest global network ofindependent accounting, tax and consulting firms.

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For more information, please contactMcGladrey & Pullen Partner Markus Veith at212.372.1700.