Washington, D.C. – Federal Reserve Vice Chair for Supervision Miki Bowman delivered a speech today at the Georgetown University McDonough School of Business Psaros Center for Financial Markets and Policy. The speech outlined her vision for key bank examination and supervision reforms, including the elimination of regulatory box-checking, a renewed focus on regulatory tailoring, stress testing and potential modification of the supplementary leverage ratio.
BPI issued a statement:
“Vice Chair Bowman’s remarks signal a constructive return to evidence-based rulemaking. Financial regulation directly affects the health of the U.S. economy and has real implications for banks’ ability to support businesses and communities. Given the stakes, bank examination should be measured by the risk it reduces, not the paperwork it produces.”
Additional Highlights:
- Material focus: Supervision focused on material financial risks is “inherently more effective and efficient,” Bowman said. “We should be cautious about the temptation to overemphasize or become distracted by relatively less important procedural and documentation shortcomings.” She also said: “Checklists should not distract examiners from the central purpose of examinations.” Bowman said she will review the use of horizontal reviews, with the goal of ensuring they are transparent and compliant with the Administrative Procedure Act, and the use of guidance in supervision, which she said should clarify expectations.
- Tailoring: Bowman, a longstanding advocate of regulatory tailoring, recommended applying that principle to supervision as well as rulemaking. She noted past tendencies at the Fed to “push down” requirements meant for the largest banks to smaller ones. She warned against the gradual erosion of distinct regulatory and supervisory standards – “essentially the subtle reversal of tailoring over time.” Regulators and lawmakers should “consider whether the bank regulatory framework includes appropriate thresholds for defining distinct categories of institutions, and whether simple fixes—for example, the indexing of thresholds to inflation or growth—could better ensure a sound, tailored approach that remains durable over time.”
- Correcting the ratings mismatch: Fed supervisory ratings last year suggested that a majority of large banks were in unsatisfactory condition, yet the majority of the same banks met all supervisory expectations for capital and liquidity – suggesting the ratings are not reflective of banks’ material financial risks. “The Federal Reserve will soon begin to address this mismatch, by proposing changes to the Large Financial Institution ratings framework,” Bowman said. “The proposed changes will be designed to result in a more sensible approach to determining whether a firm is well-managed, no longer disproportionately weighting a single framework component for a firm that has demonstrated resilience under a range of conditions and stresses.” She also called for considering whether the broader ratings framework, including CAMELS ratings, is appropriately tailored.
- Capital: When it comes to capital, policymakers should look at the big picture, Bowman said. “While each component is important, the aggregate calibration of requirements is ultimately the most meaningful, and we must examine whether this approach in totality appropriately captures risk.” Over-calibrated capital requirements can create market distortions, “disfavoring some activities over others in a way that is divorced from prudential safety and soundness goals and economic conditions” – she noted leverage ratios as a key example. “I expect that in the near future, the agencies will publish a proposal to help address this concern and ensure that the eSLR resumes functioning as a backstop capital requirement,” Bowman said.
- Basel, GSIB, stress tests: This change is necessary, but may not be sufficient, Bowman said, previewing a Fed conference in July that will feature discussions on the capital framework. “In addition to considering potential changes to leverage ratio requirements and stress testing, the capital conference will also include a discussion of potential reforms to the GSIB surcharge and the Basel III capital requirements,” she said. She noted the Fed’s ongoing effort to provide more transparency in stress testing. “The lack of transparency around the models used in stress testing prevents meaningful discussions about how the stress tests can be improved,” she said.
- Unintended consequences: Bowman discussed the need to review post-Global Financial Crisis regulations – many of which were “backward-looking” — with a view to addressing unintended consequences. “Some of the regulations put in place immediately after that financial crisis resulted in pushing foundational banking activities out of the regulated banking system into the less regulated corners of the financial system,” she said. “We need to ask whether this was and continues to be appropriate.”
- Waiting in limbo: In the speech and the Q&A following the remarks, Bowman warned against the harmful consequences of lengthy delays in merger applications. “We need to understand the consequences of delaying decisions, and we need to make sure that we’re creating a system that’s transparent, fair and predictable,” she said.
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Media Contacts
- Tara Payne, Bank Policy Institute, tara.payne@bpi.com
