Speech: Early Observations on Improving the Effectiveness of Post-Crisis Regulation by Vice Chairman for Supervision Randal Quarles at the American Bar Association Banking Law Committee Annual Meeting, Washington, D.C.
The Federal Reserve and our colleagues at other agencies have now spent the better part of the past decade building out and standing up the post-crisis regulatory regime. At this point, we have completed the bulk of the work of post-crisis regulation, with an important exception being the U.S. implementation of the recently concluded Basel III “end game” agreement on bank capital standards at the Basel Committee. As such, now is an eminently natural and expected time to step back and assess those efforts. It is our responsibility to ensure that they are working as intended and–given the breadth and complexity of this new body of regulation–it is inevitable that we will be able to improve them, especially with the benefit of experience and hindsight.
In undertaking this review and assessment, in addition to ensuring that we are satisfied with the effectiveness of these regulations, I believe that we have an opportunity to improve the efficiency, transparency, and simplicity of regulation. By efficiency I mean the degree to which the net cost of regulation–whether in reduced economic growth or in increased frictions in the financial system–is outweighed by the benefits of the regulation. In other words, if we have a choice between two methods of equal effectiveness in achieving a goal, we should strive to choose the one that is less burdensome for both the system and regulators.
Transparency is an objective that ought to particularly resonate with this audience. As lawyers, we were all trained to view transparency as a necessary precondition to the core democratic ideal of government accountability–the governed have a right to know the rules imposed on them by the government. In addition, as any good lawyer also recognizes, there are valuable, practical benefits to transparency around rulemaking; even good ideas can improve as a result of exposure to a variety of perspectives.
Finally, simplicity of regulation is a principle that promotes public understanding of regulation, promotes meaningful compliance by the industry with regulation, and reduces unexpected negative synergies among regulations. Confusion that results from overly complex regulation does not advance the goal of a safe system.
On LCR: Liquidity regulation, for example, does not have a G-SIB versus non-G-SIB gradation. In particular, the full liquidity coverage ratio (LCR) requirement and internal stress testing requirements of enhanced prudential standards apply to large, non-G-SIB banks in the same way that they apply to G-SIB banks. I believe it is time to take concrete steps toward calibrating liquidity requirements differently for large, non-G-SIBs than for G-SIBs. And I see prospects for further liquidity tailoring in that the content and frequency of LCR reporting are the same for the range of firms currently subject to the modified LCR as they are for the large non-G-SIBs that are subject to the full LCR. We should also explore opportunities to apply additional tailoring for these firms in other areas, such as single counterparty credit limits and resolution planning requirements.
On a meaningful simplification of our framework of loss absorbency requirements: There are different ways to count the number of loss absorbency constraints that our large banking firms face–which is perhaps in itself an indication of a surfeit of complexity if we can’t be perfectly sure of how to count them–but the number I come up with is 24 total requirements in the framework. While I do not know precisely the socially optimal number of loss absorbency requirements for large banking firms, I am reasonably certain that 24 is too many. Candidates for simplification include: elimination of the advanced approaches risk-based capital requirements; one or more ratios in stress testing; and some simplification of our TLAC rule. I am not the first Federal Reserve governor to mention some of these possibilities, and we should put them back on the table in the context of a more holistic discussion of streamlining these requirements. Let me be clear, however, that while I am advocating a simplification of large bank loss absorbency requirements, I am not advocating an enervation of the regulatory capital regime applicable to large banking firms.
On an enhanced stress testing transparency package: Our stress testing disclosures can go further. I appreciate the risks to the financial system of the industry converging on the Federal Reserve’s stress testing model too completely, so I am hesitant to support complete disclosure of our models for that reason. However, I believe that the disclosure we have provided does not go far enough to provide visibility into the supervisory models that often deliver a firm’s binding capital constraint.