Forget interest rates.
The debate surrounding theFederal Reserve’s significant bank deregulation efforts is intensifying, with market analysts, consumer advocates and eager investors sharply divided on how it impacts bank health and stock valuations.
Then there’s the internal debate brewing under Fed Chair Kevin Warsh, who promised a “regime change” at the U.S. central bank during his Senate confirmation hearing in the spring.
The regulatory shifts include the dramatic watering down of the original “Basel III Endgame” capital hike proposals and a notable pivot toward lighter supervision across the regulatory risk landscape.
Fed Governor Michael Barr slammed his fellow regulators’ efforts over the past year to relax the rules for U.S. lenders, saying in prepared remarks on June 6 that the proposals “considerably weaken bank regulation and supervision.”
“I believe that recent steps by the Federal Reserve and other agencies will undermine the safety and soundness of banks and increase financial stability risks,” Barr said.
“Vulnerabilities that result from deregulation may not be apparent today, but they will result in problems that will build over the coming years and could threaten serious harm to the economy,” he added.
Bowman testifies about bank deregulation ‘innovation’ before Congress
Barr’s comments came just days after Fed Vice Chair for Supervision Michelle Bowman testified before Congress with regulators from other federal agencies exhorting their bank deregulation efforts.
Bowman joined the regulatory chiefs of the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency in saying that their efforts to trim bank rules and oversight put into place following the 2008 financial crisis will boost economic activity and innovation without injecting undue risk into the financial system.
“By tailoring requirements to actual risk, focusing supervision on what truly matters, and integrating innovation into the regulatory framework, the Federal Reserve is creating conditions for banks to thrive while maintaining the robust safeguards,” Bowman said in prepared remarks posted June 3.
2008 financial crisis kicked off flurry of global banking reforms
The U.S. banking system underwent its most sweeping regulatory overhaul in decades following the 2008 financial crisis which triggered the collapse or rescue of several major financial institutions and plunged the economy into the deepest recession since the Great Depression.
In response, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. It was designed to:
- Strengthen oversight of banks.
- Reduce systemic risk.
- Prevent taxpayer bailout of failing financial institutions.
The law created new safeguards for large financial institutions including:
- Tougher capital requirements.
- Annual stress tests.
- Enhanced supervision by federal regulators.
The legislation also established the:
- Financial Stability Oversight Council.
- Consumer Financial Protection Bureau.
- Volcker Rule.
Global regulators simultaneously adopted the Basel III framework which requires banks to hold more capital and maintain stronger liquidity buffers to withstand periods of market stress.
Aaron Schwartz / Getty Images
Post-crisis banking reforms prompt debate, more change
Supporters argue the Dodd-Frank reforms make the banking system safer and more resilient.
Critics respond that some of the rules increased compliance costs and limited lending activity.
Congress and federal regulators have steadily eased some of the most significant safeguards enacted after the 2008 financial crisis
The biggest change hit in 2018 when lawmakers raised the threshold for enhanced Federal Reserve oversight from $50 billion to $250 billion in assets, thus reducing regulatory compliance for regional and mid-sized banks.
Then in 2019, regulators created a new framework that tailored liquidity, capital and supervisory requirements based on a bank’s size and profile rather than a single standard for all institutions over $50 billion in assets.
They also loosened restrictions under the Volcker Rule which was designed to limit speculative trading and certain investments by banks.
Bowman calls for lifting of ‘punitive’ regulatory oversight of banks
More recently, Bowman and other regulators have re-examined the current tough standards surrounding regulatory risk of U.S. banks.
The argument: Overly punitive oversight has hindered banks’ ability to support the economy.
For example, Bowman testified the Fed has found that examiners have reported numerous bank deficiencies that were procedural or documentation gaps, not actual financial risk.
Bowman noted that new AI models have “dramatically accelerated” the identification of vulnerabilities in the banking system.
Related: JPMorgan, BofA, Citi investors get good news from Fed, FDIC
“Innovation is essential to meeting customer expectations, lowering costs, enhancing services, and maintaining a dynamic banking industry that adapts to the introduction of new technologies,’’ Bowman testified. “This is especially important given the intense competition banks face from nonbank financial institutions.’’
Bowman announced in February that large banks’ “stress capital buffers” will be revised in 2027 once the U.S. central bank has had a chance to identify any shortcomings in the models it uses to test large-bank finances against a hypothetical economic downturn.
Barr urges caution as Fed advances banking deregulation
Bowman took over as Fed Vice Chair for Supervision last June after Barr resigned the role to bypass a potential battle with President Donald Trump over the position, according to Bloomberg.
The White House — as it did in the first Trump administration — has been very active in supporting bank deregulation efforts.
In a June 6 speech at American University, Barr said that weaker capital rules, liquidity requirements and oversight can increase risks of bank stress.
“Achieving appropriate bank regulation and supervision is a balancing act,” he said. “Banks need room to grow so that their lending can support innovation and aspiration throughout the economy.
“At the same time, long experience has shown that without proper safeguards, banks striving to innovate in pursuit of higher profits may take excessive risks,’’ he said.
Congressional Democrats blast Fed’s bank deregulation efforts
U.S. Rep. Maxine Waters, the ranking member of the House Financial Services Committee, and Sen. Elizabeth Warren, ranking member of the Senate Banking Committee, recently sent a scathing letter to Bowman.
Both Democrats urged the Fed to immediately rescind its dangerous stress testing proposals and do a complete overhaul of its internal stress testing models in advance of the 2027 stress tests.
“Wall Street has long sought to weaken the Fed’s stress tests in order to reduce their loss-absorbing capital cushions through higher dividends and share buybacks,’’ the letter said.
“The Fed’s proposal would reduce capital cushions at the riskiest banks by (more) than $35 billion — that’s billions of dollars that could be diverted directly to shareholders and stock repurchases, and billions less to absorb losses during periods of economic turbulence,’’ the letter concluded.
Warsh promised “regime change” as new Fed Chair
Warsh has long been critical of the central bank after resigning his position as a Fed governor in 2011 when he became increasingly uncomfortable with the Fed’s post-financial crisis emergency stimulus measures.
Fed watchers are waiting to see if Warsh’s “regime change” will, over time, prioritize financial-market efficiency and economic growth or adhere to the stricter regulatory framework deployed after 2008, a framework Warsh helped to create as Fed governor.
Aaron Klein, a financial regulations expert at the Brookings Institution, has expressed deep concern over the political environment surrounding these current deregulation shifts.
Klein has emphasized that a fragmented approach to bank deregulation fails to protect consumer interests.
Fed to announce results of latest bank stress tests
The Fed announced June 9 that results from its annual bank stress test will be released June 24.
This year, 32 large banks were subject to the Fed’s stress test.
The scenario includes a severe global recession with heightened stress in both commercial and residential real-estate markets, as well as in corporate debt markets.
Related: Fed governor flags growing risk that could hit markets and investors