October 4, 2022

FRB Governor Bowman Discusses Costs of Over-Regulation for Banking Industry

Federal Reserve Board ("FRB") Governor Michelle W. Bowman outlined her perspective on supervision and regulation of the banking industry and highlighted the costs of over-regulation. Ms. Bowman argued that any change to banking regulation should "yield significant improvement to safety and soundness at reasonable cost," and said that the FRB should "seek to avoid approaches that fail to consider the tradeoffs between cost and safety."

Ms. Bowman's remarks came at a speech before the Institute of International Finance in Washington D.C., and cited four principles that guide her judgments about whether changes in regulation are appropriate: (i) ensuring bank regulation and supervision is transparent, consistent and fair; (ii) properly balancing the promotion of responsible innovation with ensuring safety and soundness; (iii) ensuring regulation and supervision are efficient; and (iv) crafting regulation that "serve[s] a legitimate prudential purpose, like promoting safety and soundness, or reducing financial stability risk."

Ms. Bowman went on to address a handful of significant topics for banks and financial market participants broadly.

Stress Testing. Ms. Bowman emphasized the need for consistency in the FRB's stress testing framework among those being tested, taking into account different bank business models and profiles. She said that the current stress testing framework produces "year-to-year variations [that] are often not based in underlying changes to banks' business models and [that] can create short-term challenges for capital management." Ms. Bowman suggested ways to limit such volatility, such as by averaging results over multiple years. She recommended that the FRB consider what it has learned from past stress tests, as well as public and industry feedback.

Capital. Ms. Bowman said that bank capital requirements had been "quickly bolstered without extensive analysis in response to the 2008 financial crisis," resulting in a one-size-fits-all approach that required smaller banks with lower risk profiles to "comply with the highest capital requirements." Ms. Bowman said that, looking forward, the correct balance should be found that balances bank and stability risks with the costs of over-regulation. She highlighted the supplementary leverage ratio, the countercyclical capital buffer and the stress capital buffer as components of the FRB's bank capital requirements that should be reviewed.

Banking Mergers. Ms. Bowman highlighted the need for transparency in the FRB's review of bank mergers and acquisitions, and emphasized that the FRB's review of such mergers should pursue "legitimate prudential purposes." Furthermore, she said that the FRB's review of bank mergers must be "guided by the statutory factors prescribed by Congress," and not be influenced by other factors, such as "the idea that mergers are harmful or that increased bank size is inherently problematic." Ms. Bowman argued that the FRB's merger framework works best when there is clarity in timelines and expectations with respect to firms. She encouraged the implementation of a case-by-case analysis to address the specific risks posed by a given merger, with a particular focus on changes in markets, industry and customer preferences when evaluating large bank mergers.

Resolution Planning. Ms. Bowman said that the FRB should emphasize regulation over supervision when it comes to resolution planning or "living wills." She said that while she expects further changes to occur, "fairness dictates that broad supervisory powers should not displace rulemaking."

Digital Assets. Ms. Bowman highlighted her view that the "goal with digital assets should be to match oversight to risk and to provide clarity in supervisory expectations." She emphasized that the FRB should consider whether "there is a stabilizing role for banks to play in intermediation," and should ensure that competition from nonbank financial entities, among other market participants, does not "create a financial stability risk by pushing activities outside the banking system." Ms. Bowman said that banks should be allowed to participate in digital assets markets as long as "the risks can be identified and managed appropriately and responsibly."

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