Fed's Bowman calls regulatory reform a financial stability risk

Bloomberg News

Federal Reserve Gov. Michelle Bowman further cemented herself as the voice of opposition to recently proposed regulatory capital changes in a speech on Wednesday.

In remarks delivered on stage at the Marrakesh Economic Festival in Morocco, Bowman argued that capital requirements are "no substitute" for sufficient bank supervision. She added that changes to the regulatory framework could have significant consequences, especially for midsized and smaller banks.

"In my view, regulatory reform can pose significant financial stability risks, particularly if those changes to regulation fail to take sufficient account of the incentive effects and potential consequences," she said.

Bowman said she was not opposed to regulatory reform entirely, but noted that the focus should be on expanding the regulatory perimeter to address financial risks that have migrated outside the banking system and closing regulatory gaps. She added that more could be done to enforce rules that are already on the books.

Bowman also took aim at the Fed's supervisory practices leading up to the failure of Silicon Valley Bank, which, by all accounts, emphasized identifying as many issues as possible at the bank over trying to address the most pressing ones. 

"To effectively support financial stability, bank supervision cannot simply rely on pinpointing compliance issues, failed processes or rule violations," she said. "It must go further to examine a bank's critical risk exposures while prioritizing core safety and soundness issues in the context of its financial condition."

Appointed to the Federal Reserve Board in 2018 to fill the seat reserved for someone with a community banking or state bank supervision background, Bowman has emerged as the most ardent critic of the central bank's current regulatory agenda, as set by Vice Chair for Supervision Michael Barr. 

Bowman voted against initiating a rulemaking process on the so-called Basel III endgame in July. That proposal, which was put forth in collaboration with the Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency, sets new risk-weighted capital rules for various operational risks within banks. 

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She also opposed seeking comment on a proposal that would apply new resolution plan requirements to large, non-systemically important banks in August, and express reservations about supporting a long-term debt requirement for banks with more than $100 billion of assets. 

During her latest speech, which aimed at addressing the management of financial stability risks globally, Bowman warned that if interest rates remain elevated for an extended period — as Fed officials have forecasted — they will likely be a "drag" on bank earnings and could hurt the credit quality of bank loan portfolios. 

She also noted several risk factors that need to be monitored closely in the current environment, including the functioning of the Treasury market and higher leverage among hedge funds and money market funds. 

Bowman pointed to the commercial real estate sector as another vulnerability, highlighting banks with CRE loan books that are concentrated among specific markets and property types. She also cautioned banks and regulators to be mindful of non-performing commercial mortgage-backed securities, or CMBS, which could have ripple effects throughout the financial sector.

"Pooled CMBS portfolios are often held in significant volumes or in concentrated shares by large insurance companies and pension plans," she said. "Should we see significant losses in their CMBS holdings, there could be broader effects on the securitization pipeline for CMBS and on the CRE market."