WASHINGTON — Over a decade after the financial crisis, how regulatory agencies adjust their supervisory approach may prove just as important as changes to post-crisis rules, the Federal Reserve's top regulatory official said Friday.
“It may be that when I look back on my tenure in doing this, everyone thought that I was sort of supposed to come in with a flamethrower and set fire to [the] Dodd-Frank [Act], but the most important thing that the Fed does during this period is to think intentionally then about what are we doing through supervision and what can we do through supervision, and how do we make that effective but also fair,” said Fed Vice Chair of Supervision Randal Quarles at an event hosted by Georgetown University's law school.
Supervision can “provide some warning notice” and “opportunity for input,” Quarles said, while not being tied to the constraints that accompany regulation.
“What falls on the regulation side of the line, which requires publication and due process and comment and input and cost-benefit analysis, and what falls on the supervision side of the line, which requires none of that, has happened largely accidentally as opposed to intentionally,” he said.
Quarles' remarks come as the Fed continues working to recalibrate many post-crisis rules, some related to the regulatory relief law passed by Congress last year.
Over the next few years, Quarles also said he wants due process “to be an important focus of the regulatory process generally.”
“That’s certainly what we do with the Federal Reserve, to think about exactly those sorts of questions,” he said. “This is not just a post-crisis issue. This is something that has been developing over decades with bank supervision.”
That includes whether or not all injunctions and penalties against banks should be public, said Quarles.
“I kind of begin from the default view that the government should be transparent about everything it does… and that you need some argument and it’s a reasonably high bar for lack of disclosure,” he added.
That same principle applies to stress tests, he said, but should be carefully considered when using stress tests as a supervisory tool.
Some economists have warned that supervising banks through uniform stress tests could lead to “model monoculture.” While some financial institutions have expressed frustration about the transparency of the Fed's stress testing regime, officials argue that providing banks with too much information about the agency’s stress test could heighten risk because each bank’s balance sheet might react the same in an economic downturn.
“I am persuaded that that’s true so I don’t think that we should completely open our kimono with respect to the stress tests,” said Quarles. “But I think that … we should disclose as much as possible while limiting that mono-model problem risk.”
But it’s a “hard question” for regulators to answer as to whether they’ve struck the appropriate balance between transparency and limiting risk, he said.
“I think there are reasonable constraints that all of us would agree should be applied to perfect transparency on the part of the government, but I think that that same principal then applies to bank supervision and with respect to what we do with the stress tests,” said Quarles.
