Michelle W Bowman: Remarks on the economy and prioritization of
bank supervision and regulation
Speech by Ms Michelle W Bowman, Member of the Board of Governors of the Federal
Reserve System, at the New York Bankers Association's Financial Services Forum,
Palm Beach, Florida, 9 November 2023.
* * *
It is a pleasure to join you this morning for the New York Bankers Association's
1
Financial Services Forum. I look forward to hearing your perspectives on the economy,
the financial system, and, more recently, the Federal Reserve's regulatory reforms
which help to shape my perspective on these issues. This month marks five years since
I joined the Board of Governors of the Federal Reserve System. Over the years, I have
drawn heavily upon my experience as a former state bank commissioner and a banker
in carrying out my responsibilities, especially as they relate to bank supervision,
payments, and consumer and community affairs. This perspective informs my views
about evolving bank regulations and the real-world impact that changes can have on
financial institutions, their local communities, and the broader U.S. economy.
As you know, the federal regulatory agenda has been very active lately, with a
significant volume of rules, guidance, and supervisory reforms either recently published
or in the pipeline. Today, I will offer my thoughts on some of these developments, to lay
a foundation for a discussion about the vital importance of the prioritization of
supervisory and regulatory approaches for the banking system. As the agencies move
forward with an active and potentially disruptive reform agenda, we should pause,
reflect upon these changes, and ask several questions: Are these reforms efficient? In
totality, do they work together to enhance the regulatory framework, resulting in a
rational and efficient framework? Are the reforms within the scope of our statutory
authority? Have we met the appropriate standards of due process and public
engagement? And, given the current economic and banking landscape, are we focusing
on the appropriate regulatory and supervisory priorities?
Before I dig a bit deeper into these questions, including the critical importance of
prioritizing supervisory and regulatory actions, I'd like to offer a few thoughts on the
economy and monetary policy.
After sharply tightening monetary policy over the past year and a half to reduce
inflation, at our November meeting, the Federal Open Market Committee (FOMC) voted
to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent and
continued the run off of the Fed's securities holdings.
We have seen considerable progress on lowering inflation, but inflation remains high
and recent readings have been uneven. The latest personal consumption expenditure
(PCE) inflation index data showed 12-month changes in total and core inflation of 3.4
percent and 3.7 percent, roughly similar to the previous month's reading. However,
some components of core services inflation have picked up, and I see a continued risk
that core services inflation remains stubbornly persistent. In my view, there is also a risk
that higher energy prices could reverse some of the progress made to bring overall
inflation down.
The economy has remained strong as the FOMC raised the federal funds rate, and
recent data indicate that economic activity has accelerated with real gross domestic
product (GDP) growing at a 4.9 percent annual rate in the third quarter. Consumer
spending has also accelerated, and the housing sector appears to be continuing to
rebound.
The latest employment report showed a labor market with healthy job gains. Over the
past year, labor force participation has improved with the average pace of job gains
slowing somewhat, a sign that labor market supply and demand may be coming into
better balance.
Throughout the past few years, we have seen continued significant data revisions, with
the most recent of these revisions reflecting significant changes to employment data.
Job gains in prior months were revised lower, but average hourly earnings for the past
12-months were revised higher. The frequency and extent of data revisions make the
task of predicting how the economy will evolve even more challenging, and I will
continue to monitor these data carefully.
While I continue to expect that we will need to increase the federal funds rate further to
bring inflation down to our 2 percent target in a timely way, I supported the FOMC's
decision last week to hold the target range for the federal funds rate at the current level
as we continue to assess incoming information and its implications for the outlook.
Currently, the federal funds rate appears to be restrictive, and financial conditions have
tightened since September.
Some of this tightening has occurred through longer-term bond yields, which can be
volatile over time as conditions change. For example, since the November FOMC
meeting, the 10-year Treasury yield has declined by around 35 basis points, or a bit
more than half of the increase in the 10-year yield since our September meeting. A
variety of models attribute a significant portion of the increase in longer-term yields to
higher term premiums. There are a number of potential factors that may be influencing
term premiums, including an improved economic outlook, higher Treasury debt
issuance, concerns about future inflation risk, and higher uncertainty about the future
path of the economy and monetary policy. Any or all of these factors may contribute to
the movement of longer-dated yields. I will continue to monitor these and the broader
financial conditions to observe changing conditions and any potential effects on
economic activity and inflation and to better understand the implications for appropriate
monetary policy.
I am also closely watching liquidity conditions and Treasury market functioning, which
have held up well so far even amidst large movements in yields. The U.S. Treasury
market plays a central role in the transmission of monetary policy, in financing the
federal government, and in providing safe and liquid assets to support the flow of capital
and credit to households and businesses. Treasury market liquidity strains could be
amplified and spill over to related financial markets if longer-dated Treasury securities
experience an abrupt selloff and investors reposition their portfolios in response to a
rapid increase in long-term Treasury yields. Financial market volatility spurred by
additional geopolitical shocks could further strain financial market functioning. These
risks could be exacerbated if bank holding company-affiliated market makers
experience balance sheet constraints during periods of volatility. It is also important that
Treasury markets remain resilient and stable.
More broadly, I believe we should keep in mind that we don't yet know the effects of
tightened financial conditions on economic activity and inflation. There is an unusually
high level of uncertainty regarding the economy and my own economic outlook,
especially considering recent surprises in the data, data revisions, and ongoing
geopolitical risks. But I will be closely watching the incoming data as I assess the
implications for the economic outlook and appropriate monetary policy.
It is important to note that monetary policy is not on a preset course. My colleagues and
I will make our decisions at each meeting based on the incoming data. I remain willing
to support raising the federal funds rate at a future meeting should the incoming data
indicate that progress on inflation has stalled or is insufficient to bring inflation down to 2
percent in a timely way. Returning inflation to the FOMC's 2 percent goal is necessary
to achieve a sustainably strong labor market and an economy that works for everyone.
I will turn now to address recent developments in the ongoing reform of the bank
regulatory framework. While this is by no means a comprehensive list of all recent
reforms-or more that may come in the months ahead-I will share some thoughts on
capital requirement reforms; the Community Reinvestment Act (CRA); the cap on debit
interchange fees; and climate guidance. I will also share my perspectives on the vital
importance of prioritization of supervisory and regulatory actions by regulators. It is
essential that our actions are driven by data and are specifically designed to address
core banking risks or existing shortcomings in our bank regulatory framework.
Capital Requirements Reform
In July of this year, the federal banking agencies proposed significant reforms to capital
requirements for banks with more than $100 billion in assets. Although many banks
would not be directly affected based on their asset size, the proposal could have a
significant impact on the U.S. banking market and economy.
The proposal would increase total risk-weighted assets across bank holding companies
subject to the rule by an estimated 20 percent. These impacts would vary based on
firmspecific attributes-but not by asset size. I have spoken in the past about my concerns
with the quantitative and analytical foundations of this proposal. It is not designed to
address identified regulatory deficiencies and shortcomings and gives insufficient
attention to the potential unintended consequences and harm that could result if
finalized and implemented in its current form.
In drafting the Basel III capital proposal, it seems clear that the agencies made broad
assumptions that the current capital framework is insufficient to support bank and
financial market activity. So, as a part of my remarks today, I will address the current
state of capital in the banking system, concerns with the proposed changes to the
capital framework, and the path forward for fair and efficient capital reform.
Current State of the Banking System
To begin, the U.S. banking system remains strong and resilient. The system is much
better capitalized than after the 2008 financial crisis, with substantially more liquidity. U.
S. banks are also subject to a range of new supervisory tools that did not exist prior to
2008. The current framework represents a risk-based, tailored approach, which strives
to align regulation with institution and activity risk, fulfilling the congressional mandate to
2
tailor the prudential regulatory framework. The current level of capital in the U.S.
banking system is a strength, not a weakness, which is complemented by liquidity
regulations and other prudential requirements that have contributed to the resilience of
U.S. banks. These banks also continue to play an important role in the U.S. economy
by extending credit, providing banking and payment services, and participating in U.S.
securities and derivatives markets. Context matters, and when we discuss changes to
the bank regulatory framework-including through changes to capital requirements-we
need to understand the direct and indirect consequences that may result.
Potential Consequences of Capital Reform
One of the key questions I ask when considering regulatory proposals is whether the
benefit of the change outweighs the costs of implementation, both for the financial
institutions subject to the proposal and for the broader economy.
On a simplistic level, higher capital levels make the banking system safer. But this must
be the beginning of the analysis, not the definitive end. Increased safety comes at a
cost, and the business of banking is built upon risk. The complete elimination of risk
would transform a bank into a public utility. Assuming this is not the desired end state of
the banking system, we must evaluate a proposal's merit by thoroughly understanding
the balance between these benefits and the resulting costs.
As I noted earlier, the U.S. banking system continues to be much better capitalized than
before the 2008 financial crisis. That capital cushion has broadly enhanced the
resiliency of the banking system through business, economic, and interest rate cycles,
enabling the banking system to continue supporting the U.S. economy, even throughout
the pandemic and the related economic stress.
While the full extent of "costs" under the proposal are not entirely clear, in the
aggregate, those costs-including the direct costs experienced by banks, and the indirect
costs experienced by bank customers and the U.S. economy-would be substantial.
Capital increases of this magnitude are likely to have a detrimental impact on U.S.
market liquidity and lending, and firms without sufficient scale are likely to exit certain
markets. Increased capital requirements for certain types of loans may also lead to
reduced credit availability or increased cost of credit, which could disproportionately
harm underserved markets, businesses, and communities. Ultimately, bank customers
will bear the cost of these increases.
The Path Forward for Capital Reform
What does the path forward entail? The agencies have received substantial initial public
feedback, and in response, have extended the comment period into mid-January 2024.
The agencies have also engaged in a parallel effort to gather more information about
the potential impact of the proposal's approach and calibrations. These actions reflect
an important recognition of the proposal's length and complexity and are certainly a
positive step. While it would be impossible to highlight all the issues in the proposal that
raise concerns in my remarks today, I will note several areas that will be necessary to
address:
Redundancy in the Capital Framework. The proposal does not include an
analysis of the appropriate aggregate level of capital requirements. This
consideration is important since many of the existing enhanced capital standards
that apply for U.S. banks were contemplated and finalized while the prudential
regulation framework, including capital and liquidity rules, were still under
development. For example, there are known overlaps and redundancies among
the new market risk and operational risk requirements, and the stress capital
buffer.
Calibration of the Market Risk Capital Rule. The revisions to the market risk
rule alone will increase risk-weighted assets from $430 billion to $760 billion for
Category I and II firms, and from $130 billion to $220 billion for Category III and IV
3
firms. These increases are significant, with broad-based impacts, affecting
business and municipal financing, risk management, hedging of foreign exchange
and interest rate risk, or managing the risks of fluctuating commodity prices
through hedging activities.
Inefficiency of Two Standardized Capital Stacks. Firms subject to the new
riskbased capital rule would remain subject to the standardized approach applicable
to all firms, resulting in a "dual-stack" capital calculation, with the firm required to
use the lower capital ratio. This approach will add complexity to the capital
calculation for all firms, but it will be especially cumbersome for Category III and
IV firms, applying a one-size-fits-all approach for these smaller firms despite the
variation in their risk, size, business models, and complexity, likely resulting in
costs that outweigh the benefits of this provision.4
Punitive Treatment of Fee Income. The proposal adopts a punitive treatment for
noninterest and fee-based income through the proposed operational risk
requirements, coupled with an internal loss multiplier. Imposing this type of capital
charge for operational risk can deter banks from diversifying revenue streams,
even though this can enhance an institution's stability and resilience.
Missed Opportunity to Review Leverage Ratio Requirements. The proposal
does not address or propose changes to leverage requirements, including the 5
percent leverage ratio that applies to U.S. global systemically important banks,
commonly referred to as the enhanced supplementary leverage ratio (or eSLR).
Treasury market intermediation can be disrupted by constraints imposed by the
eSLR, as occurred during the early days of market stress during the pandemic. It
seems prudent to address this known leverage rule constraint before future
stresses emerge that would likely disrupt market functioning.
Policymakers may disagree about the best choices to further supervisory goals, but we
have an obligation to understand and assess the true cost of reform, going beyond the
direct costs to banks and their customers to include the potential harm to U.S. bank
competitiveness in the global economy. As I have noted previously, unless we consider
reforms with a thorough understanding of their combined and aggregate impact on the
institutions subject to the revised regulatory framework, we create a significant risk of
arriving at a capital end state that is inefficient, contradictory, and potentially harmful to
banks, their customers, and the broader economy.
I also want to briefly address the role of international coordination in establishing capital
standards both in the United States and around the world. International bodies and
agreements can help foster the creation of similar regulatory frameworks across
jurisdictions. Significant banking activities occur in the international and cross-border
context, and we know that financial stability risks can spread throughout global financial
markets. By engaging in international coordination, U.S. regulators can promote
minimum standards across jurisdictions, and these minimum standards can improve
competitive equity in banking markets and make the financial system safer.
While the capital proposal reflects elements of the agreed upon Basel standards, it is
not a mere implementation of the Basel standards. In this proposal, the calibration-with
a large increase in capital requirements for U.S. firms-far exceeds the Basel standards
mandate. Instead, the scale of the increase is driven by deliberate policy choices to
significantly increase capital requirements for U.S. banks over $100 billion, even for
those that are not internationally active. As we have seen since the proposal was
published, there has been growing support for improving the proposal's quantitative,
analytical foundations, including the need for and impact of capital increases of this
scale.
Community Reinvestment Act
Shifting away from capital rules, late last month, the federal bank regulators adopted a
new final rule to implement the Community Reinvestment Act. The purpose of the CRA
is to improve access to credit in all communities where banks are located, especially
low- and moderate-income (LMI) communities. The CRA was enacted in 1977 shortly
after the civil rights movement and against the backdrop of other significant federal laws
designed to address financial inclusion and equal access to credit. I am a strong
supporter of these goals and the requirements that banks support their communities to
the greatest extent possible. Unfortunately, as you know, my support for the important
goals of CRA did not translate into support for the final rule.
While many positive changes are included in the rule, in my view those changes
ultimately did not outweigh its shortcomings, including that the agencies arguably
exceeded the authority granted by the CRA statute. The rule is unnecessarily complex,
overly prescriptive, and directs outcomes that result in disproportionately greater costs
than benefits, adding significantly greater regulatory burden for all banks, but especially
for community banks. Even the foundational question-are banks doing enough to
support their communities?-is left unanswered in the final rule, perhaps because there
is no evidence to support the agencies' assumption that broadly speaking, banks are
falling short.
Scope and Impact on Community Banks
First and foremost, the final rule applies the same regulatory expectations for small
banks as it does for the largest banks. For example, a wide range of community
banksthose with more than $2 billion in assets-are treated as "large banks" under the final
rule, forcing these banks to comply with the same CRA evaluation standards as a bank
with $2 trillion in assets. The lack of recognition that these banks are fundamentally
different, with different balance sheets and business models, misses an important
opportunity to appropriately tailor CRA expectations to a bank's size, risk, service area,
and business model. This approach is a radical departure within the regulatory
framework where no other provision considers a bank with $2 billion in assets as "large."
As a result of this decision, many community banks will be subject to new and
materially enhanced requirements, including a new retail lending test, significantly
expanded assessment areas, and increased data and reporting obligations. As I made
clear throughout the development of the original proposal and final rule, instead of
requiring these changes, community banks should have had the option, at their
discretion, to opt into the new retail lending test and assessment areas, or to continue
with the existing framework. The significant increases in burden and cost associated
with these changes are simply disproportional when applied to community banks, in a
way that may constrain the resources community banks can devote to supporting their
communities.
Lack of Congressional Authorization
The final rule also arguably exceeds the authority granted by Congress. While the final
rule aspires to modernize the CRA to account for changes in the way banks operate-for
example, aligning the rule with current practices of extending credit in communities,
including through mobile and online banking-there are limits to what the banking
agencies can do. Congress alone has the power to modernize the CRA statute,
including reflecting the variety of financial institutions that provide credit and financial
services in their communities. In my view, some of the changes made by the agencies,
including those that evaluate banks outside of their deposit-taking footprint, are likely
beyond the scope of our authority under the statute.
Clarity and Transparency
If these new standards were in place today, based on data from 2018 through 2020,
there would be a nearly tenfold increase in banks with a "Needs to Improve" CRA
rating. In some ways, this highlights a fallacy underlying these rule changes: that the
low number of banks with a "Needs to Improve" rating itself demonstrates that the
standards of the CRA regulations have been too lax historically, ignoring the more
plausible explanation that banks work hard to support their communities. It is not
appropriate for the banking agencies to materially increase the requirements on banks,
resulting in a downgrade of currently satisfactory performance to "Needs to Improve,"
without a thorough, data-supported analysis that justifies a recalibration evidenced by
actual shortcomings in bank activities.
Unintended Consequences and Other Problematic Provisions
Perhaps most concerning about the final rule is that it may incentivize banks to reduce
their support for certain communities, forcing them to pare back lending in areas where
there is a need for credit accessibility. The addition of retail lending assessment areas
and outside retail lending areas, coupled with a new requirement for large banks to
include an entire county instead of a partial county as an assessment area, may
ultimately incentivize firms to pull back lending.
There are many other areas of the rule that raise concern-including the odd new
publication of already available HMDA data, expanded reliance on summary of deposit
data, and an implementation period of two years, which is far too brief in light of the
rule's extraordinary complexity. While I have confidence that banks will make the best
of this new rule, and continue to support their communities, I regret that the new final
rule may complicate, and in some instances frustrate, the important goals of the CRA.
Interchange Fee Cap Proposal
Also, late last month, the Federal Reserve proposed amending the regulatory cap on
debit card interchange fees. For many years, bankers have expressed significant
concern about external factors, like fraud, increasing the costs of supporting bank debit
card programs-concerns that could be exacerbated by a lower regulatory cap on
interchange fees. While the Board's proposed rule suggests that it could result in
benefits to consumers, I am concerned that the costs of this fee cap revision for
consumers-through the form of increased costs for banking products and services-will
be real, while the benefits to consumers-such as lower prices at merchants-may not be
realized.5
At its heart, the proposal is unfair to many issuers and in some ways regressive in its
impacts. The proposed rule acknowledges the varied size, business models, and
product offerings of banks subject to the interchange fee cap and yet aims to achieve
"rough justice" by establishing a single cap that applies to all covered issuers. This
approach will disadvantage lower-volume issuers.
Retail banking is an essential, core function for many smaller issuers, so this pricing
dynamic may not ultimately lead them to abandon their debit card programs. Under the
proposed rule, a staggering one-third of bank issuers would not be able to recover even
the partial costs that factor into the interchange fee cap. For banks that operate debit
card programs at a loss, presumably those costs will need to be recovered elsewhere,
such as through higher borrowing costs for bank customers or through other fees for
services provided, which are also targeted by the banking agencies for elimination.
Higher borrowing costs or fees could be particularly harmful for low-income customers
who may not qualify for credit card products or other alternatives, as banks may be
forced to discontinue their lowest-margin products, including options designed to
increase financial inclusion and access for LMI individuals and families. I sincerely hope
that this is not the case, but it is a real and important risk.
I also want to note one other element related to the proposal. The proposal applies only
to a subset of issuers-those with more than $10 billion in assets-but I expect the fee cap
will continue to affect a broader range of issuers, including community banks and small
credit unions. Issuers of all sizes use the same payment rails, and smaller issuers will
inevitably face some pricing pressure, at least indirectly, from the interchange fee cap.
Ultimately, the net result of this proposal may be to simply shift costs from merchants to
bank customers, and to make those costs far less transparent (for example, if those
costs are recovered through higher loan interest rates). Of course, this proposal has
been published for public comment, and my colleagues and I welcome public feedback
on the proposal, particularly on the impacts it may have on financial institutions,
including those not directly subject to the rule.
Climate Guidance
On October 24, the Federal Reserve-in conjunction with the Federal Deposit Insurance
Corporation and the Office of the Comptroller of the Currency-published guidance
directing banks' approach to climate-related financial risks. The final guidance will
create confusion about supervisory expectations and will result in increased compliance
cost and burden, without a commensurate improvement to the safety and soundness of
financial institutions or to the financial stability of the United States. This is another
regulatory action that raises questions about need and legal basis, but also about
whether the focus of reforms is appropriate in the current economic and supervisory
environment. This guidance represents a departure from sound banking policy and
potentially a distraction from more important risk-management objectives.
While the guidance adopts a specialized regime for climate risks, it does not explain
why this unique treatment for climate risks is warranted. Without taking stock of
riskmanagement practices today and evaluating whether it is appropriate as it comes to
climate-related financial risks-essentially without identifying a problem statement-the
guidance goes directly to solutions that are at once unclear and expensive, without
clearly promoting safety and soundness or U.S. financial stability.
Under the guidance, banks must monitor and measure climate-related risks over
indefinite time horizons and "develop strategies, deploy resources, and build capacity to
identify, measure, monitor, and control for climate-related financial risks." The guidance
includes few specifics about this data collection expectation-which surely will expand
over time-nor does it clarify how banks are intended to integrate this new information
into risk-management programs and policies, and even into lending decisions. Indeed,
the guidance adopts an intentionally vague standard, with an expectation that data
collection and the planning horizon for "scenario analysis" to probe on such risks may
extend "beyond the financial institution's typical strategic planning horizon." And yet, the
benefit of requiring banks to plan for events that occur far into the future seems limited,
as long-dated predictions about the future are likely to be highly speculative and heavily
influenced by the underlying assumptions, and therefore of limited or no utility to the
bank in managing risk. This approach is a significant departure from existing
supervisory standards and includes no explanation for the deviation from normal
supervisory time horizons.
In addition to being unclear, the guidance will surely be expensive to implement. The
costs to implement new data collections will be substantial not only to institutions
attempting to comply with uncertain elements of the guidance, but also to bank
customers that will be asked to provide more information when seeking credit or other
banking products. One likely potential consequence could be to discourage banks from
lending and providing financial services to certain industries, forcing them to seek credit
outside of the banking system from nonbank lenders. This will undoubtedly result in
decreasing or eliminating access to financial services and increasing the cost of credit
to these industries.
I have every confidence that banks will work diligently to try to understand the
expectations created under the agencies' climate guidance and will craft an approach
that works-despite the uncertainty the guidance itself creates. However, looking to the
future, I am concerned that the scope of this guidance-which is limited to banks with
over $100 billion in assets-will trickle down to far smaller institutions by treating
approaches adopted by large banks as "best practices" for banks of all sizes, resulting
in a much higher regulatory burden for these firms.
I am also concerned that the actions taken by banks to manage climate risk could have
unintended consequences for LMI communities, including increasing the cost of credit
or reducing credit availability in those communities. Oddly, while the guidance
acknowledges this concern, it does not emphasize the obligations banks have under
the CRA to help meet the credit needs of the communities in which they do business,
especially in LMI communities.
While climate change is an important public policy issue in the United States and
globally, the Federal Reserve has limited, narrowly focused mandates and
responsibilities that are established by statute. These mandates and responsibilities do
6
not extend to climate policymaking. Although the climate guidance nominally focuses
on climate-related "financial risks," I am concerned that the guidance could be used by
the Federal Reserve and other federal banking agencies to pursue climate policies
leveraging the opacity of the supervisory process, even though such actions would
clearly exceed the statutory authorities given to the Board by Congress.
Prioritization of Regulation and Supervision
I'd also like to spend a few minutes on a topic that has been an undercurrent throughout
my remarks so far: prioritization of supervisory and regulatory actions. In my view, it is
essential that regulators appropriately calibrate and prioritize their supervisory and
regulatory actions. Failing to do so could distract banks, bank management,
supervisors, and regulators from focusing on key risks.
As I noted earlier, the banking system remains strong and resilient, and banks are
much better capitalized, with substantially more liquidity compared to 2008. The
banking agencies also have substantially more tools available than they did two
decades ago. Yet, in light of recent actions taken by regulators, some could be led to
question whether this was truly the case. We have seen several complex and lengthy
proposals, rules, and gu