Michelle W Bowman: Remarks on the economy and bank supervision
and regulation
Remarks by Ms Michelle W Bowman, Member of the Board of Governors of the Federal
Reserve System, at the 2023 Ohio Bankers League "Main Event," Columbus, Ohio, 7
November 2023.
* * *
1
It is a pleasure to be with you in Columbus this afternoon. I always find it helpful and
informative to travel outside of Washington, D.C., to learn about views on the economy,
the financial system, and, more recently, regulatory reforms. This month marks five
years of my service as a member of 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 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. As
the agencies move forward with an active and potentially disruptive reform agenda, we
should pause, reflect upon these changes, and ask some 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? And have we met the appropriate standards of due process and
public engagement?
Before I dig a bit deeper into these questions and we turn to our conversation, 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.
However, throughout the past few years, we have seen continued 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. We don't yet know
the effects of tightened financial conditions on economic activity and inflation. Moreover,
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 the appropriate setting of
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. However, 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 to 2 percent in a timely way. Returning inflation to the FOMC's goal is
necessary to achieve a sustainably strong labor market and an economy that works for
everyone.
I will turn now to developments in the ongoing bank regulatory framework reform
agenda and share some of my observations and takeaways. While this is by no means
a comprehensive list of all of the current reforms-or reforms that may still be to come-I
will focus my remarks on capital requirements reform, the Community Reinvestment
Act, the cap on debit interchange fees, and climate guidance.
Capital Requirements Reform
In July of this year, the agencies proposed significant reforms to capital requirements
for banks with more than $100 billion in assets. Given this threshold, many banks would
not be directly impacted based on their asset size, but the proposal does provide
important insights about how regulators are considering reforms more broadly.
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 firm-
specific attributes-but not by asset size. The contemplated capital increases do not
appear to be supported by facts and analysis and will likely result in significant
unintended consequences.
One could reasonably ask whether there is cause for such material change. Is this
proposal designed to address identified regulatory deficiencies and shortcomings?
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. And U.S.
banks are 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 risk and fulfill the congressional mandate to tailor the prudential
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regulatory framework. The current level of capital in the U.S. banking system is a
strength, not a weakness, and is complemented by liquidity regulations and other
prudential requirements that have contributed to the resilience of U.S. banks.
I am skeptical of assertions that the costs of the proposal are justified by the benefits.
The proposed capital increases, if implemented, would have a tangible effect on
banking activities and unintended-but predictable-consequences. For example,
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.
I do 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.
So, what is the path forward? In response to the considerable early public feedback, the
comment period has now been extended into mid-January 2024, with a parallel effort to
gather more information about the potential impact. The public and stakeholder
comment process will guide a discussion of the changes needed to strike the right
balance between costs and benefits. Public feedback during the rulemaking process will
help to ensure that a final rule would address the proposal's deficiencies.
Although I did not support the initial proposal, I will reserve judgment for my support of a
draft final rule. I look forward to engaging with my colleagues to improve the initial
proposal, and then consider whether a final rule sufficiently addresses my concerns.
Policymakers may disagree about the best policy choices to further supervisory goals,
but we must honestly assess the costs 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. Of course, this cost analysis would not be complete unless it
incorporates the impact of other concurrent and complementary proposals. The
analysis must include the new long-term debt proposal for all firms with more than $100
billion in assets, and the other existing rules that affect capital and firm incentives, like
the stress capital buffer and the supplementary leverage ratio.
Meaningful, accurate input can only be provided if regulators are clear about the
desired end state of reforms and how they would work together to complement the
framework, avoiding conflicting or contradictory requirements. Approaching reform in a
piecemeal manner increases the risk of arriving at a capital end state that is inefficient,
redundant, and unfair to those subject to the regulation and harmful to banks, their
customers, and the broader economy.
Community Reinvestment Act
Late last month, the federal bank regulators adopted a new final rule to implement the
Community Reinvestment Act (CRA). The purpose of the Community Reinvestment Act
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. At the time
Congress passed the CRA, it found that banks had a "continuing and affirmative
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obligation to help meet the credit needs" of their local communities. Congress
reinforced this obligation by instructing the federal financial supervisory agencies to
encourage banks to help meet the credit needs of those same communities.4
As you know, my support for the important goals of the CRA did not translate into
support for the final regulations, and I would like to highlight a few specific deficiencies
in the final rule that led to this result. In my view, it was absolutely essential that the final
rule be straightforward and clear, encouraging banks to meet the credit needs of their
communities without unintentionally disincentivizing or limiting banks from supporting
their communities.
While the rule includes many positive changes, 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 "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 being made by the
agencies in this rule, 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.
Taken as a whole-all 1,494 pages of the final rule-it will be a challenge for banks,
particularly smaller banks, to understand what they must do to continue to receive
satisfactory ratings under the CRA.
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 their lending.
There are many other areas of concern I have with the rule-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, citing the Dodd-Frank Act requirement that the Federal
Reserve establish a cap that is reasonable and proportional to the cost incurred by the
issuer with respect to debit transactions. 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. Larger
issuers-those with the highest transaction volumes, greater negotiating power, and the
most efficiencies that come from scale-would continue to have a significant competitive
advantage under this rule. Even the lower interchange fee may allow them to continue
profitably operating their debit card programs. By contrast, smaller issuers subject to
the cap-those with smaller transaction volumes, less negotiating power, and fewer
efficiencies in scale-would likely be at a significant competitive disadvantage.
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. But it is
certainly possible that banks will be forced to either pass costs through to customers or
operate their debit card programs at a loss, which many banks do today. 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.
The fees banks charge for provided services have been criticized by some regulators,
but in many instances these fees-including interchange fees-support a bank's ability to
offer low-cost or no-cost banking products or services to customers. If finalized as
proposed, this revision may force banks 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.
While I am concerned by both the timing and basis for this proposed downward revision
to the interchange fee cap, I want to note two other elements of the proposal. First, the
proposal includes a formula for periodic updates, under which the cap would
automatically
be updated based on reported data every two years. Once this type of
formulaic approach is adopted, I expect it will be very difficult to overcome inertia to
revisit and reopen it, even if there are compelling reasons to do so.
Second, 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. And while the interchange fees many
smaller issuers have collected since the introduction of the interchange fee cap may
have remained stable, it is difficult to determine how this compares to the aggregate
costs of processing, fraud and fraud prevention, and the many other inputs for running a
debit card program. It is not clear that interchange fees have kept up with the increasing
expenses for many smaller issuers, including repeated reissuing of debit cards due to
retail industry data breaches.
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. This broader context and understanding
is necessary when we revise a critical piece of the U.S. payments infrastructure.
Climate Guidance
Finally, 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.
As a foundational matter, it is good to recognize that institutions of all sizes have long
been expected to manage the risks associated with their activities, including these
climate-related financial risks. While the guidance adopts a specialized regime for
climate risks, it does not explain why this unique treatment for climate risks is
warranted. The guidance simply suggests that banks are "likely to be affected" by the
physical and transition risks associated with climate change. 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.
History tells us that these increased costs will ultimately be borne by consumers. The
lessons learned from supervisory failures during the bank stress in the spring clearly
illustrate that bank examiners and bank management should focus on core issues, like
credit risk, interest rate risk, and liquidity risk. Today's guidance could ultimately distract
attention and resources from these core risks.
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. Consumers and businesses in LMI
communities often have fewer options for obtaining credit and banking services, and I
am concerned that today's guidance could exacerbate this problem. 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
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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.
Conclusion
The recent volume and materiality of new reforms implemented and under
consideration by the federal banking agencies is significant, with nearly 5,000 pages of
rules and proposals published since July. While the unintended consequences of these
reforms may not be clear at the outset, our ability to predict these consequences is
even more limited when the reforms overlap or conflict. The sheer volume of change
presents significant challenges for banks, who will be required to prioritize the
implementation of new and revised requirements, with the risk of being distracted from
more material concerns or supervisory issues.
My voting record on these proposals is a reflection of my concern about the path of
regulatory reform, particularly in the wake of the bank failures and banking system
stress earlier this year, which highlighted that some reforms may be warranted, where
they address specific problems or clearly identified shortcomings. Regulators, like
banks, should never shy away from improving and evolving as the underlying conditions
evolve. But taking our focus away from potentially more pressing matters, like interest
rate and liquidity risk management, could result in supervisors and banks that are less
prepared and able to deal with emerging stresses.
In my view, our regulatory agenda should focus on evolving conditions and data-driven,
identified risks. At a time when confidence in public institutions is waning, the Federal
Reserve should strive to demonstrate beyond doubt that it executes its duties in an
independent manner, focusing on its statutory obligations. As I've discussed today, I
fear that many of these actions may fall short of this objective.
The views expressed here are my own and not necessarily those of my colleagues on
the Federal Open Market Committee or the Board of Governors.
2
Economic Growth, Regulatory Relief, and Consumer Protection Act, Pub. L. No.
115174, 132 Stat. 1296 (2018).
3
12 U.S.C. § 2901(a)(3).
4
12 U.S.C. § 2901(b).
5
The Board memo discussing the proposed revisions to the interchange fee cap
suggests that "[m]erchants, - may pass on some portion of their savings from lower
interchange fees to consumers." See "Proposed Revisions to Regulation II's
Interchange Fee Cap (PDF)," memorandum, Board of Governors of the Federal
Reserve System, Reserve Bank Operations and Payment Systems and Legal Divisions,
October 18, 2023, p. 9.
6
While the climate guidance was released shortly after the U.S. Department of the
Treasury's pronouncements about net-zero financing and investment, the climate
guidance is silent about "net-zero" commitments. See U.S. Department of the Treasury,
Principles for Net-Zero Financing & Investment (PDF) (Washington: U.S. Treasury
Department, September 2023).