For release on delivery
12:45 p.m. EST
February 27, 2024

Reflections on the Economy and Bank Regulation

Remarks by
Michelle W. Bowman
Member
Board of Governors of the Federal Reserve System
at the
Florida Bankers Association Leadership Luncheon Events

Miami, Florida

February 27, 2024

I would like to thank the Florida Bankers Association and your new President and CEO,
Kathy Kraninger, for the invitation to share my thoughts with you today.' It is really a pleasure
to join you here in Florida to discuss current trends in bank regulation, and to learn the issues on
your mind, especially about the path of regulatory reform, and your views on local banking and
economic conditions in the communities you serve. I find great value in spending time outside
of Washington, D.C. These conversations provide valuable insights to inform my work at the
Federal Reserve-both for my understanding of the economy and the banking environment.

Before discussing bank regulation, I would like to briefly touch on the economy and
monetary policy.

Monetary Policy

Over the past two years, the Federal Open Market Committee has significantly tightened
the stance of monetary policy to address high inflation. At our most recent meeting in January,
we voted to continue to hold the federal funds rate target range at 5'% to 5'4 percent and to
continue to reduce the Federal Reserve's securities holdings.

We have seen progress on inflation over the past year, with the 12-month readings
through December of total and core personal consumption expenditures (PCE) inflation both
below 3 percent for the first time since the spring of 2021. However, the latest consumer price
index (CPI) and producer price index (PPI) inflation data through January suggest slower
progress in bringing inflation down toward our 2 percent target. Throughout this time, economic
activity has remained strong with ongoing strength in consumer spending. We had also seen

signs of the labor market coming into better balance, but recent strong jobs reports-including

' The views expressed here are my own and are not necessarily those of my colleagues on the Federal Reserve
Board or the Federal Open Market Committee.

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upward revisions to employment growth-show a continued tight labor market. Last year, the
average pace of job gains slowed and the labor force participation rate rose through November,
with the unemployment rate edging up to 3.7 percent. In recent months, however, job growth
has rebounded and the labor force participation rate declined, retracing some of its earlier gains.
At its current setting, our monetary policy stance is restrictive and appears to be
appropriately calibrated to reduce inflationary pressures. As I've noted recently, my baseline
outlook continues to be that inflation will decline further with the policy rate held steady, but I
still see a number of upside inflation risks that affect my outlook. These include risks from
geopolitical developments, including the risk of spillovers from geopolitical conflicts and the
extent to which food and energy markets and supply chains remain exposed to these influences.
There is also the risk that a loosening in financial conditions and additional fiscal stimulus could
add momentum to demand, stalling any further progress or even causing inflation to reaccelerate.
Finally, there is a risk that continued labor market tightness could lead to persistently high core
services inflation, as illustrated by the uptick in 12-month core services CPI inflation in January.
Recent labor market data suggest ongoing elevated wage growth as some businesses continue to
report above-average wage increases to compensate for elevated prices and high inflation.
Given these risks, and the general uncertainty regarding the economic outlook, I will
continue to watch the data closely as I assess the appropriate path of monetary policy. The
frequency and extent of data revisions over the past few years, as seen in the most recent
employment report, make the task of assessing the current state of the economy as well as
predicting how the economy will evolve even more challenging, and I will remain cautious in my
approach to considering future changes in the stance of policy. Should the incoming data

continue to indicate that inflation is moving sustainably toward our 2 percent goal, it will

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eventually become appropriate to gradually lower our policy rate to prevent monetary policy
from becoming overly restrictive. In my view, we are not yet at that point. Reducing our policy
rate too soon could result in requiring further future policy rate increases to return inflation to 2
percent in the longer run.

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 and the implications for the
outlook. While the current stance of monetary policy appears to be at a restrictive level that will
bring inflation down to 2 percent over time, I remain willing to raise the federal funds rate at a
future meeting should the incoming data indicate that progress on inflation has stalled or
reversed. Restoring price stability is essential for achieving maximum employment and stable
prices over the longer run.

Notable Developments in Bank Regulation

Turning back to bank regulation and supervision, as I look at the bank regulatory
framework agenda, I am struck by the sheer volume of matters that have recently been
completed, that have been proposed, and that are in the pipeline. These reforms touch on a wide
range of topics that directly or indirectly impact banks of all sizes. I expect that the regulatory
agenda will remain very active for the foreseeable future, adding further to the already
significant collection of rules, guidance, and supervisory changes made to date. While I
supported some of these recent changes, the vast number of finalized, proposed, and potential
changes suggest a lack of prioritization-whether we have effectively identified actual risks to
the banking system and devoted resources to the most pressing of these issues. The significant
volume of revisions also poses a real problem for banks that must review, provide feedback, and

implement changes.

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The primary goal of prudential bank regulation and supervision is to promote a safe and
sound banking system. Although policymakers may agree on this shared objective, we
sometimes disagree on the best path to achieve it. As we consider modifications to our
regulatory framework, an important question arises about how we identify and implement areas
for change. To be sure, we should focus on the areas of greatest risk, addressing known
vulnerabilities and shoring up the framework to address emerging risks. But we also need to
focus on efficiency, efficiency in how we deliver on our safety and soundness goals, and how
regulatory reforms affect the banking market, the economy, and those who use banking services.
We should also ensure, in our pursuit of reform, that our efforts result in a bank framework that
is appropriately tailored and calibrated.

So today, I will offer my reflections on bank regulation, focusing on notable recent
developments. As I have said in the past, more is not always better when it comes to the rules,
guidance, expectations, and supervisory standards that apply to banks.* In many ways, more can
be counterproductive and harmful when it comes to regulatory reform. When reforms are
disproportionate to risk or fail to promote safety and soundness in an efficient way, those
changes can harm the competitiveness of the U.S. banking system, impede the ability of banks to
manage their risks, and even result in the allocation of capital by regulators instead of by bank
management. Even if the consequences of reforms are unintended, we must consider those

consequences and how they may shape the future of the banking system.

2 See Michelle W. Bowman, The Path Forward for Bank Capital Reform, (speech at Protect Main Street, sponsored
by the Center for Capital Markets at the U.S. Chamber of Commerce, Washington, D.C., January 17, 2024),
https://www.federalreserve.gov/newsevents/speech/files/bowman20240117a.pdf.


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Recently, we have seen many rule revisions, proposals, and ideas for reform, including
supervisory reform. I expect that this activity will continue to feature prominently in the coming
months.

Capital Reform

Starting with the proposed changes to bank capital requirements, as you all know, the
federal banking agencies have published several proposed reforms to the capital framework.
These include proposals to implement Basel III "endgame" capital reforms, to reform the G-SIB
surcharge, and to introduce new long-term debt requirements for all banks with over $100 billion
in assets. These reforms pose real challenges in striking the right balance between safety and
soundness on the one hand, and efficiency and fairness on the other. Capital plays a critical role
in promoting the safe and sound operation of banks and supporting confidence in the broader
banking system. Higher levels of capital improve a bank's resilience to stress and increases the
capacity of a bank to absorb losses, protecting depositors, the deposit insurance fund, and other
creditors.

At the same time, capital has a cost, and regulatory capital requirements apply to all
banks, not just to those that fail. Higher capital requirements generally are passed through to
customers in the form of increased costs for financial services, or ultimately reduced availability
of these services in the market. The cost of bank capital also influences whether activities
occur within the banking system or in non-bank entities outside the banking system.

So, the question then becomes, what's next? The Basel comment period has closed, as
has the comment period for submission of information for the quantitative impact study. The
agencies continue to review the extensive stakeholder feedback and identify key areas of

concern. This deliberative process should help regulators better understand the implications of

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the proposed capital changes-both the scale of the proposed change in capital requirements and
the tradeoffs between the benefits of increased safety and soundness compared to the intended
and unintended consequences.

Since the proposal was published, the agencies received numerous comments identifying
elements of the proposal that will have significant downstream effects on consumers, businesses,
and the broader economy. Therefore, regulators need to thoroughly understand these
consequences in a comprehensive way before moving forward with changes of the scope and
materiality contemplated in the proposal. The agencies also have an obligation to consider
changes to enhanced risk-based capital rules in the broader context of other existing and
contemplated regulatory requirements, which requires a clear understanding of the cumulative
impacts and the implications for U.S. economic activity, the structure of the financial system,
and financial stability, and whether any reforms are consistent with our requirement to tailor
regulation.

My hope is that policymakers will take this opportunity to make significant revisions to
the proposal to address the concerns raised by the public, and that I will be able to support the
next step on Basel capital reforms.

Community Reinvestment Act

Shifting away from capital, last year, the federal bank regulators adopted a new final rule
to implement the Community Reinvestment Act. Unfortunately, I was not able to support the
final rule. While the final rule included several positive changes from the proposal, those
changes ultimately did not outweigh the rule's extensive shortcomings. The final 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

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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 banks are falling short.

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 banks-those 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 sheer lack of recognition that these banks are fundamentally different, with different balance
sheets, customers, 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, 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. This intentional blurring of commonly accepted
regulatory standards for large banks and community banks is problematic as it will result in
increased regulatory expectations for smaller banks and a more one-size-fits-all approach to
banking regulation rather than a tailored and calibrated system. The unsupported increases in
burden and cost associated with these changes are simply disproportionate when applied to
community banks, in a way that will undoubtedly constrain the resources that community banks
can devote to supporting their communities.

If the final rule's 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.

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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 are
committed to supporting their communities. It is unwarranted for the federal banking agencies to
materially increase these 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.

Perhaps most concerning about the CRA 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
or even to close branches.

I am confident that banks will attempt to make the best of this new rule, and I am certain
that they will continue to support their communities regardless of the rule's requirements. But I
regret that this new final rule may complicate, and in some instances frustrate, the important
goals of the CRA.
Regulation II and Debit Card Interchange Fees

Alongside the rule changes to the CRA, one of the other most significant proposals this
past year would significantly lower the debit card interchange fee cap under Regulation I.? The

Dodd-Frank Act mandates that the Federal Reserve establish a cap on debit interchange fees that

3 Debit Card Interchange Fees and Routing, 88 Fed. Reg. 78,100-132 (November 14, 2023),
https://www.govinfo.gov/content/pkg/FR-2023-11-14/pdf/2023-24034.pdf.


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is reasonable and proportional to the cost incurred by the issuer with respect to debit
transactions.* I am concerned about the data underpinning this proposal, and the potential
unintended consequences of moving forward with such a change, including the proposal to
automatically adjust the cap every two years based on an incomplete formula that may not
account for all of the relevant variables.

As published, the Board's proposal was based on survey data collected by the Board.* I
remain concerned that the analysis underpinning this rulemaking overlooks gaps in the reported
data and ignores the broader context-the wide range of business models and sizes of issuers
subject to the rule, the potential effect of the rule on bank capital and earnings, the benefits and
costs to consumers, and the cumulative effect of regulatory changes, particularly those that affect
the pricing and availability to consumers of low-cost or no-cost debit card programs. The data
also does not take into account recent revisions to Regulation II, revisions that may have the
unintended consequence of increasing the incidence of fraud in bank debit card programs, trends
that are not reflected in the data due to the timing of the change, and also would not be taken into
account in calibrating the new debit interchange fee cap.° As proposed, the rule would also
adopt a "rough justice" approach by establishing a single cap that applies to all issuers, which
will leave nearly one third of issuers unable to recover even the subset of costs that are taken into
account in calculating the debit interchange fee.

On January 22, 2024, the Board announced that the comment period on the proposed

revisions to Regulation II has been extended until May 12, 2024, and concurrently published

4 15 U.S.C. § 16930-2.
5 Debit Card Interchange Fees and Routing, 88 Fed. Reg. 78,105-6; Form FR 3064a, FR 3064b.

© See dissenting statement, "Statement on Final Amendments to Regulation II to Clarify the Prohibition on Network
Exclusivity by Governor Michelle W. Bowman," news release, October 3, 2022,
https://www.federalreserve.gov/newsevents/pressreleases/bowman-statement-2022 1003.htm.

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additional data to inform the public about the basis for the proposal.' I look forward to
reviewing the comments and hearing feedback from stakeholders on this proposal, specifically as
it relates to identifying any issues or concerns with the data that informed the original calibration
of the proposal, and any potential gaps in this data or the supporting analysis. I remain
concerned about the unintended consequences of this proposal.

Without question, an ongoing, permanent decrease in debit card interchange fees will
have consequences for banks of all sizes, and more importantly, for their customers that rely on
debit card products for payments. Banks may be reluctant to discontinue their retail debit card
programs, even with revisions to the interchange fee cap. However, I think it is likely that if this
proposal is finalized, banks may need to make some tough decisions about the path forward.
Will they need to recover the lost income by imposing higher borrowing costs on bank
customers, or where possible increasing other fees? To the extent banks are relying on fee
income to support debit card programs, will this be a long-term, sustainable source of revenue if
the banking agencies continue to target other fees for elimination? How will this change impact
low- and moderate-income (LMI) individuals and families? For example, will banks be forced
to discontinue their lowest margin products that target underserved populations, and what will
the cost of such changes mean for financial inclusion? How would this change impact the
success of financial inclusion efforts encouraged by federal banking agencies, such as Bank On

programs?

7 Board of Governors of the Federal Reserve System, "Federal Reserve Board announces it will extend the
comment period on its interchange fee proposal until May 12, 2024 and published additional related data," news
release, January 22, 2024, https://www.federalreserve.gov/newsevents/pressreleases/bcreg20240122a.htm.


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The pain here will likely be felt broadly by banks and their customers, and will continue
to trickle down to smaller institutions, including community banks, even if those banks are not
directly subject to the interchange fee cap. The consequences for bank debit card programs, and
the customers who rely on those programs, may be significant.

Bank Mergers and Acquisitions

Another policy area where I expect to see ongoing federal regulatory attention is in the
bank merger application process. Some policymakers and the Department of Justice have
strongly signaled an intent to revisit and significantly tighten the existing standards and the
related economic analysis used in that process. This ongoing scrutiny of mergers has encouraged
a growing public focus on the role of federal banking regulators in reviewing merger
applications, and sparked a concern about whether that process is fair, transparent, and consistent
with the applicable statutory requirements. This public scrutiny is increasing in light of the
growing interest of bank regulators in revisiting standards and processes for approval.*

The past year certainly has not improved the outlook for the bank merger process. While
the idiosyncratic features of each bank merger transaction can make it difficult to predict how
long the regulatory approval process may take, I remain concerned about delays in average
processing times and that subsequent regulatory actions could lead to further delays. The
reported data on merger processing timelines may also understate the true timeline for
processing, particularly to the extent reported data may not reflect preliminary discussions with

regulators, pre-filings with regulators, and may not reflect technical agency "acceptance" of an

8 See, e.g., Office of the Comptroller of the Currency, "Business Combinations Under the Bank Merger Act: Notice
of Proposed Rulemaking," OCC Bulletin 2024-4, January 29, 2024, https://occ.gov/news-
issuances/bulletins/2024/bulletin-2024-4.html.


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application-thereby triggering the regulatory processing clock-auntil well after an application
has been received by the agency.'

As all bankers know, application processing delays can be quite harmful, resulting in
greater operational risk, increased expenses due in part to contract delays, reputational risk, and
staff attrition due to the prolonged uncertainty. In the broader context, reducing the efficiency of
bank mergers and acquisitions may also act as a deterrent to a healthy evolution of the banking
system. Taken together, reducing merger or acquisition activity could have the consequence of
prohibiting transactions that may preserve the presence of banks in rural or underserved areas;
transactions that may further prudent growth strategies or that may result in increased
competition with larger peers.

And yet, there has been little discussion or recognition of how the regulatory process can
be enhanced to improve the speed and timeliness of regulatory decision-making on these
applications. In my view, the regulators would be well-served by evaluating the merger review
process with the goal of promoting efficiency and fairness. Stakeholders who are concerned
about the current bank merger review procedures and policies should consider direct engagement
with regulators on these issues, including the recently launched mandatory review of regulatory
burden under the Economic Growth and Regulatory Paperwork Reduction Act of 1996.'°
Climate Change

Banks face many well-known, material risks, including credit risk, interest rate risk,

liquidity risk, cyber risk, and many others. New risks continue to emerge as the banking system,

9 See, e.g., Hurry v. FDIC, 589 F. Supp. 3d 100 (D.D.C. 2022).

'0 Statement by Governor Michelle W. Bowman, "Federal Bank Regulatory Agencies Seek Comment on
Interagency Effort to Reduce Regulatory Burden," news release, February 6, 2024,
https://www.federalreserve.gov/newsevents/pressreleases/bcreg20240206a1 .htm,


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technology, and customer preferences evolve. In the aftermath of the bank failures last spring,
both bank management and bank regulators have refocused their efforts related to managing
material risks to improve early identification and to facilitate prompt actions to mitigate the
buildup of risks.

Last October, following on an earlier proposal in 2022, the agencies issued principles for
climate-related financial risk management for large institutions.'' While climate change is a
public policy issue in the U.S. and globally, the unique focus on this particular risk could lead
one to believe that financial risk associated with climate change is a key risk facing the banking
industry, or that somehow banks with exposures to these risks have not been appropriately
considering climate-related financial risks in managing their material risks. The supporting
documents published in connection with the principles do not support this view, however, and
raise questions about whether they further the goal of appropriate risk management at regulated
institutions.

Banks of all sizes have long been expected to manage all material risks associated with
their activities. Bankers know that their risks vary based on their business models and loan
portfolios, among other things-banks that make loans in drought or flood-prone areas, or
tornado-prone areas, or areas that experience wildfires, take those risks into consideration in the
underwriting and ongoing monitoring of loans and loan portfolios. Risk management as applied
to weather-related financial risks is not new, and this recent approach misses the larger context of

how banks manage all material risks.

'! Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Office of the
Comptroller of the Currency, "Agencies issue principles for climate-related financial risk management for large
financial institutions," joint press release, October 24, 2023,
https://www.federalreserve.gov/newsevents/pressreleases/bcreg20231024b.htm.


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Specifically, the prescription to address this perceived deficiency in risk management,
rather than providing clarity and concrete expectations, creates unclear expectations and, as a
result, gives examiners almost unlimited supervisory discretion to interpret what expectations are
appropriate for regulated institutions. We will need to be vigilant to ensure these expectations
are appropriate and proportionate.

Under the guidance, banks are expected to monitor and measure climate-related risks
over indefinite time horizons-or put another way, engage in expensive, ongoing data collection
and speculate about very uncertain effects far into the future-in the context of their lending
activities. Banks are also expected to engage in scenario analysis, without a clear roadmap as to
what such an analysis should consider. This will likely lead to detrimental impacts on low- and
moderate-income communities by increasing the cost of or reducing the availability of credit in
those communities. I think we can all agree that examiners should not criticize banks for prudent
lending in LMI communities. I am concerned that the net effect of this guidance will be
increased costs for banks subject to it, creating further differences between banks and non-bank
lenders engaged in the same activities.

The effects of this guidance-and follow-on efforts by other regulators-could be
material even for banks that are not directly subject to the rules. The principles themselves note
that "all financial institutions, regardless of size, may have material exposures to climate-related

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financial risks...."!? Notwithstanding the carveout in the principles for institutions with less than
$100 billion in assets, I suspect banks may take little comfort from this nominal carveout in light

of the language in the principles, and other government agencies focused on escalating climate

risk above many other more material and present-tense risks. For example, the U.S. Treasury

12 88 Fed. Reg. 74,183-184 (October 30, 2023).

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has published principles for net-zero financing and investment that focus on indirect greenhouse
gas emissions included in a creditor company's "value chain."!? While these principles are
described as wholly voluntary, they too could exert significant pressure on banks to reprioritize
their risk management function, prioritizing climate change risks that may be immaterial to a
bank over more pressing risks.

The Federal Housing Finance Agency (FHFA) has also published a report that suggests
Federal Home Loan Banks (FHLB) must assess risks related to climate and natural disasters "on
the FHLBanks' businesses, their members, and the communities they serve."'* The vast majority
of FHLB member banks fall well below the $100 billion threshold, but now may fall within
FHLB's climate assessment requirements, even while being excluded from the scope of their
primary regulator's climate guidance. In the context of these many competing directives, banks
may be puzzled about supervisory expectations, particularly when a "carveout" in supervisory
guidance from a bank's primary banking regulator seems to be at odds with the guidance itself,
and with expectations from other government agencies.

Banks of all sizes are likely to continue facing regulatory pressure to collect increasing
amounts of data. While it is imperative that banks manage all material risks that they face,
focusing on climate risk-independent of the many other risks banks must manage in
successfully running their businesses-could force banks to reallocate resources to meet unclear

and confusing regulatory expectations related to perceived nebulous climate-related financial

3 "Principles for Net-Zero Financing & Investment," U.S. Department of the Treasury, September 2023,
https://home.treasury.gov/system/files/136/NetZeroPrinciples.pdf.

4 "FHLBank System at 100: Focusing on the Future," Federal Housing Finance Agency, p. 38,
https://www. fhfa.gov/AboutUs/Reports/ReportDocuments/FHLBank-System-at-100-Report.pdf.


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risks. This approach has the potential to undermine safety and soundness, creating an expensive
distraction from more pressing areas of concern.
Liquidity

Following the bank failures last spring, significant attention has been paid to the alleged
"lessons learned" creating a path for regulatory reform efforts. This has generated discussion
among both policymakers and the public on how to think about liquidity regulation: Should
these requirements be expanded to a broader range of institutions? Should the calibration or
operation of liquidity requirements like the Liquidity Coverage Ratio (LCR), and Net Stable
Funding Ratio (NSFR) be modified? Should we consider new liquidity requirements, and if so,
what form should they take?

While these are important policy questions, and are certainly worthy of discussion, it is
important to identify exactly what problem we are trying to solve. To those ready to march
steadily forward without fully considering the cumulative impacts of change currently being
considered, this may seem like a step backwards in the policymaking process. But it is not
prudent policymaking to create solutions to solve perceived problems that have not been
identified, researched, and supported with evidence and data. We must clearly understand and
agree upon the problem before seriously proposing and considering solutions.

Answering this question has been complicated by the long shadow of the banking stress
last spring, and the hurried and incomplete analyses prepared in the aftermath of those failures.
These early efforts-efforts that relied on admittedly incomplete analyses and limited
perspective-have generated many policy prescriptions, without fully diagnosing the problem.

As a threshold matter, we must recognize that liquidity regulation alone is not a panacea.

Liquidity regulation does not result in more focused and nimble supervision. Liquidity

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regulation alone does not improve the risk management at regulated institutions. Liquidity
regulation also has the potential to impose significant costs and limit the lending capacity and
business operations of banks, which we must recognize and take into account before imposing
any new requirements.

But even with these caveats, liquidity regulation should be part of the overall reform
discussion. We must think about liquidity broadly, including the sources and uses of liquidity
that institutions use today, including the Federal Reserve's Discount Window and its role as
lender of last resort, advances from the FHLBs, and other