For release on delivery
11:00 a.m. EDT
October 7, 2023

Brief Remarks on the Economy and Insights from Past Bank Regulatory Reform Efforts

by
Michelle W. Bowman
Member
Board of Governors of the Federal Reserve System
at
Connecticut Bankers Association Annual Meeting

White Sulphur Springs, West Virginia

October 7, 2023

It is a pleasure to be with you here today.! As a former community banker and a
former state bank commissioner, I bring a unique perspective to my service on the Board
of Governors of the Federal Reserve System. These different experiences help inform
my views on the Fed's important role in bank regulation and supervision. Over the past
five years, I have found that one of the most informative, enjoyable, and productive
aspects of my work at the Fed is hearing from bankers about issues that are important to
you, and that affect you and your customers. This includes, of course, the impact of the
Fed's regulation and supervision. So today, I would like to share some thoughts about
that and, should changes to the bank regulatory framework be necessary, how we can
support thoughtful and considered changes.

Before we turn to our conversation, I'd like to offer a few thoughts on the
economy and monetary policy, in light of our Federal Open Market Committee (FOMC)
meeting last month. As you know, at that meeting, my colleagues and I voted to maintain
the target range for the federal funds rate at 5'4 to 5' percent, after raising rates sharply
over the past year and a half to reduce inflation. Since then, there has been considerable
progress on lowering inflation, and the FOMC has responded this year with a more
gradual pace of increases. In keeping with this approach, we held the policy rate steady
in June, raised it by 25 basis points in July, and then held steady again last month.
Inflation continues to be too high, and I expect it will likely be appropriate for the
Committee to raise rates further and hold them at a restrictive level for some time to

return inflation to our 2 percent goal in a timely way.

' 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.

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Most recently, the latest inflation reading based on the personal consumption
expenditure (PCE) index showed that overall inflation rose, responding in part to higher
oil prices. I see a continued risk that high energy prices could reverse some of the
progress we have seen on inflation in recent months.

At the same time, the economy has remained strong as the FOMC has tightened
monetary policy. Real gross domestic product (GDP) has been growing at a solid pace.
Consumer spending has remained robust, and the housing sector appears to be continuing
to rebound. The most recent employment report showed a labor market with solid job
gains. The average pace of job gains over the past year has slowed somewhat and the
labor force participation rate has also improved over the same time frame, a sign that
labor market supply and demand may be coming into better balance.

The banking system continues to be strong and resilient. Banks have tightened
lending standards due to higher interest rates and funding costs and in anticipation of
future regulatory requirements. But despite this tightening of lending standards, there has
not been a sharp contraction in credit that would significantly slow economic activity.
Bank loan balance growth has slowed, but ongoing strong household and business
balance sheets combined with the growing importance of nonbank lending suggest that
monetary policy may have smaller effects on bank lending and the economy than in the
past.

Given the mixed data releases recently-strong spending data but a decline in
inflation and downward revisions to jobs created in previous months-I supported the
FOMC's decision to maintain the target range for the federal funds rate. Since then, the

GDP and employment data have also been revised. The frequency and scope of recent

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data revisions complicates the task of projecting how the economy will evolve. But I
continue to expect that further policy tightening will likely be needed to return inflation
to 2 percent in a timely way. The Summary of Economic Projections released in
connection with the September FOMC meeting showed that the median participant
expects inflation to stay above 2 percent at least until the end of 2025. This, along with
my own expectation that progress on inflation is likely to be slow given the current level
of monetary policy restraint, suggests that further policy tightening will be needed to
bring inflation down in a sustainable and timely manner.

It is important to note that monetary policy is not on a pre-set course. My
colleagues and I will make our decisions based on the incoming data and its implications
for the economic outlook. I remain willing to support raising the federal funds rate at a
future meeting if the incoming data indicates that progress on inflation has stalled or is
too slow to bring inflation 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 would now like to share some views on how I see a responsible evolution of the
bank regulatory framework in my day-to-day work on the Board. To frame this
discussion, I would like to revisit a few of the regulatory actions the Board has engaged
in over the past year. I will identify several lessons we can learn from these actions and
consider how we can apply these lessons when thinking about ongoing and future
reforms to the bank regulatory framework.

Specifically, I would like to address three broad themes: (1) how efficiency

should be a key factor in policy discussions, (2) how to think about limits on the Board's

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tools to implement policy decisions, and (3) the importance of due process and public
engagement in rulemaking.

Efficiency should play a central role in policymaking. Policymakers should
consider how a desired policy goal can be achieved in a targeted manner that minimizes
costs and administrative burdens on financial institutions. In June of this year, the Board,
along with the FDIC and OCC, released third-party risk management guidance for banks
of all sizes. While I continue to support the overarching and worthy goal of the guidance,
as I noted at the time, I think the agencies lost an opportunity to maximize efficiency in
the release of this guidance. The text acknowledged the need for resources to assist
community banks in meeting the untailored expectations set forth in the guidance, but
failed to provide those resources on a timeline that would have improved transparency
and understanding among community banks. In the absence of clearly defined
expectations, the regulatory agencies should have supplemented the published guidance
to ensure that the smallest banks understand how to apply the guidance to their third-
party relationships." Over the years, the bank regulatory agencies have made great efforts
to enhance our approach to consider financial institution risk, business model, and asset
size in our regulatory proposals and guidance. This guidance did not meet that bar, and
we should do better for the smallest in size, yet largest number, of banks.

The benefits of an efficient approach extend well beyond rulemaking and

guidance and apply broadly to all aspects of the Federal Reserve's approach. For

? "Statement on Third-Party Risk Management Guidance by Governor Michelle W. Bowman," (June 6,
2023), https://www.federalreserve.gov/newsevents/pressreleases/bowman-statement-20230606.htm. ("The
guidance contemplates that the agencies plan to develop additional resources to assist smaller, non-complex
community banks in managing relevant third-party risks, but provides no timeline for development of these
resources. It also makes clear that these additional resources will not be available for some time. This
leaves one to wonder why the rush to publish without appropriate tools available for small banks.")

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example, as I noted at the St. Louis Reserve Bank Community Banking Conference
earlier this week, delays in processing applications can be harmful to banks of all sizes.
The Board's application review processes should support the efficient resolution of
applications.> One way the Board could do this is by improving the approach to
processing applications in cases where a member of the public has made an adverse
comment. When the recent supervisory record addresses the concerns raised in the
protest and the record is consistent with approval, the decision should be delegated to the
Reserve Bank for a determination.* Our goal should be to ensure that bona fide concerns
raised by the public are appropriately considered, without resulting in unnecessary
processing delays.>

Another important issue relates to how policymakers should consider the limits on
available regulatory tools. Before the Board uses its regulatory or supervisory authority,
we need to ask a basic question: Does the Board have the legal authority to use the tool in
the manner contemplated? Late last year, the Board published principles for climate-
related financial risk management for large financial institutions for public comment.°
While I supported publishing the draft principles, I noted at the time that the Board "has

specific responsibilities, established by Congress, to supervise holding companies and

3 Michelle W. Bowman, "The Role of Research, Data, and Analysis in Banking Reforms" (speech at the
2023 Community Banking Research Conference sponsored by the Federal Reserve System, the Conference
of State Bank Supervisors, and the Federal Deposit Insurance Corporation, October 4, 2023),
https://www.federalreserve.gov/newsevents/speech/bowman2023 1004a.htm.

4 See "Statement on Application by Vantage Bank Texas by Governor Michelle W. Bowman," (June 27,
2023), https://www.federalreserve.gov/newsevents/pressreleases/bowman-statement-20230627.htm.

5 See Michelle W. Bowman, "Independence, Predictability, and Tailoring in Banking Regulation and
Supervision" (speech at the American Bankers Association Community Banking Conference, February 13,
2023), https://www.federalreserve.gov/newsevents/speech/files/bowman202302 13a.pdf.

6 Board of Governors of the Federal Reserve System, "Federal Reserve Board Invites Public Comment on
Proposed Principles Providing a High-Level Framework for the Safe and Sound Management of Exposures
to Climate-Related Financial Risks for Large Banking Organizations," news release, December 2, 2022
https://www.federalreserve.gov/newsevents/pressreleases/other20221202b.htm.


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banks, with a focus on the safety and soundness of these regulated institutions."" Of
course, any decision to mandate guidance on a narrow area like climate-related financial
risk-highlighting this one risk out of the full range of risks that banks manage today-
should be based on evidence of unique climate financial risks and an identified need for
more guidance addressing this area. Of course, any new guidance should complement
existing standards as well. As I observed at the time the climate guidance was proposed,
"Tt]he new principles contemplate additional obligations on firms to monitor and measure
a broader set of climate-related risks, over indefinite time horizons."*® Such narrow and
specific guidance runs the risk of going beyond the scope of safety and soundness, by
focusing on narrow, remote and uncertain risks with minimal demonstrated impacts on
financial institutions. I am concerned that the Board could unintentionally interfere with
the ability of a bank's management to make credit allocation decisions. Under no
circumstances should the Board mandate credit allocation decisions for banks-directly
through a prohibition, or indirectly through policy tools like guidance-and we must
carefully evaluate this type of guidance with an eye toward whether the policy tool we
use is appropriate in the circumstance.

Another example I want to highlight is the use of conditions in applications. In
the process of deliberating on applications that come before the Board, the Board can
impose limitations or restrictions in certain circumstances, to address specific supervisory
or policy concerns raised by the application. While this can be an important tool, it

cannot replace rulemaking.

7 "Statement by Governor Bowman on Principles for Climate-Related Financial Risk Management for
Large Financial Institutions," (December 2, 2022),
https://www.federalreserve.gov/newsevents/pressreleases/bowman-statement-20221202.htm.

8 See footnote 7.

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In a Board Order approving a large bank application last year, the Board used its
commitment authority in a way that "could impose heightened prudential standards at a
fixed date in the future" on a firm, in a manner "inconsistent with the Board's existing
regulatory framework, which imposes tailored requirements based on clear, quantitative
measures of the firm's underlying risk."? This Board action highlights yet another
question policymakers should ask when using one of many bank regulatory and
supervisory tools, namely whether the tool is appropriate in the circumstances, or whether
another tool-one established by regulation to address the very concern raised-is more
appropriate.'° The Board's rules and regulations are often the most appropriate and
effective tools to address supervisory and financial stability concerns.

Finally, I want to talk about how due process and promoting public engagement
can improve the rulemaking process, including by helping policymakers understand the
impact of proposed rules. In October of last year, the agencies finalized amendments to
the Board's Regulation IH, implementing new rules pertaining to debit card routing on
different networks. During the public comment process, community banks raised
substantial concerns with the proposal, specifically around the uncertainty of the rule
revisions on fraud and the cost of compliance. As a result of comments raised, and my
view that significant questions remained about the effect of the rule, I did not support the

Board's final action.'' But a key element in that rulemaking is that banks engaged in the

° "Statement by Governor Bowman on Advance Notice of Proposed Rulemaking on Resolution
Requirements for Large Banks and Application by U.S. Bancorp," (October 14, 2022),
https://www.federalreserve.gov/newsevents/pressreleases/bowman-statement-20221014.htm

10 See footnote 9.

'l "Statement on Final Amendments to Regulation II to Clarify the Prohibition on Network Exclusivity by
Governor Michelle W. Bowman," (October 3, 2022),
https://www.federalreserve.gov/newsevents/pressreleases/bowman-statement-20221003.htm.

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rulemaking process shared their feedback, especially around potential fraud concerns and
the speed with which the rule mandated system changes and implementation without
consideration of the practical implementation and processor functionality constraints.

Community banks have unique perspectives and concerns, and raising these
issues with policymakers can make a difference in the contours of any final rules. In my
conversations with state member banks over the past 12 months, many have shared their
concerns about the proposed changes to the criteria for becoming or maintaining their
designation as a certified community development financial institution (CDFI). While
CDFI certification is the sole purview of the CDFI Fund within the Treasury Department,
I appreciate the implications the recent proposed revisions to these guidelines may have
on nearly 200 bank CDFIs and the communities they serve. But this also shows the
opportunity, and the need, for the robust public engagement of affected stakeholders.

From time to time, my colleagues and I disagree on policy questions. But, the
rulemaking process benefits when policymakers have the full scope of information
needed to inform our discussions and debate. This enables us to fully appreciate the
actual impact of our policy decisions.

The rulemaking process provides a path for policymakers to follow that is
designed to ensure that we are aware of the important tradeoffs and considerations in
understanding the intended and unintended consequences resulting from each proposal.
Conclusion

I would like to conclude by emphasizing the critical role you and other public

commenters play in making the rulemaking process work as it was intended. This is a

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topic I have frequently raised, which is the importance of robust public engagement on
the Federal Reserve's and the other federal banking agencies' rulemaking agendas.

A number of rules have been proposed for comment or are currently in the
pipeline. Some have already been published, including the proposal to implement Basel
III "endgame" by significantly expanding capital requirements and bringing the threshold
for compliance down to include all banks over $100 billion in assets from only the largest
banks, and the expansion of the long-term debt requirement from only the largest banks
again to all banks over $100 billion in assets. Still other proposals have not yet been
published or moved to the next stage of the rulemaking process, including the
Community Reinvestment Act rulemaking, the further consideration of climate guidance,
and others. The Board has also publicly indicated it may propose additional revisions in
the future to Regulation II.

The scope of some of these reforms will be extensive and could reshape the
contours of the bank regulatory framework, including for community banks, and could
restrict the ability of consumers and businesses to access credit and other financial
services from chartered financial institutions. It is critical that stakeholders engage in the
comment process and communicate with policymakers to share their views on the
rulemaking agenda, including the specific impacts-intended and unintended-of any
changes. Public comments, data, and analysis help to inform decisions made throughout
the rulemaking and proposal process. The bankers in this room and across the country
are vitally important to the banking system, and to the broader economy. As reforms take
shape, it is important that we incorporate your perspectives on the real-world

consequences of any considered changes.

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I look forward to our conversation.