Michelle W Bowman: Independence, predictability, and tailoring in
banking regulation and supervision
Remarks by Ms Michelle W Bowman, Member of the Board of Governors of the Federal
Reserve System, at the American Bankers Association Community Banking
Conference, Orlando, Florida, 13 February 2023.
* * *
I would like to thank the American Bankers Association for the invitation to speak to you
today. It is a pleasure to be with you and to have the opportunity to share some of my
views on banking regulation and supervision. Of course, as you know, the Federal
Open Market Committee (FOMC) recently held its first meeting of the year. So, before
getting into the substance of my remarks, I'll provide some brief thoughts on the
economic outlook and monetary policy.1
Monetary Policy
Let me begin with the FOMC's effort to lower inflation, which continues to be much too
high. Stable prices are necessary for a healthy economy and to support a labor market
that works for everyone. As a member of the FOMC, I remain focused on bringing
inflation down to our 2 percent goal.
Over the past year, the Committee has taken forceful actions to address unacceptably
high inflation by significantly raising the federal funds rate and reducing our balance
sheet holdings of Treasury and agency mortgage-backed securities. At our most recent
meeting, we continued on that path by further increasing the target range for the federal
funds rate by 25 basis points to 4-1/2 to 4-3/4 percent. I expect that ongoing increases
will be appropriate to bring the federal funds rate to a sufficiently restrictive level and
that it will need to remain there for some time to restore price stability.
The economic outlook and the outlook for inflation continue to be highly uncertain.
Global and domestic factors are contributing to heightened uncertainty, and I expect
that we will continue to be surprised by economic and geopolitical developments and by
the incoming data. While we have seen modestly lower inflation readings in recent
months, overall inflation remains high. Measures of core services inflation have been
persistently elevated, and labor demand exceeds the supply of available workers, which
is leading employers to increase wages in an effort to retain and attract workers. The
ongoing tightness in the labor market puts upward pressure on inflation, even if some
components of inflation moderate due to improvements in supply-side factors. The
longer high inflation persists, the more likely it is that households and businesses may
come to expect higher inflation in the longer term. Should that be the case, the FOMC's
job of lowering inflation would be even more challenging.
Given the highly uncertain environment, my views on the future path of monetary policy
will continue to be informed by the incoming data and its implications for the outlook. I
will continue to look for consistent evidence that inflation remains on a downward path
when considering further rate increases and at what point we will have achieved a
sufficiently restrictive stance for the policy rate.
We are still far from achieving price stability, and I expect that it will be necessary to
further tighten monetary policy to bring inflation down toward our goal. Doing so will
likely lead to subdued growth in economic activity and some softening in labor market
conditions. While there are costs and risks to tightening monetary policy to lower
inflation, I see the costs and risks of allowing inflation to persist as far greater. Restoring
price stability is essential to support a sustainably strong labor market.
Turning to the focus of my remarks today, I would like to share my thoughts on several
current aspects of banking supervision and regulation.
What I say next will certainly not surprise you: I expect there will be meaningful changes
in regulations, guidance, and supervisory expectations over the coming year. While
some of these changes will affect only the largest institutions, many will affect
community bankers like you and may impact your work to support your local
communities.
To be clear, the issues facing the banking industry continue to evolve over time, and the
regulatory response to these changes must adapt as well. But as we continue to review
and revisit the regulatory framework, I'd like to share a few thoughts about how the
Federal Reserve can best fulfill its missions of furthering the safety and soundness of
banks and promoting the stability of the financial system. Specifically, I will discuss
three topics that are more interconnected than they may appear: (1) Federal Reserve
independence, (2) predictability in applications, and (3) tailoring of regulations and
supervision.
Federal Reserve Independence
Most often, the independence of the Federal Reserve is discussed in terms of
independence in the setting of monetary policy. While the value of independent decision
making in monetary policy is vital, and research shows that it leads to better policy
outcomes in the long run, it is also important to emphasize the value of independence in
banking supervision and regulation.
You may have seen Chair Powell's recent speech on this topic, in which he noted that
independence in our bank regulatory function helps to ensure that our decisions are
driven primarily by the goals of promoting a safe and sound financial system and
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safeguarding the stability of the U.S. financial system stability. In this context,
independence also means that we are not influenced by political considerations in
making policy decisions. The Federal Reserve's independence in bank regulation also
provides stability and consistency to regulated institutions. I am not suggesting that
bank regulation remain static in the face of change. To the contrary, the Federal
Reserve's regulatory approach must be capable of addressing and adapting to new
activities and new risks but also must be constantly directed towards furthering our
statutory objectives.
Of course, this independence in bank regulation must be accompanied by
accountability, to both Congress and the American public.
Existing law provides a number of mechanisms to ensure this accountability to
Congress. First, members of the Board of Governors are appointed by the President,
subject to the advice and consent of the Senate. Second, the Board also regularly
communicates with Congress, both through in-person testimony to relevant banking
and financial services committees and by providing regular reports on key areas within
the Federal Reserve's areas of responsibility, including semiannual reports on banking
applications activity, supervision and regulation, cybersecurity and financial system
resilience, and financial stability. This regular cadence of testimony and public reporting
provides visibility into the inner working of the Federal Reserve, not just for Congress,
but also for the public.
Beyond these measures though, accountability also means having transparent policies
and procedures and conducting supervision in a way that is predictable and fair.
Transparency builds legitimacy and helps demonstrate that the Fed is executing its
responsibilities in a fair way for all regulated institutions. One area I think we are always
looking to improve is the publication of clear, appropriate guidance, especially for
community banks. I think there are examples where we have done a pretty good job, for
instance providing tools to help community banks estimate their losses under the
Current Expected Credit Loss, or CECL, accounting standard. We owe this duty of
transparency to all regulated institutions. For example, I expect the Board will soon
publish the supervision criteria implemented by the Large Institution Supervision
Coordinating Committee-the LISCC manual. Banks should have some assurance that
they are being held to the same standards as their peers over time. While publication of
the manual may be only a modest improvement in transparency, I think it will be an
important step.
Transparency helps us not only with accountability, but also with building legitimacy and
public trust. To be clear, I do not consider transparency to mean leniency. We hold
banks of all sizes to high standards, commensurate with their size and risk, and being
transparent does not dilute the rigor of our regulatory standards. Transparency helps
ensure that banks are aware of these standards and expectations so that they can work
more effectively and efficiently to meet them.
Perhaps most importantly, though, we must implement the laws that Congress has
passed as they are written and not stretch that authority to venture into other areas of
policymaking.
For example, consider the distinction between (1) making sure institutions are
managing all of their material risks and (2) instructing banks to make certain credit
allocation decisions, that is, telling banks to make or not make loans to certain
industries. The first objective-making sure financial institutions manage their material
risks-is one of the central functions of a bank supervisor, and is fundamental to safety
and soundness. But it is equally clear that the second objective-influencing a bank to
make certain credit allocation decisions-is not the role of a banking regulator. If you look
across the regulated banking sectors, you will find that each bank makes different credit
decisions, reacting not only to market demand and economic conditions, but also
implementing the bank's strategy. And to be clear, I share the widely held view that the
appropriate role of the Federal Reserve is not to make credit allocation decisions for
banks.
The Fed's role as a banking supervisor is not to replace a bank's management and
board of directors in adopting a banking strategy and risk appetite. Instead, it is to apply
appropriate, targeted regulation and supervision, in order to be able to assess that
when a bank engages in an activity, it does so in compliance with applicable laws and
in a safe and sound manner. This can be a difficult balance to strike but it is something I
believe we must always bear in mind whenever the Fed uses or proposes using its
regulatory or supervisory tools. Banking regulation and supervision should not be the
place to implement new policies that are not mandated by Congress.
In the past, I have shared my views about the Fed's rulemaking agenda, which remain
the same today. I continue to support changes based on our experience applying
existing rules or prompted by new and emerging issues. However, any incremental
changes to regulation should yield significant improvements to safety and soundness at
reasonable cost, in consideration of the tradeoffs between cost and safety. And of
course, any changes should be to further our regulatory responsibilities as mandated by
Congress.
I'll turn now to a few examples of "how" the Federal Reserve should regulate and
supervise financial institutions in the context of merger applications and in the tailoring
of our regulations and supervision.
Predictability in Reviewing Bank Mergers
Recently, there has been significant attention focused on the role of federal bank
regulators in reviewing merger applications, with scrutiny of not only the rigor of the
review, but also on how the review process impacts the merger applicants. I certainly
welcome this discussion and hearing public feedback, to see if the process can be
improved.
Congress established the factors that must be considered when the Federal Reserve
and other regulators review bank applications. These include the competitive effects of
the proposed merger, financial and managerial resources, future prospects of the
merged institutions, convenience and needs of the communities to be served,
compliance with money laundering laws, and the effect of the transaction on the stability
of the financial system. Although the review framework is the same for all applications,
the facts of each case can vary widely, from community bank mergers to mergers of
much larger institutions that can affect markets across large regions of the country.
While this variability necessitates an in-depth review of each transaction on its own
merits, these reviews are most effective when the expectations of the regulators are
clear in advance and the parties can reasonably anticipate the application review
process.
The agencies are required to review the statutory factors, but it is also important that we
understand that timing matters in merger transactions. There are significant
consequences to firms when applications are not acted on in a timely manner, including
increased operational risk, the additional expense associated with running two
institutions in parallel over a longer period of time, employee retention issues, and
perceived reputational risk. Congress has also recognized the need for prompt action,
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imposing a variety of time limits for agency action on bank applications. Recently, we
have seen an increase in average processing times in the merger review process. I am
concerned about delays in the applications process and am concerned that the
increase in average processing times will become the new normal.
I think it's helpful to consider the source of delays in processing applications and
consider whether there are opportunities for improvement. This is another area where
increased transparency can help. The legal standards we apply have not changed, and
yet the review of applications can be affected by incomplete or inaccurate information or
information that does not meet the expectations for an approvable transaction. Filling
this information gap with clearer guidance, and making sure applicants understand our
expectations could meaningfully improve the process. New supervisory information that
comes to light during the examination process can also lead to delays, particularly if
new supervisory issues need to be remediated before the application can be approved.
In these cases, transparency between the regulator and the applicant helps ensure
clear expectations about potential delays.
That being said, improved transparency only goes so far. I think it will come as no
surprise to the bankers here today that often, the key difference in processing times is
whether the application will be acted on by the Reserve Banks on a delegated basis or
will require Board action. While an application can come to the Board for many reasons,
the most common reason is that the Board has received a protest on the application
from a member of the public. I think it is helpful to consider whether this process could
be improved, so that bona fide concerns raised by the public are appropriately
considered, while still ensuring timely decision-making.
Finally, to reiterate a point I've made in the past, I continue to believe that the
application process should not be used as a substitute for rulemaking. If the rules
applicable to a firm or group of firms needs to be updated, we should follow the
rulemaking process to update those rules.
Tailoring
Finally, I would like to emphasize the role of tailoring in regulation and supervision.
Tailoring was a core feature of the response to the 2008 financial crisis and since then
has been the subject of a concerted effort to refine and improve the regulatory and
supervisory framework based on experience since the framework was implemented.5
Tailoring has proven to be an effective and efficient way to regulate and supervise
banks of all sizes.
Of course, all of you here today are very familiar with risk-based supervision, which is
itself a form of tailoring, focusing supervisory attention on areas that pose the greatest
risks. But tailoring also helps us adopt meaningful differences in regulatory
requirements and supervisory expectations, depending on the size and complexity of
the regulated institution, from the largest G-SIBs to the smallest community banks. This
tailored approach manifests itself across the spectrum from the stringency of capital
requirements, the regulatory reporting obligations, and the frequency of examination,
among many others.
Time has demonstrated the virtues of this tailored approach. The U.S. banking system
entered the early days of the COVID-19 pandemic with high levels of capital and
liquidity, and banks of all sizes supported the economy during the darkest days of the
pandemic and have continued to support the economy ever since. This tailored
approach should continue to feature prominently in upcoming proposed revisions to the
capital framework. While I expect the Board will propose new capital requirements for
the largest institutions, including the Basel III "endgame" reforms, I do not expect every
tier of firms to be subject to the same changes. And my understanding is that there are
no plans to propose changes to the community bank capital framework as part of this
capital review.
This tailored approach is sensible not only by matching regulation to risk, but it is
embedded in the statutory framework. For example, the bipartisan Economic Growth,
Regulatory Relief and Consumer Protection Act included several elements designed to
tailor regulatory requirements. For the largest firms, this law instructs the Board to tailor
its "enhanced prudential standards" framework-the strictest standards-to firms based on
the risks they pose. This statute also reduced the burden on smaller institutions,
including through the community bank leverage ratio, the creation of short-form call
reports for smaller community banks and a longer examination cycle for small,
wellcapitalized banks. In my view, the current community bank capital requirements,
including the community bank leverage ratio, are functioning well.
In practice, tailoring requires a framework that both distinguishes firms by size, risk, and
complexity, and imposes appropriate regulatory requirements in light of these
differences. The largest institutions are classified by a number of factors including size,
cross-jurisdictional activity, reliance on short-term wholesale funding, off-balance sheet
exposures, and nonbank assets. These factors, and the G-SIB scoring methodology
more broadly, help contrast the largest firms that pose the greatest risks with the
smaller and less systemic firms. This translates into a regulatory regime where the
GSIBs are subject to the most stringent standards, incorporating enhancements like a
GSIB-specific risk-based capital surcharge and the enhanced supplementary leverage
ratio. Even the smallest banks are subject to size and risk considerations in their
supervisory expectations, like a longer examination cycle, and straight forward capital
and liquidity requirements and expectations.
This very intentional approach accomplishes utility and efficiency, for both regulators
and the regulated institutions, that would be otherwise impossible. Tailoring our
regulatory approach enables us to strike an appropriate balance for each relevant bank
tier, with requirements that address risks, including financial stability risks, while
recognizing the costs of over-regulation.
Closing
We have a dynamic financial system in the United States, a system that has long been
supported by having independent and accountable regulators. As the financial system
has evolved over time, so has the regulatory and supervisory framework designed to
further the goals of safety and soundness, and financial stability. In my view, it is
important that we continue to emphasize the value of accountability and transparency,
while continuing to improve the fairness and efficiency of this framework.
These views are my own and do not necessarily reflect those of my colleagues on the
Federal Reserve Board or the Federal Open Market Committee.
2
Chair Jerome Powell, "Panel on Central Bank Independence and the Mandate-
Evolving Views" (PDF) (speech at the Symposium on Central Bank Independence,
Sveriges Riksbank, Stockholm, Sweden, January 10, 2023).
3
See, e.g.,
12 U.S.C. 1842(b)(1); 4807(a).
4
See
Banking Applications Activity Semiannual Report (PDF), January 1-June 30,
2022, Vol. 9, No. 2, Table 1, "Dispositions and processing times of proposals,
20182021 and 2021:H1 and 2022:H1" (December 2022).
5
Economic Growth, Regulatory Relief, and Consumer Protection Act, Pub. L. No.
115174, 132 Stat. 1296 (2018); Chris Dodd and Barney Frank, interview by David
Brancaccio , Marketplace, September 12, 2018; Daniel K. Tarullo, "Departing Thoughts"
(speech at the Woodrow Wilson School, Princeton, NJ, April 4, 2017); Randal K.
Quarles, "Between the Hither and the Farther Shore: Thoughts on Unfinished Business"
(speech at the American Enterprise Institute, Washington, DC, December 2, 2021).