Now that Michael Barr has been confirmed to join the Federal Reserve Board’s Vice Chair for Supervision, the Board’s last vacancy has finally been filled and a regulatory agenda held in abeyance can now see action. The nation’s banks may have survived the pandemic with capital intact, but problems like Too Big To Fail — which forced a taxpayer bailout of banks in the last crisis — persist.
The agenda also includes examining the Fed’s emergency facilities in response to the pandemic, emerging risks presented by cryptocurrencies and markets, rules relating to bank chartering and mergers, and the moribund designation of systemically risky firms — and tame inflation too. We survey and comment on that agenda below.
The Vice Chair for Supervision position at the Federal Reserve is filled with Michael Barr sworn in last month as the nation’s chief banking regulator, making this the first time since 2018 that the Federal Reserve Board has all seven seats filled.
The to-do list before Barr is daunting, but the new Vice Chair for Supervision will need to balance the importance of certain reforms with the political calendar in Washington. Barr has to work expeditiously with allies running other banking agencies while laying the groundwork for tasks he can lead at the Federal Reserve himself.
In this update, we lay out what Barr’s interagency and Fed-specific agendas should look like and make the case for prioritizing interagency efforts in the short-run.
The presidential election in 2024 is a potential deadline for the implementation of interagency reforms. Time is of the essence as Barr’s allies running Treasury, OCC, FDIC, and the CFPB could all be whisked away by a Republican president.
The leading challenge is a review of the pillars of the systemic risk protections in Dodd-Frank, which have either been rolled back or modified so as to obscure rather than clarify the capital preparedness of banks and non-bank financial institutions. Of the items requiring interagency cooperation and sign-off, the priorities are:
- Supplementary Leverage Ratio: The most widely used measure of capital adequacy was softened during the early days of the COVID-induced economic crisis to ensure the financial system held up. Despite Nostradamus-like predictions of collapse if the relief was not extended, the reforms lapsed in March 2021, but there is a clear hunger to permanently alter the SLR. Barr needs to ensure whatever reforms are adopted do not risk the financial system by materially reducing capital levels, particularly for the biggest banks.
- SIFI Designation: The Financial Stability Oversight Council needs to reverse the 2019 SIFI designation guidance that made it more difficult to label systemically risky players, particularly large non-bank firms, as SIFIs. Barr and CFPB Director Chopra could work together to lead the charge on this repeal.
- Bank Mergers: Antitrust in the financial sector is getting a glance following an executive order from President Biden and multiple requests for input from other agencies. More stringent merger guidelines and enforcement would bring competition to the financial sector and potentially mitigate the formation of more Too Big To Fail entities.
- Living Wills: Barr and the FDIC should collaborate on how they can strengthen the requirements for plans on how to deal with financial distress or failure and make the submission of these plans more frequent.
- Cybersecurity: The data financial institutions have access to must be protected and secured. Regulators must ensure firms use the strongest technologies and protections to safeguard their users’ data, have detailed plans and processes in place to prevent hacking via software or employee manipulation, and effectively supervise their third-party providers.
- Crypto: Banking regulators need to explain the significant risks of cryptocurrencies and help financial institutions mitigate said risks. It would also be prudent for the Federal Reserve to get the FedNow instant payment service fully operational to cordon off the rise of assets like stablecoins, which present other financial risks and should not be granted depository insurance.
- FinTech: Regulators should hold the line and not grant any special-purpose national bank charters to FinTech companies and must engage in rigorous oversight over the industry.
- CRA Modernization: Modernizing the Community Reinvestment Act of 1977 in the first significant interagency way in nearly 30 years is already underway. While the initial proposal can be strengthened, the suggested reforms would meaningfully bring the CRA into the 21st century. Barr and other regulators should bolster the proposal by strengthening the racial equity and climate provisions.
- Big Data: Regulators must ensure that any use of big data adheres to fair lending standards and that the factors that inform algorithms are disclosed and transparent.
Squarely on the Fed’s Shoulders
Many of these items are critical for preventing the seepage of risk into the financial sector, but some items may have to wait until bandwidth opens after 2024. Barr will need to work with the rest of the Board on financial stability, systemic risk as well as preparing better for the next crisis by looking again at the variety of facilities deployed by the Fed at the height of the pandemic:
- Stress Tests: Barr needs to roll back the weakening of stress tests under his predecessor by strengthening the financial distress scenarios and removing the methodological disclosures. Barr should also establish scenarios dealing with emerging risks like climate change and crypto as part of the stress test regime.
- Tailoring: Barr ought to reverse the loosening of regulations on banks with assets in the $250B-$700B range, increase liquidity standards, and once again require the use of sophisticated financial models for calculating capital ratios.
- Capital Buffers: The establishment of a Countercyclical Leverage Buffer that would take into account the overall state of the economy should be on Barr’s mind. The Fed should also implement a Countercyclical Capital Buffer as an automatic stabilizer for additional capital requirements that would be tied to metrics like credit-to-GDP ratio, asset valuations, real-estate prices, and financial leverage. The concept of a Stress Leverage Buffer should also be revived in order to better supervise firms following a stress test.
- CCAR Qualitative Objection: Following its demise in 2019, Barr should restore the qualitative objection as part of the stress test process. A qualitative assessment is a critical instrument when quantitative models do not show the entire story of a financial institution’s capacity to incur stress.
- Emergency Lending Facilities: While overall broadly praised, Barr should examine lessons learned from the §13(3) facilities to ensure there is compliance with Congressionally-authorized language as well as to increase the effectiveness and equitability of the programs in future crises. The Fed’s role as a lender to small-and-medium businesses came under intense scrutiny following the deployment of the Main Street Lending Program, and this concept should be further examined as part of how to best structure §13(3) programs.
The Time to Strike
The above agenda reflects our key items as part of a broader consensus among liberals and progressives following numerous conversations with stakeholders. Some items like climate and finishing Dodd-Frank rulemaking are not touched on in this piece but are important nonetheless. If Barr, the Fed Board, and its fellow financial regulatory agency brethren focus on and offer reforms outlined in this agenda, the country and financial system would benefit from the systemic protections as intended in Dodd-Frank
Time is not on Barr’s side. Tension between the immediate need to address systemic risk and the need to engage in interagency work before the 2024 election should not hinder progress. Focusing on the laborious process of interagency reforms is the place to start in the next few months. The items within the exclusive purview of the Fed have a longer time horizon. Barr and his brethren can work with the hundreds of organizations and individuals that would be eager to support the agenda above.