Governor Bowman calls for transparent supervisory expectations and attention to the consequences of regulatory reform on the broader financial system.
On June 25, 2023, US Federal Reserve Board (FRB) Governor Michelle W. Bowman gave a speech that outlined her views of the best path forward for regulatory reform in the wake of the spring 2023 US bank failures (for more information, see this Latham blog post). To achieve optimal supervisory results and preserve a dynamic banking sector, while minimizing unintended consequences, Governor Bowman cautioned against implementing higher capital requirements on banks based on incomplete information or erroneous assumptions. Instead, she recommended bolstering institutional risk management and the effectiveness of the FRB’s supervisory program.
Countering the Barr Report
Governor Bowman once again criticized some of the conclusions of the April 28, 2023, report published by Federal Reserve Board Vice Chair for Supervision Michael Barr (the Barr Report) that analyzed the context and causes of one of the major US spring 2023 bank failures. The Barr Report indicated that the FRB plans to revisit the tailoring framework that it developed following passage of the Economic Growth, Regulatory Relief and Consumer Protection Act (EGRRCPA — S. 2155), the 2018 bipartisan banking law that relaxed provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. EGRRCPA resulted in lower capital and liquidity requirements for the failed bank under review in the Barr Report. Barr stated that the FRB will therefore reevaluate the application of enhanced prudential standards, liquidity, and capital requirements for banks with US$100 billion or more in assets.
Taking issue with the findings in the Barr Report, Governor Bowman noted in a April 14, 2023, speech that although the bank failures have “demonstrated that some changes may be warranted,” they are not “an indictment of the broader regulatory landscape.” She reiterated similar sentiments in a May 12, 2023, speech, warning against shifting away from tailoring and risk-based supervision, and stating that “[t]he unique nature and business models of the banks that recently failed, in my view, do not justify imposing new, overly complex regulatory and supervisory expectations on a broad range of banks.”
In the most recent speech, Governor Bowman also denied that EGRRCPA contributed to recent bank stress, echoing sentiments shared by Federal Deposit Insurance Corporation (FDIC) Vice Chairman Travis Hill on April 12, 2023 (for more information, see this Latham blog post), and in contrast with the White House’s recommendation that regulators reverse some of the 2018 deregulatory measures (for more information, see this Latham blog post).
Analyzing the Recent Bank Failures
Governor Bowman noted that recent attempts by regulators to analyze the root causes of the spring bank failures “rel[ied] on a limited number of unattributed source interviews, and completed on an expedited timeframe with a limited scope,” and that no other FRB Governors were permitted to review or contribute to the Barr Report before it was published. She called for an independent, third-party investigation into the bank failure under consideration in the Barr Report to help calibrate the regulatory reform agenda that is already taking shape. Governor Bowman insisted on further “review, analysis, and discussion” before implementing any regulatory reform that may have ramifications for the broader financial system.
Capital Requirements
Governor Bowman said higher capital requirements that are disproportionate to risk could hinder bank lending and diminish the competitiveness of US banks on the international stage. She contended that US regulators often adopt a “gold plating” approach to certain requirements of the Basel III international capital framework, “layering on higher or expanded requirements above those adopted internationally, including an added stress capital buffer, the enhanced supplementary leverage ratio, and the ‘method two’ calculation methodology for the global systemically important bank (G-SIB) surcharge.”
Higher capital requirements could also drive financial activity out of the regulated banking system, and into the shadow banking system where non-bank companies offer financial services with lower costs and regulatory burdens.
Although the intention may be increased resiliency and risk mitigation in the financial system, higher capital requirements also heighten the risk of increased costs, decreased competition, decreased credit availability, and increased cost of credit. Governor Bowman therefore urged that regulators consider the tradeoffs of implementing higher capital requirements. “At a certain point,” she noted, “regulatory requirements become unmoored from risk and force good banks out of the market.” She fears that the consequences would be felt most in the mid-size bank tier, resulting in a market with a few too-big-to-fail banks on one end, and smaller community banks at the other, with very little in between.
FRB Chairman Jerome H. Powell recently echoed such concerns, stating that tradeoffs must be evaluated when considering regulatory reform, and affirming that preserving a multi-tiered and diverse banking sector is important.
Emerging Technologies
Governor Bowman also criticized the absence of a clear regulatory framework in the US for novel technologies, in particular banking as a service and digital assets. Leaving financial institutions “in a supervisory void” puts them at risk of arbitrary supervision and enforcement, which is at odds with two regulatory reform principles Governor Bowman believes are critical: transparency and due process. Regulators should improve their engagement with emerging technologies to “build capacity to embrace, evolve with, and respond to emerging risks.”
Conclusion
Overall, Governor Bowman calls for a fully informed and more circumspect approach to regulatory reform. She continues to see the benefit of risk-based supervision and tailoring (i.e., aligning supervision and regulation with bank risk and complexity) and opposes regulatory reform that erodes this traditional approach to banking oversight. Ultimately, she insists that any regulatory reform consider all consequences and practical outcomes (both intended and unintended) on individual institutions, the banking sector, the wider financial system, and ultimately consumers.
Governor Bowman’s stance on these issues may have been corroborated by the latest round of annual FRB stress testing. During the hypothetical severe recession and commercial real estate shock that the FRB tested for, all 23 banks under review remained above their minimum capital requirements. Vice Chair for Supervision Barr commented positively on the results, as they demonstrated strength and resilience in the US banking sector. He did note, however, that the FRB “should remain humble about how risks can arise” in the financial system. Based on her repeated calls for further review, analysis, and discussion, Governor Bowman would likely add that one potential source of banking sector risk is rash regulatory reform.
Latham & Watkins will continue to monitor developments in this area.
