January 22, 2018

Fed Board’s Randal Quarles calls for regulatory efficiency, transparency at ABA Banking Law Conference

Randal K. Quarles, vice chair for supervision of the Federal Reserve Board of Governors, called for more efficiency, transparency and simplicity of regulations in the U.S. financial system during a Jan. 19 speech at the ABA Business Law Section’s Banking Law Conference in Washington, D.C.

Federal Reserve Board vice chairman for supervision Randal K. Quarles was the keynote luncheon speaker at the Business Law Section’s Banking Law Conference on Friday, Jan. 19 in Washington, D.C.


“By efficiency I mean the degree to which the net cost of regulation–whether in reduced economic growth or in increased frictions in the financial system–is outweighed by the benefits of the regulation,” he explained. In other words, if we have a choice between two methods of equal effectiveness in achieving a goal, we should strive to choose the one that is less burdensome for both the system and regulators.

As for transparency, Quarles said lawyers are trained to view transparency as a necessary precondition to the core democratic ideal of government accountability. “The governed have a right to know the rules imposed on them by the government,” he said. “In addition, there are valuable, practical benefits to transparency around rulemaking; even good ideas can improve as a result of exposure to a variety of perspectives.”

Simplicity of regulation, he said, “is a principle that promotes public understanding of regulation, promotes meaningful compliance by the industry with regulation and reduces unexpected negative synergies among regulations. Confusion that results from overly complex regulation does not advance the goal of a safe system.”

Quarles, who was appointed by President Donald Trump three months ago, laid out his vision for charting a course forward on financial regulation aimed at large banks. He acknowledged that post-crisis financial regulation has resulted in critical gains in the financial system — higher and better-quality capital, innovative stress-testing, new liquidity regulation and improvements in the resolvability of large firms.

“We undoubtedly have a stronger and more resilient financial system due in significant part to the gains from those core reforms,” Quarles said.

Quarles said the achievements are consistent with the responsibility of the Federal Reserve to be a steward of a safe financial system, and with the goal of maintaining the ability of banks to lend through the business cycle.  Still, he said, more can be done.

“That said, the Federal Reserve and our colleagues at other agencies have now spent the better part of the past decade building out and standing up the post-crisis regulatory regime,” Quarles said. “At this point, we have completed the bulk of the work of post-crisis regulation, with an important exception being the U.S. implementation of the recently concluded Basel III “end game” agreement on bank capital standards at the Basel Committee. As such, now is an eminently natural and expected time to step back and assess those efforts. It is our responsibility to ensure that they are working as intended and — given the breadth and complexity of this new body of regulation — it is inevitable that we will be able to improve them, especially with the benefit of experience and hindsight.”

He then outlined what he thinks is next for post-crisis regulation, beginning with the issue of tailoring supervision and regulation to the size, systemic footprint, risk profile and business model of banking firms.

“I would emphasize that tailoring is not an objective limited in scope to a subset of the smallest firms,” he said. “We should also be looking at additional opportunities for more tailoring for larger, non-global systemically important banks. In this regard, I support congressional efforts regarding tailoring, whether by raising the current $50 billion statutory threshold for application of enhanced prudential standards or by articulating a so-called factors-based threshold. I believe we at the Federal Reserve have the responsibility to ensure that we do further tailoring for the institutions that remain subject to our rules to ensure that regulation matches the risk of the firm.”

Another area Quarles said needs revisiting is what he called the "advanced approaches" thresholds that identify internationally active banks.

“These thresholds are significant not only for identifying which banking firms are subject to the advanced approaches risk-based capital requirements, but also for identifying which firms are subject to various other Basel Committee standards, such as the supplementary leverage ratio, the countercyclical capital buffer and the LCR,” he explained. “The metrics used to identify internationally active firm —$250 billion in total assets or $10 billion in on-balance-sheet foreign exposures—were formulated well over a decade ago, were the result of a defensible but not ineluctable analysis and have not been refined since then. We should explore ways to bring these criteria into better alignment with our objectives.”

Also, up for review is a meaningful simplification of the framework of loss-absorbency requirements. He said there are different ways to count the number of loss-absorbency constraints that our large banking firms face. “That in itself is an indication of a surfeit of complexity if we can’t be perfectly sure of how to count them — but the number I come up with is 24 total requirements in the framework,” he said to laughter. “While I do not know precisely the socially optimal number of loss absorbency requirements for large banking firms, I am reasonably certain that 24 is too many.”

Quarles said candidates for simplification include: elimination of the advanced approaches risk-based capital requirements, one or more ratios in stress testing, and some simplification of our TLAC rule. “I am not the first Federal Reserve governor to mention some of these possibilities, and we should put them back on the table in the context of a more holistic discussion of streamlining these requirements,” he said. “Let me be clear, however, that while I am advocating a simplification of large bank loss-absorbency requirements, I am not advocating an enervation of the regulatory capital regime applicable to large banking firms.”

Quarles said the Fed Board’s complex and occasionally opaque framework for making determinations of control under the Bank Holding Company Act (BHC Act) is another area that is ripe for re-examination through the lenses of efficiency, transparency, and simplicity.

The final emerging area for review, Quarles said, is enhanced stress-testing transparency.

“I personally believe that our stress-testing disclosures can go further,” he said. “I appreciate the risks to the financial system of the industry converging on the Federal Reserve’s stress-testing model too completely, so I am hesitant to support complete disclosure of our models for that reason. However, I believe that the disclosure we have provided does not go far enough to provide visibility into the supervisory models that often deliver a firm’s binding capital constraint.”