The Fed Reserve’s New Bank Supervision: Ease Requirements and Streamline Oversight

The Federal Reserve is looking anew at how it supervises banks. Michelle Bowman, the newly appointed Federal Reserve Vice Chair for Supervision, sketched a vision that could change how big banks as well as small community ones operate.

Streamlined supervision could lessen the operational and financial burden on credit card issuers, especially mid-sized and regional banks, freeing up capital for other things like product innovation or exploring riskier lending segments.

Bowman pointed out a growing imbalance between supervision and bank health. Regulations have grown more concerned with form at the cost of function and a reboot centered on common sense and sound judgment is needed, said Bowman, speaking at Georgetown University recently.

Her message, in a nutshell, is it’s time to get focused on actual risks — and weed out regulatory noise.

Supervision has lost its way, Bowman warned, paying insufficient attention to real threats to finances such as liquidity or credit, and paying too much attention to documentation issues. She recommended the Fed return to basics: making sure banks are sound and acting quickly if they are not.

She also protested horizontal examinations that compare banks side by side, which she said not only miss the mark but punish small banks for not modeling on the bigger banks. Instead, she would like examinations more tailored to a bank’s size as well as situation.

She panned current rating systems — especially for larger banks under the Large Financial Institution system — as out of touch. Banks that were poorly rated were meeting their funding demands. Bowman believes it’s a credibility issue on the Fed’s part.

“Our goal should not be to prevent banks from failing or even eliminate the risk that they will,” said Bowman. “Our goal should be to make banks safe to fail, meaning that they can be allowed to fail without threatening to destabilize the rest of the banking system.”

One of Bowman’s more specific targets was curbing regulatory flexibility at small banks. She complained about the trend of applying big-bank regulations to community lenders that operate in a very different environment.

She wants to build a new regulatory framework that shields smaller banks from expectations set for much larger banks. One such initiative is a new conference this fall with a definite agenda focused instead on community bank issues.

She also highlighted growth in check fraud as a critical issue. She promised action and said the Fed is working with the FDIC and Office of the Comptroller of the Currency on steps to reduce losses as well as speed responses.

Bowman indicated change is on the way for requirements on capital. She was particularly scathing on the more rigid enhanced supplementary leverage ratio (eSLR), a rule meant as a safeguard, for distorting banks’ size.

She explained that the rule actually discourages banks from making low-risk transactions like trades in Treasuries, a decision that can be harmful to market functioning. A resolution is in development, with even more potential change on the horizon.

The Fed is planning a July conference to consider changes to stress testing, GSIB surcharges, and Basel III capital requirements. Bowman said all updates need to be made with an eye toward transparency as well as ensuring requirements are aligned with risks.

Smaller banks would also be a focus. Bowman suggested the community bank leverage ratio would need change and floated innovations on evolving mutual bank capital formation.

Bowman said most regulations made after the 2008 financial crisis were made to address yesterday’s problem — and may be perpetuating more problems than they address today. It is time for some housecleaning, she said.

Under the Economic Growth and Regulatory Paperwork Reduction Act review process, the Fed, as well as other agencies, would sift through outdated regulations and see what no longer applies.

Bowman also called for a reexamination of any regulations on insider lending, affiliate transactions, as well as state-chartered bank activities, some of which have not been updated in decades.

She also confronted the often slow, frustrating process banks go through when they seek a merger, charter, or regulatory sanction. She called it a confusing system bogged down with duplicative information requirements.

She asked for shorter timelines, more consistent standards, and a better system for processing public comments without presenting new facts. In rural markets, she said, antiquated competitive screens are holding back transactions that would benefit under-served communities.

Not everyone is cheering Bowman’s plan. Some see it as a stealthy push toward deregulation that would leave the financial system more open.

Critics of Bowman’s plan view it as a move toward deregulation and instability.

Dennis Kelleher, CEO of Better Markets, has argued that we’ve learned the hard way what happens when supervisors underreact to early warning signs.

Sarah Bloom Raskin, a former Federal Reserve Governor, has also voiced concern about moves that soften capital or stress-testing regimes. She says that there’s no innovation without stability — cutting the rulebook won’t serve anyone in the long run.

Critics worry loosening oversight would tip the playing field in favor of giant companies at consumer expense.

In her speech, Bowman returned to a key theme: It’s not a matter of eliminating all risk, but of containing it with a thoughtful methodology. That requires a supervisory system strong enough in its flexibility to adjust in an ever-changing world.

She promised greater standards for training examiners and ensured that on-the-ground teams will be well credentialed. That’s particularly important, she stressed, as older, veteran employees retire and new ones replace them.

“Conditions constantly evolve in the banking system, and so too must the regulatory and supervisory framework,” Bowman said. Her message to banks: smart oversight is on its way — and it won’t be business as usual.