Institute for Financial Transparency

Shining a light on the opaque corners of finance


Bank Regulatory Pendulum Swings Back To Light Touch

Barely a decade after the Great Financial Crisis began and already the argument is being made the post-crisis regulatory response went too far and its time to ease up on bank oversight.

Regular readers know there is a regulatory pendulum that swings between anything goes and mildly restrictive regulations and enforcement.  Clearly, we have seen the extreme of mildly restrictive and now are headed back to anything goes.

For example,

With Quarles on board, banks and analysts expect the Fed to ease aspects of everyday examination and supervision, in particular reducing the number of post-inspection notices demanding fixes to technical compliance issues, ranging from sales practices to outsourcing contracts….

The Fed has indicated it is willing to refine stress tests, but Quarles is expected to push ahead with an overhaul – making the assumptions more generous, giving banks more information on the models, or moving to a less onerous two-year cycle. He is also likely to phase-out the qualitative aspect of the tests which gives the Fed wide-ranging discretion to fail lenders, bank lobbyists said.

In addition, and signifying the end of regulatory interest in increasing bank capital requirements:

Former Federal Reserve governor Jeremy Stein, now back at Harvard, and three of his colleagues say big banks have a good point: Post-crisis rules on capital are way too complicated and are having unwelcome, unintended consequences….

Their solution is to streamline the capital rules into a single risk-based constraint, one that reflects the findings of stress tests that regulators conduct regularly to gauge the losses a bank would suffer if the economy deteriorates.

One of the reasons FDR and his Administration made transparency the foundation for the redesign of the global financial system is market discipline doesn’t have an anything goes mode.

Investors know they are responsible for the losses on their investments.  This is always true.  As a result, they constantly adjust their exposures based on the risk of their investments.  Market discipline is the aggregated effect of all the investors adjusting their exposure to reflect changes in the risk of the underlying investment.