Federal Reserve Gov. Michelle Bowman reiterated her stance Wednesday on the proposed regulatory capital requirement changes, stating capital alone cannot substitute for sound risk management and supervision — most improvements are possible without overhauling frameworks.
While speaking at the Marrakech Economic Festival in Morocco, Bowman noted that recent bank failures exposed deficiencies in supervision, heightening financial stability risks. However, she said effective regulation is critical for mitigating vulnerabilities.
“In my view, regulatory reform can pose significant financial stability risks, particularly if those changes to regulation fail to take sufficient account of the incentive effects and potential consequences,” she said. “Regulatory actions also have the capacity to depress economic activity through the reduced availability of credit or by limiting the availability of financial products or services.”
Bowman did not oppose the regulatory framework altogether but emphasized that the focus should be on expanding the regulatory boundary and addressing the regulatory gaps, allowing innovation in the banking space while enforcing the existing regulation.
“Inhibiting innovation in the banking sector could push growth of certain products and services further into the nonbank sector, leading to much less transparency and potentially greater financial stability risk,” she said.
Bowman also took a dig at the supervisory practices leading up to the failure of Silicon Valley Bank, saying supervision must go beyond compliance to proactively identify and escalate core safety and soundness issues based on banks’ risk exposures and conditions. Failing to address critical deficiencies in a timely manner enables risks to grow, she said.
“To effectively support financial stability, bank supervision cannot simply rely on pinpointing compliance issues, failed processes or rule violations,” Bowman said.
As regulations become more complex, supervisors should be adequately equipped to maintain rigorous oversight to maintain the highest quality of supervision, Bowman said. Bank leadership should be a part of the supervision, and any changes should be transparent and implemented with full knowledge of the trade-offs and unintended consequences, she said.
Bowman has time and again voiced her concern over the capital requirements proposal, noting she favors stricter bank supervision. She voted against the July proposal, saying there was insufficient proof that showed the benefits of the proposal would justify the cost related to it.
“Policymakers should carefully consider whether the contemplated significant increases in capital requirements in the United States related to the finalization of Basel III capital standards meet this standard for being efficient and appropriately targeted,” Bowman said Wednesday.
Under the new proposed rule, U.S. banks with more than $100 million in assets will face stricter capital requirements — a decision prompted by the failures of several banks of that size in March and May.
In June, Martin Gruenberg, the Federal Deposit Insurance Corp. chair, stressed the liquidity run at Silicon Valley Bank could have been avoided had the Basel III standards been maintained since “there would have been more capital held against these assets."
Following the financial crisis in 2007-08, U.S. agencies laid out rules to strengthen the banking system with major revisions to the capital framework, consistent with the Basel Committee on Banking Supervision standards. The committee issued a new set of revisions in 2017.
Other areas of concern
Bowman warned that rising interest rates could erode loan quality and earnings as economic activity slows. Banks relying on expensive deposits and holding long-term, low-rate assets face revenue drags that may persist if rates stay elevated, while realized losses from these asset sales could also hit the capital. So, ongoing monitoring of these risks is critical with prompt action when needed to stop spillovers, she said.
Another area of concern is potential declines in commercial real estate values that could weaken related loan quality, Bowman said. Lower office occupancy may increase vacancies and pressure on property values, especially in cities and retail. A slowing economy could further hit CRE loans as rates stay elevated or property values drop, she said.
Bowman also highlighted other vulnerable areas posed by large nonbank financial institutions.
“Hedge fund leverage remains elevated and prime money market funds, insurance companies, and some corporate bond mutual funds remain vulnerable to run risks,” she said. “These are not novel vulnerabilities, however, as the nonbank financial institution sector continues to expand, monitoring these risks has become especially important.”
