The job of the new Federal Reserve vice-chair of supervision is clear: keep the financial system stable. The harrowing experience of the 2008 financial crisis demonstrated the costs of failing to do this task properly. The much more successful navigation of the coronavirus pandemic by big US banks — supported by monetary largesse — showed, by contrast, what can be gained from stricter regulation of a sector that is so fundamental to the wider economy. For that reason former Treasury official Sarah Bloom Raskin is a welcome choice by president Joe Biden for the nomination.
If confirmed, the appointment ought to mean an end to the erosion of post-financial crisis regulations by her predecessor Randy Quarles, appointed by former president Donald Trump. In a supposed “tailoring” of the rules to the specific circumstances of banks, the Fed made it possible for midsized lenders to reduce their capital and liquid reserves — the buffers they keep in case of adverse conditions. Many banks, too, could then avoid the “stress tests” that had become a fundamental plank of post-crisis regulation, assessing whether banks could cope with a sharp downturn in the wider economy.
This process has weakened the banking system and made it more vulnerable. With signs of excess risk-taking and irrational exuberance in a bubbly market, as well as the Fed beginning a process of monetary tightening, this easing should firmly go into reverse. There is no need for further regulation at the moment, just a need to return to the lower thresholds and enforce the existing rules properly. In common with other large economies, the US has never used its existing countercyclical buffer, a requirement to increase capital levels in good times.
The next challenge is regulating non-banks — lenders such as private debt funds — that fulfil many of the same functions of banks but escape the particular legal definition and hence many of the same rules. This encourages “regulatory arbitrage”, pushing financial risk into the shadows. The interactions between these institutions and their more conventional peers can then spread vulnerabilities through the system. A fragmented US regulatory system allows these shadow banks, as well as fintech and crypto companies, to fall through the cracks.
Raskin’s Senate nomination hearings, however, are likely to be controversial given her belief that the Fed should incorporate climate change risks into its pursuit of financial stability. Lael Brainard, Biden’s nomination for Fed vice-chair, faced intense Republican questioning during her hearing at the Senate banking committee over her commitment to the Fed’s political independence and her, similar, belief that the Fed should examine climate-related risks to financial stability. She ruled out preventing lending to oil and gas companies but made it clear the central bank would expect banks to monitor the associated risks with care.
While it would be preferable if climate policy were not left to technocrats, ultimately anything that could imperil the banking sector is within the Fed’s bailiwick. Climate change is an inherently political topic — with scientific consensus over its man-made cause there is still controversy over the speed of the clean-energy transition — but that cannot be an excuse for regulators to do nothing. Even outside the realm of drillers and miners, much of America’s property-related assets, both residential and commercial, sit on areas vulnerable to higher sea levels or forest fires. The Fed must make sure that banks monitor and take into account these risks, co-operating with other agencies.