Crisis can arise anew; ‘hard-won’ improvements in regulation must be preserved, FDIC leader says

It would be a mistake to assume a severe downturn or crisis cannot happen again, and “all of us” have a stake in preserving hard-won improvements in the strength and stability of the nation’s banking system achieved in the wake of the financial crisis, the outgoing chairman of the Federal Deposit Insurance Corp. (FDIC) told a Washington audience Tuesday.

Speaking at the Brookings Institution, FDIC Chairman Martin Gruenberg (whose term at the deposit insurance agency ends this month) said that history shows surprising and adverse developments in financial markets occur with some frequency.

“History also shows that the seeds of banking crises are sown by the decisions banks and bank policymakers make when they have maximum confidence that the horizon is clear,” Gruenberg said to about 100 persons in the audience at the think-tank event. “It is also worth keeping in mind that the evolution of the global financial system towards greater interconnectedness and complexity may tend to increase the frequency, severity , and speed with which financial crises occur.”

Gruenberg said there is room to “simplify or streamline” some aspects of prudential regulation without sacrificing safety-and-soundness objectives. He pointed to a simpler Volcker Rule compliance regime, ways to reduce compliance costs associated with company-run stress tests and resolution plans, and simplifications to capital rules for smaller banks

However, he said that the danger to a continued strong and safe banking system is that changes to regulations could cross the line into substantial weakening of requirements.

“Let’s be clear: Our largest banking organizations are not voluntarily holding the enhanced capital and liquid asset cushions required by current rules,” he said. “Some have made quite clear that, left to their own devices, they would operate with less capital and less liquidity.”

He said that, if and when some banks go down such a path, others will be pressured by shareholders to do so as well, to boost return on equity by operating with less capital.

“A well – functioning bank regulatory system should provide a set of guardrails that allows for healthy and sustainable access to credit without endangering stability or unduly exposing the Deposit Insurance Fund,” the FDIC chairman said. “Our aim should be a regulatory framework in which banks provide a sustainable volume of well – underwritten credit that can support the economy.”

Gruenberg said that weakening the core reforms that apply to the nation’s largest banking organizations would increase the risk of future banking crises that would be very costly for the U.S. financial system and economy .

“As I have indicated in the past, I would particularly raise a concern in regard to weakening capital requirements for systemically important financial institutions. I refer specifically to the idea of removing central bank exposures, Treasury securities, and initial margin from the calculation of the Enhanced Supplementary Leverage Ratio and lowering the ratio,” he said. “These changes would be at odds with the purpose of the leverage ratio, which has served for many years in the United States as a simple, unweighted measure that limits excessive leverage, and complements, rather than mimics, the risk – based capital framework.”

Financial Regulation: A Post – Crisis Perspective