Quarles to tell House panel: regulatory framework strong, but improvements are still possible

While the Federal Reserve has taken steps to make the current regulatory framework more effective, that framework can still be improved – while continuing to monitor for emerging risks to the financial system, the central bank’s top supervisory official will tell a House committee Tuesday.

In written remarks distributed Monday (to be delivered Tuesday before the House Financial Services Committee), Federal Reserve Board Vice Chairman for Supervision Randal Quarles wrote that the reforms adopted since the financial crisis of 2007-08 represent a substantial strengthening of the Fed’s regulatory framework and “should help ensure that the U.S. financial system remains able to fulfill its vital role of supporting the economy.”

But the framework’s effectiveness can be improved, Quarles wrote.

“There are other areas where I believe that we can increase the framework’s effectiveness, and we will look to do so where we are confident that we still have all appropriate tools needed to maintain the gains in safety and soundness made over the past several years,” he wrote.

However, Quarles counseled continued vigilance for risk within the financial system. “This calls for better analysis and more agility by supervisors in identifying emerging risks, as well as vigilance against complacency,” he wrote.

In other comments, Quarles will tell the committee:

  • In the aggregate, banks realized profits of approximately $152 billion during 2017. While total net income fell in 2017 compared with 2016, he wrote that this was largely a result of non-recurring items. Total loans held by U.S. commercial banks grew roughly 5% during 2017; the loans now exceed the previous peak from 2008.
  • The largest U.S. banking organizations–those the failure of which would pose the greatest risk to the financial system and that are subject to the Federal Reserve’s stress testing framework–have increased the dollar amount of their loss-absorbing common equity capital by more than $700 billion since 2009, more than doubling their common equity capital ratios from approximately 5% to more than 12%.
  • The eight U.S. global systemically important banking organizations (G-SIBs) have developed significantly more stable funding positions as their reliance on short-term debt–including repurchase agreement, or repo, financing–has decreased by more than half since 2007 and now is equal to less than 15% of their total assets. The big banks now also hold approximately $2.4 trillion in “high-quality” liquid assets, representing an increase of more than 60% since 2011.
  • The 5,000 community-based bank holding companies (subject to Federal Reserve oversight) show marked improvements in profitability that have contributed to a strong overall capital position. Community banks reported net income of $20.6 billion during 2017, up 4% from 2016. “The banks also experienced particularly strong loan activity, as their most recent year-over-year loan growth of 7.7% materially exceeded that of the banking industry as a whole,” Quarles will tell the committee.
  • The Fed continues to emphasize the need for banking organizations to maintain underwriting discipline and strong risk-management practices. Particular focus is placed on banking organizations that have or are developing concentrations in loan segments vulnerable to adverse economic developments. He wrote that banks generally would also be vulnerable to an unexpected and swift change in the shape of the yield curve.

Semiannual Supervision and Regulation Testimony, Vice Chairman for Supervision Randal K. Quarles