The Federal Reserve has not communicated as clearly as it could with the banks it supervises, the vice chair for supervision of the agency’s board said Friday – a situation he wants to address with a multi-faceted approach aimed at providing more transparency and clarity.
“Supervision is most effective when expectations are clear and supervision promotes an approach to risk management that deters bad behavior and decisions by banks,” Fed Vice Chair for Supervision Randal Quarles told the American Bar Association Banking Law Committee Meeting 2020, in Washington, D.C.
“I don’t believe the Federal Reserve has communicated as clearly as it could with the banks we supervise,” he said. “More transparency and more clarity about what we want to achieve as supervisors and how we approach our work will improve supervision, and I have several specific proposals.”
Quarles said his methods for addressing transparency and clarity would “square the public interest in agile supervision with the public interest in transparency and accountability.” He said the methods he recommended would increase transparency, accountability, and fairness, and would make “supervision more efficient and effective, and our financial system stronger and more stable.”
The Fed vice chairman outlined actions in three categories: large bank supervision; transparency improvements; and overall supervisory process improvements.
Large bank supervision
Quarles said his goal is to develop a “clear and transparent standard” for identifying banks that fall under the Fed’s Large Institution Supervision Coordinating Committee (LISCC).
“My preferred approach for achieving this objective would be to align the LISCC portfolio with our recent tailoring categorizations,” he said. He added that the Fed should “draw the LISCC line” to coincide with firms under Category I of the Fed’s new tailoring rules (which hold the greatest risk portfolio). “The justification for this line-drawing is that Category I firms pose the most systemic risk and require the most supervisory attention. In this state of the world, Category II and III firms would remain subject to heightened supervisory standards that are commensurate with their risk profile.” (Category II and III firms are considered less systemic than Cat 1 firms.)
Quarles also proposed publishing the internal procedural materials the Fed uses to supervise LISCC firms (the so-called “Program Manual”). “Publishing the Manual would help the public and the banks better understand why we take the actions that we take as supervisors and would demystify some of our processes,” he said.
The Fed governor called those two actions “simple steps” that would go a long way in helping to make the agency’s supervisory practices more understandable and accessible “without undermining supervisory effectiveness.”
Regarding stress tests (under the Comprehensive Capital Analysis and Review [CCAR]), Quarles said he expects the Fed to continue to provide more transparency on the models used in tests.
He also said that, as part of the stress capital buffer, the Fed will give banks more time to review their stress test results and understand their capital requirements before they must provide their final capital plan. Further, he said the Fed continues to “look for ways to reduce the volatility of stress-test requirements from year to year.”
To increase supervision transparency, the vice chairman proposed three actions:
- Creation of a word-searchable database on the Fed’s website with the historical interpretations by the Federal Reserve Board (FRB) and its staff of all significant rules.
- Issue significant supervisory guidance for public comment.
- Submit significant supervisory guidance to Congress for purposes of the Congressional Review Act (CRA).
Overall supervisory improvements
Quarles laid out five points for improving overall supervision:
- Increase the ability of supervised firms to share Fed confidential supervisory information (CSI) with employees, affiliates, service providers, and other government agencies “to promote greater compliance with laws and facilitate the response to enforcement actions.”
- Adoption of a rule on how the Fed uses guidance in the supervisory process.
- Restoration of the “supervisory observation” category for lesser safety and soundness issues. “This approach would provide supervisors with a tool – supervisory recommendations – for continuing to raise concerns about less pressing supervisory matters while focusing a bank’s attention on the most urgent matters,” Quarles said, or those that would receive “matters requiring attention” (MRA) notices from the agency.
- Limit future MRAs to violations of law, violations of regulation, and material safety and soundness issues. “In limiting MRAs to legal violations and significant supervisory concerns, we would take care to clearly define the breadth of what constitutes a ‘material safety and soundness issue,’” Quarles told the group.
- Make routine the Fed’s existing practice of providing an independent review of important supervisory communications and guidance documents.