Fed faulted for failing to do more to prevent regulatory capture

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The Federal Reserve Board should take more aggressive steps to prevent regulatory capture in the supervision of the nation’s largest banks, according to a top government watchdog.

The Government Accountability Office concludes in a new report that a seven-year-old Fed-wide supervisory program for big banks should be strengthened, criticizing the Fed’s Board of Governors for so far failing to implement an enterprise risk management framework.

Such a risk management system could help the central bank head off situations where regulators adopt the mindset of the bank they are supervising, a problem known as regulatory capture, the report argues.

Andrew Harrer/Bloomberg

“Among many factors that contributed to the financial crisis of 2007-2009 was weakness in federal supervision of large banks, and some analyses have identified regulatory capture as one potential cause of this weakness,” the GAO wrote in a letter to Reps. Maxine Waters, D-Calif., and Al Green, D-Texas, who requested the report.

The report did not identify any specific instances of regulatory capture at the Fed, though the GAO said that it was not looking for evidence of either the presence or absence of the phenomenon.

Thirteen financial institutions are in the Fed’s supervisory program for large firms. The list includes JPMorgan Chase, Citigroup, Bank of America, Wells Fargo, Goldman Sachs, Morgan Stanley, Barclays, Credit Suisse, Deutsche Bank and UBS.

In 2013, a former employee of the Federal Reserve Bank of New York filed a lawsuit after she was allegedly fired for refusing to change supervisory findings that were critical of Goldman Sachs. The suit was later dismissed. In a more recent case, a former Goldman employee admitted to illegally obtaining confidential documents from a friend who worked at the New York Fed.

“This report is yet more evidence that the Federal Reserve and other prudential regulators need to take the supervision of large banks much more seriously,” Waters said Wednesday in a press release. “Regulators must strengthen the independence of their large bank supervisory programs and fully enforce the law when it comes to wrongdoing by banks.”

Waters and Green asked the GAO to launch an examination of regulatory capture more than two years ago. But the election of President Trump has shuffled the deck in Washington, leading to a new focus on deregulation.

Earlier this week, Comptroller of the Currency Joseph Otting announced that he is nixing a plan to remove OCC employees from the offices of the large banks they supervise. The plan had been aimed at preventing regulatory capture, but Otting said that it was not practical.

The GAO report is the first in a series that the watchdog agency is planning to write on issues related to regulatory capture and supervisory independence at financial regulatory agencies.

The Fed said in its response to the report that it is continuing to refine its large institution supervision program and is developing an enterprise risk management program that will assess the risk of regulatory capture. The Fed also said that it believes the regulatory capture risk is already being managed effectively.