Fed's Barr: Weakening oversight risks 'race to the bottom'

• Key insight: Federal Reserve Gov. Michael Barr worried that too much deregulation could hurt rather than help the financial system. He also said cuts to the Consumer Financial Protection Bureau have weakened oversight of the nonbank sector.
• Expert quote: "If you look at these patterns in history, people start to get complacent, or the political mood in Washington changes, and regulation starts to weaken, and you get a little sugar high at first. But you know that bill comes due, it always comes due, so down the road you might have greater risk." — Federal Reserve Gov. Michael Barr
• Forward look: A federal appeals court is currently deciding whether the CFPB can move forward with widespread layoffs, further minimizing the bureau's ability to oversee parts of the financial services sector.

Federal Reserve Gov. Michael Barr warned Wednesday that the current deregulatory environment can trigger a "race to the bottom" in financial services.
Speaking at an AI symposium hosted by the National Fair Housing Alliance, Barr said loosening oversight in the financial sector can create a "sugar high" initially, but problems may emerge if standards are eased too far.

"If you look at these patterns in history, people start to get complacent, or the political mood in Washington changes, and regulation starts to weaken, and you get a little sugar high at first," Barr said. "But you know that bill comes due, it always comes due, so down the road you might have greater risk."

Barr pointed to his many dissents over the past year on proposed Federal Reserve changes aimed at streamlining regulations, including publicly releasing stress-testing models and implementing new Basel III standards, saying such steps would weaken oversight.

He said the central bank also relies on regulatory counterparts to effectively oversee the financial system, but that the weakening of the Consumer Financial Protection Bureau has made that more difficult.

"The Fed oversees consumer protection of smaller banks and does risk assessments of big banks, but in order to more efficiently regulate the financial system, the central bank needs partners," said Barr. "We used to have a very strong Consumer Financial Protection Bureau that was our partner in making sure that supervision was strong.

"That partner is being gutted and the CFPB is the only agency that supervises nonbank institutions," he added.

The CFPB has lost roughly one-third of its employees in the past year, largely in response to the Trump administration's efforts to eliminate the agency, including threats of firing up to 1,400 employees. With reduced capacity, the CFPB has shifted enforcement to the states, eliminated all nonbank oversight and moved to remote supervision of large banks. 

Barr said the CFPB's pullback from monitoring nonbank institutions creates "huge risk to the system" and could lead to declining standards.

"Having a level playing field is really important," said Barr. "Or you get a race to the bottom, and the banks say, 'that fintech is doing it, I'm going to do it too.' If the fintechs can't do it because they're properly regulated, because there's good guardrails in place, then everybody's standards are lifted, and you can compete on that higher level playing field."

Barr also cited proposed reforms to the Community Reinvestment Act, which were intended to strengthen the rule but were challenged in court, as evidence that pressure on regulation predates recent developments.

"The Community Reinvestment Act has been a bipartisan effort, supported by banks, civil organizations and community groups," he said. "In 2023, we put out a stronger CRA rule and banks sued us and stopped us, so we were already in an environment where civil rights principles are under attack.

"I think it's an absolutely critical moment for our country. The kind of country I want to live in has strong guardrails, strong civil rights protections, and strong enforcement and supervision."