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Fed's Quarles details his ideal approach to bank supervision

WASHINGTON — Federal Reserve Vice Chairman for Supervision Randal Quarles laid out a comprehensive set of proposals to update how the agency supervises the nation’s banks on an ongoing basis, with the overall goal of bringing more transparency to the existing regime.

“I don’t believe the Federal Reserve has communicated as clearly as it could with the banks we supervise,” Quarles said at an event Friday held by the American Bar Association. “More transparency and more clarity about what we want to achieve as supervisors and how we approach our work will improve supervision.”

Unlike regulation, he said, bank supervision is usually confidential and tailored to a specific institution, yet at the same time, there is a “public interest in in all governmental processes being fair, predictable, efficient and accountable.”

To this end, Quarles outlined several ideas to make overall improvements to the supervisory process, strengthen transparency and bolster large-bank supervision specifically.

Quarles said the Fed should align its supervisory work with the tailoring rules that the Fed finalized last year, which placed banks into different risk-based categories.

The Fed manages large-bank supervision through a coordinating committee that currently includes oversight of three categories of banks defined by the tailoring rules: Category I, II and III firms. Quarles recommended that the Fed make it so that the Large Institution Supervision Coordinating Committee portfolio includes just Category I firms.

The Fed will also continue to offer more insight into its Comprehensive Capital Analysis Review stress testing process, said Quarles. Last year, the Fed published information on some of the models it uses to evaluate the safety and soundness of the banks it supervises.

“We also continue to consider ways to increase the transparency around the scenarios we use in CCAR, including, for example, by modifying our scenario design policy statement to provide greater transparency on the design of the global market shock component of the stress tests,” said Quarles.

The Fed is also weighing a number of options to scale back on the year-to-year volatility of stress test requirements, he said.

We are considering a number of options, such as averaging outcomes over multiple years or averaging the results of the current year’s stress test with the results of one or more previous years,” said Quarles. “Again, the goal here is not to make the tests less strenuous but to give banks a greater opportunity to plan for them and to meet our expectations ex ante rather than through an ex post remedial process.”

And, as part of the stress capital buffer, Quarles expects that the Fed will provide banks with “significantly more time” to review the results of their stress tests and commensurate capital requirements before they are required to submit their final capital plans.

On the transparency side, Quarles wants to create a searchable database that would compile historical interpretations of all significant rules across different Fed boards.

“Regulatory interpretations by Board staff have grown piecemeal over the decades and haven’t consistently been treated as the valuable resource they are,” he said.

He also advocated for the Fed to start putting significant supervisory guidance out for public comment, and to submit key guidance to Congress per the Congressional Review Act, which the Fed currently does for rules but not for guidance. Doing so for guidance as well would add to the Fed’s accountability and could increase support for supervisory guidance, he noted.

The banks that the Fed oversees should also be able to share confidential supervisory information with their employees as well as other government agencies, Quarles said, adding that the Fed has been told that being able to communicate that information could help banks address supervisory issues.

The Fed issued a proposal that sought to address this last year, which should be finalized sometime in 2020, said Quarles.

Meanwhile, the board should craft a rule on how guidance is used to supervise banks, and would ideally state that the Fed would “follow and respect the limits of administrative law” in its supervisory regime, he said.

Supervision could also be improved if the Fed were to limit “matters requiring attention” to violations of law or regulation and substantial safety and soundness issues.

“Banks should be able to understand the line between MRAs significant enough to affect the bank’s supervisory rating and less significant matters that don’t affect a bank’s supervisory rating but raise concerns that should be considered by banks,” said Quarles.

Quarles also suggested that if the Fed raised the bar for what is considered an MRA, the central bank could entertain a lookback of outstanding MRAs to identify any that no long apply.

"That’s one of the projects that we need to undertake consistent with the review of supervision and supervisory guidance in light of the changes to the tailoring rules,” he said.

Quarles also laid out three principles that he believes the Fed should adhere to when evaluating future guidance: no mandatory language, no “inappropriate” bright lines and a full assessment of the scope of important guidance documents.

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