Fed’s Barr Warns Bank Deregulation Threatens Financial Stability

Recent moves by the Federal Reserve and other banking regulators to weaken regulation and supervision of banks threaten to undermine the safety and soundness of the financial institutions and increase financial stability risks, Federal Reserve Gov. Michael S. Barr said in a recent speech.

Speaking Saturday (June 6) at American University in Washington, D.C., Barr pointed to what he described as decreases in capital requirements, lighter-touch bank supervision, a potential push for lower liquidity requirements and declines in consumer protection.

“Taken together, the regulatory and supervisory changes recently enacted or proposed represent the most significant deregulation of the banking system since the Global Financial Crisis,” Barr said. “They tip the imperative balance that must be maintained between openness and innovation, on the one hand, and safety and soundness, on the other, in a way that will increase the risks of financial instability.”

“I have voted against these changes, and I feel it is also my duty to continue to speak about them and explain that the costs they impose, in the form of risk, greatly outweigh the promised benefits of a lighter regulatory burden,” Barr said.

Barr also highlighted what he described as growing risks in the nonbank sector and said these risks require a strong banking sector.

Some have argued that the banking sector should be deregulated so it can better compete with private credit and other nonbanks, but the sector needs improved regulation to protect banks from their exposure to nonbanks, Barr said.

Banks are exposed to nonbanks through credit lines and asset-holding commonalities, he said.

“What all of this means is that we need strong banks at the core of the financial system to deal with shocks, including from nonbanks,” Barr said. “Dealing with those shocks requires robust capital and liquidity, and loosening bank regulatory standards moves in the opposite direction.”

“Bank deregulation can also lead to a race to the bottom,” Barr said. “If the goal is greater overall safety, it is perverse to relax safeguards. Deregulating banks so that they can better compete with nonbanks may lead to even more risk-taking by nonbanks. The answer is thus not to regulate banks less, but to regulate unsafe practices at nonbanks more.”