The Man to See: An Exclusive Interview with Dan Tarullo, the Federal Reserve Board Member Who Is Fast Becoming Washington's Bank Regulatory Czar

The International Economy, Winter 2013 | Go to article overview

The Man to See: An Exclusive Interview with Dan Tarullo, the Federal Reserve Board Member Who Is Fast Becoming Washington's Bank Regulatory Czar


TIE: What is the Fed trying to achieve with regulatory reform? What's the end game?

Tarullo: The Federal Reserve has manifold regulatory responsibilities, which on net increased as a result of Dodd-Frank. We should be, and we are, committed to carrying out each one of those responsibilities in accordance with congressional intentions. However, since we do have a good bit of discretion in carrying out many of our statutory duties, we have some opportunity to shape the post-crisis regulatory terrain. To some extent, of course, the change needed from the pre-crisis period was simply to adopt a more robust regulatory and supervisory approach--to raise required capital levels, to plug some of the gaps that allowed some firms to take on so much risk, things of that sort. More broadly, though, I think that we must reorient our regulatory and supervisory reforms beyond traditional concern with the soundness of individual banking organizations towards safeguarding financial stability through the containment of systemic risk.

Two major threats to financial stability were revealed by the crisis. First was the problem of too-big-to-fail financial firms, both those that had been inadequately regulated within the perimeter of prudential rules and those like the large, freestanding investment banks that lay outside that perimeter. Second was the problem of credit intermediation partly or wholly outside the limits of the traditional banking system, particularly short-term wholesale funding. This so-called shadow banking system involved not only sizeable financial institutions, but also a host of smaller firms active across a range of markets and a global community of institutional investors. This system grew rapidly and then broke down even more rapidly when investors questioned the value of the mortgage-backed securities that served as collateral for so much of this funding.

To date, post-crisis regulatory reforms have concentrated on the too-big-to-fail problem, and more generally on enhancing the resiliency of the largest financial firms. We have proposed tougher prudential regulations on and supervision of large banking firms, including enhanced risk-based capital and leverage requirements, liquidity requirements, single-counter-party credit limits, stress testing, and an early remediation regime. We have revamped our supervision of the largest bank holding companies to include much more data and systematic analysis, as well as to include the perspectives of our financial, macroeconomic, and market experts to supplement traditional supervisory activities. We are also supporting the efforts of our colleagues at the Federal Deposit Insurance Corporation to build out their new statutory authority to resolve systemically important financial firms. The work on too-big-to-fail is not finished by any means, but it is well underway.

The picture is different with respect to the vulnerability associated with heavy reliance on short-term wholesale funding. The Dodd-Frank Act improves the transparency and stability of the over-the-counter derivatives markets and strengthens the oversight of financial market utilities and other critical parts of our financial infrastructure, steps that can help given the central role of dealers in these markets. Strengthened capital and liquidity standards for prudentially regulated institutions should also help by giving increased assurance to counterparties about the soundness of these firms. The Federal Reserve is also using its supervisory authority over the key clearing banks to reduce the risks associated with the tri-party repo market. And it is very important that the Securities and Exchange Commission, and now the Financial Stability Oversight Council, address the vulnerability of money market funds to destabilizing runs.

But no matter how effective the regulation of particular classes of institutions, in periods of high stress, with substantial uncertainty as to the value of important asset classes, questions about liquidity and solvency could still arise. …

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