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Fed's Quarles poses ideas to make bank supervision more transparent

The Federal Reserve's top regulatory official laid out a set of ideas Jan. 17 that would overhaul key elements of how the Fed oversees banks, including a possible removal of major foreign banks from an extra layer of supervision.

Randal Quarles, the Fed vice chairman for supervision, said the potential changes would "increase transparency, accountability and fairness" and would make the process of supervising banks more efficient.

"I don't believe the Federal Reserve has communicated as clearly as it could with the banks we supervise," Quarles said in prepared remarks at the American Bar Association's Banking Law Committee meeting. "More transparency and more clarity about what we want to achieve as supervisors and how we approach our work will improve supervision."

Among the changes that Quarles floated was removing four large foreign banks from an extra layer of oversight that Fed officials currently conduct through the Large Institution Supervision Coordinating Committee. The LISCC is composed of key Fed supervisors from the Fed's Washington headquarters and its 12 regional branches across the country.

Right now, the LISCC portfolio includes Barclays PLC, Credit Suisse Group AG, Deutsche Bank AG and UBS Group AG, all of which international regulators have deemed large and complex enough to be global systemically important banks, or G-SIBs. The eight U.S.-based G-SIBs, including JPMorgan Chase & Co. and Wells Fargo & Co., make up the bulk of the firms in the LISCC group.

But Quarles said there is a "compelling justification" to remove the four foreign banks from that list, noting that they have shrunk their U.S. assets by about 50% since 2008 and have made their U.S. operations less risky.

That approach, he said, would line up with the Fed's recent overhaul of how it regulates large banks, a package of reforms that kept the strictest regulations on the eight U.S.-based G-SIBs but generally eased some rules for foreign banks and regional banks. The foreign banks would still be subject to the same Fed supervision as banks with similar risk profiles, and the change "would not result in a loss of insight into the activities of these firms," Quarles said.

Quarles also pledged to continue to find ways to make the Fed's stress tests of large banks "more transparent without making them game-able and without diluting their potency as a supervisory tool." That includes additional details on the scenarios and models the Fed uses when testing banks' ability to withstand financial stress.

Those stress tests would undergo some simplification under the Fed's proposal to develop a stress capital buffer, though the proposal remains in limbo and the Fed has spent months tweaking key parts of its original plan.

The Fed is still hoping to finish off some parts of the proposal and implement them for the 2020 stress test cycle, but other changes will take additional time, Quarles said. Regulators are also hoping to make the results of the yearly stress tests less volatile, he added, including by potentially averaging the performance over the current year with past results.

Quarles also floated some ideas to make the supervisory process more transparent for large and small banks alike.

That includes developing a database on the Fed's website that would let users search how Fed staff has historically interpreted its significant rules, noting that rule interpretations have "grown piecemeal over the decades" and are not easily accessible on the Fed's website.

He also proposed seeking public comment on any major but non-binding supervisory guidance shifts the Fed undertakes, similar to the public comment process for the release of formal Fed rules. And he favored submitting those guidance changes to lawmakers under the Congressional Review Act, a step the Fed takes for formal rules but not guidance.

"I support doing so for significant guidance because significant guidance, though nonbinding, can still have a material impact on bank behavior," Quarles said. "I believe this step would enhance the Fed's accountability and help build support for supervisory guidance."

The Fed can also adjust how it manages supervisory feedback and criticism, including the Matters Requiring Attention notices it sends to banks. Those MRAs should be limited to violations of law, regulatory violations and any material issues that threaten a banks' safety and soundness, Quarles said.

That should help banks draw the line between addressing urgent MRAs and other issues that are less significant but that banks should still consider, he said.