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Tarullo, former Fed regulatory czar, warns about 'worrisome' rule easing

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Tarullo, former Fed regulatory czar, warns about 'worrisome' rule easing

Former Fed Governor Daniel Tarullo warned May 21 that the postcrisis regulatory framework for banks that he was instrumental in building "could be endangered" by current regulators' efforts.

While individual proposals on issues like bank capital requirements and stress tests may not garner major headlines, their cumulative impact is "truly worrisome," Tarullo said in a speech in Washington.

"There's no certainty as to when improvidently lax regulation will come home to roost in the form of a financial crisis or recession that becomes worse than it need have been," he said. "The eventual damage may well come after those who loosened up on the regulation have moved on. But somewhere down the line, someone else will suffer that damage. In all likelihood, it will once again be the most vulnerable of households and businesses."

Tarullo retired from the Fed in 2017 after years at the regulatory body, where he was the Fed's unofficial czar for implementing postcrisis rule changes and the Dodd-Frank Act. The former Fed official, who has recognized the new regulatory framework was in some instances too complex, said he "would have no quarrel with efforts" to make it more efficient as long as it did not decrease resiliency at big banks. He spoke at a conference hosted by Americans for Financial Reform, a group that backs tougher rules for banks and at times was at odds with Tarullo during his tenure at the Fed.

Among the changes from regulators that Tarullo criticized was the Fed's efforts to make its stress-testing process more transparent. The Fed has begun sharing some key equations and variables it uses in the annual examinations for large banks, a move that Fed Vice Chairman for Supervision Randal Quarles has said provides needed transparency and clarity "without giving away the test."

Tarullo, though, said banks will now likely have "most of what they need to reverse engineer" the Fed's stress-testing models, such as how risky the Fed views a certain asset class. With that information, banks will "find clever ways to reshape their assets" so that their capital requirements will be lower without actually reducing their risk, Tarullo said.

"Capital requirements for the largest banks should be going up, not down," Tarullo said.

The Fed this year opted against temporarily raising capital levels for large banks through the countercyclical capital buffer, or CCyB, a postcrisis tool that other countries have experimented with to build up bank capital cushions while the economy is healthy.

The U.S. is "at or near the peak" of the lending cycle, making it an opportune time for the Fed to activate the CCyB, Tarullo said in response to a question, though he added that he preferred raising capital requirements for banks through tougher stress tests.

The Fed voted 4-1 in March against raising the CCyB, with Fed Governor Lael Brainard dissenting.

Quarles said at a May 16 hearing at the House Financial Services Committee that he does not think financial stability risks are high enough to activate the CCyB. Fed Chairman Jerome Powell also said in a May 20 speech that he views risks as moderate and that postcrisis rules have made banks "fundamentally stronger and more resilient" to shocks.