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Outgoing Fed 'regulatory czar' leaves a wishlist of reform

In his last public remarks before retiring, Federal Reserve Board Governor Daniel Tarullo urged regulators and Congress to tailor Dodd-Frank regulations while continuing work on capital requirements, a regulatory tool that has defined Tarullo's tenure at the central bank.

Speaking at Princeton University April 4, Tarullo took a swing at Dodd-Frank regulations, noting it as a "long and wide-ranging" law that ultimately failed to provide "structural solutions" that would heave created a cleaner code for banking agencies to follow in the regulatory process. Tarullo sympathized with banks burdened by regulations, noting that sometimes supervisors also "feel overwhelmed by the breadth of the resulting compliance effort."

Tarullo cited the Volcker rule, which limits proprietary trading, as an example. He said that the rule examines the intent of traders in defining prohibited activity, which would be difficult for five regulators to jointly clarify in written rulemaking. Tarullo further added that the rule would unfairly cover community and regional banks that don't engage in such trading.

"Several years of experience have convinced me that there is merit in the contention of many firms that, as it has been drafted and implemented, the Volcker rule is too complicated," Tarullo said.

The "regulatory czar," as Princeton advertised, added that he had issue with the various bank size thresholds that constitute stricter prudential requirements. Tarullo reiterated that two key thresholds were set too low: the $50 billion mark for a "systemically important" label and the $10 billion mark for banks to conduct internal stress tests.

Despite his criticisms, Tarullo made it clear he disagreed with rhetoric that regulations have crippled lending — a message Republicans have amplified since President Donald Trump's election. Trump himself delivered remarks earlier in the day alleging Dodd-Frank made it "impossible for the banks to loan to people that are going to create jobs."

Tarullo said similar arguments are a "substantial overreach," noting record profits at U.S. banks in 2016 and a rebound in bank stock valuations. He added that, in 2009, price-to-book values for banks were down to about 0.5 but have rebounded to about 1.5 today.

"Is the financial system of any large economy that has a lot of capital market activity sounder than the one that we're in? No," Tarullo said.

Tarullo credited strong capital regulation and stress testing for the state of U.S. banks.

Touting the benefits of his initiatives to create risk-based capital requirements on global systemically important banks, Tarullo said capitalization is the "single most important element of prudential financial regulation." He further encouraged regulators to continue raising the regulatory threshold. His argument: Based on Fed research, the largest U.S. firms are currently around the lower bound of healthy Tier 1 capital requirements, which is supposedly in the 13%-to-26% range.

"In trying to avoid a future financial crisis, it is wise to err somewhat toward the higher end of the range of possible required capital levels for this group of firms," Tarullo said.

On stress testing, Tarullo also said banks have made "substantial progress" since 2009, reflecting an evolution in compliance that validates the tests' purposes of helping companies realize loss functions. Tarullo added that he continues to hope for the advancement of a calibrated "stress capital buffer" that will cover a maximum decline in a bank's common equity Tier 1 capital ratio under a severely adverse scenario, before the inclusion of capital distribution plans.

Although Tarullo did not directly address Trump's de-regulatory agenda or the suggested proposals to dismantle Dodd-Frank, Tarullo did acknowledge "much talk of changes to financial regulation." His parting remarks made it clear that the capital regime he built should be strongly protected.

"Neither regulators nor legislators should agree to changes that would effectively weaken that regime, whether directly or indirectly," Tarullo said in concluding remarks. "It would be tragic if the lessons of the financial crisis were forgotten so quickly."