Federal Reserve Chairwoman Janet L. Yellen strongly defended post-crisis financial reforms, saying that new regulations have strengthened the U.S. financial markets and wholesale roll-back would be unwise. In remarks delivered at a symposium sponsored by the Fed in Jackson Hole, Wyoming Yellen made the case for the success of these reforms, summarizing indicators and research that show the improved resilience of the U.S. financial system, due, she said, "importantly to regulatory reform as well as actions taken by the private sector.” She also addressed "evidence regarding how financial regulatory reform has affected economic growth, credit availability, and market liquidity.”
After summarizing the bleak financial landscape of the financial crisis, Yellen went on to make her case that “the evidence shows that reforms since the crisis have made the financial system substantially safer,” not just in the U.S. but globally as well.
"The United States, through coordinated regulatory action and legislation, moved very rapidly to begin reforming our financial system, and the speed with which our banking system returned to health provides evidence of the effectiveness of that strategy. Moreover, U.S. leadership of global efforts through bodies such as the Basel Committee on Banking Supervision, the Financial Stability Board (FSB), and the Group of Twenty has contributed to the development of standards that promote financial stability around the world, thereby supporting global growth while protecting the U.S. financial system from adverse developments abroad.”
Stress tests have revealed improvements in the capital positions and risk-management processes among participating banks, with large banks cutting their reliance on short-term wholesale funding essentially in half and holding significantly more high-quality liquid assets. In addition, Yellen said, regulation has reduced the risk of runs on large institutional funds and given regulators the ability to deal effectively with failing banks. In addition to supervisory metrics, Yellen also pointed to economic research and shifts in private-sector assessments that also suggest enhanced financial stability arising from new bank regulations.
A decade on, however, Yellen said that these reforms, though successful, can use some fine-tuning in order to ensure they do not stifle prudent risk-taking and economic growth. She rejected the kind of sweeping outright repeal championed by the Trump Administration and members of Congress, however, in favor of thoughtful and targeted recalibration, where necessary.
"The Federal Reserve is committed individually, and in coordination with other U.S. government agencies through forums such as the FSOC and internationally through bodies such as the Basel Committee on Banking Supervision and the FSB, to evaluating the effects of financial market regulations and considering appropriate adjustments. Furthermore, the Federal Reserve has independently taken steps to evaluate potential adjustments to its regulatory and supervisory practices.”
Yellen gave market liquidity as an example of where modest adjustments to regulation, like the Volcker Rule and the supplementary leverage ratio, could be helpful.
"While no single factor appears to be the predominant cause of the evolution of market liquidity, some regulations may be affecting market liquidity somewhat. There may be benefits to simplifying aspects of the Volcker rule, which limits proprietary trading by banking firms, and to reviewing the interaction of the enhanced supplementary leverage ratio with risk-based capital requirements. At the same time, the new regulatory framework overall has made dealers more resilient to shocks, and, in the past, distress at dealers following adverse shocks has been an important factor driving market illiquidity. As a result, any adjustments to the regulatory framework should be modest and preserve the increase in resilience at large dealers and banks associated with the reforms put in place in recent years.”
Moving forward, Yellen sees markets adjusting to regulation, and regulation responding to technological and other innovations. Keeping the lessons of the financial crisis fresh in our minds, she said, is key to addressing the challenges ahead and avoiding the pitfalls of the past.
"I expect that the evolution of the financial system in response to global economic forces, technology, and, yes, regulation will result sooner or later in the all-too-familiar risks of excessive optimism, leverage, and maturity transformation re-emerging in new ways that require policy responses. We relearned this lesson through the pain inflicted by the crisis. We can never be sure that new crises will not occur, but if we keep this lesson fresh in our memories--along with the painful cost that was exacted by the recent crisis--and act accordingly, we have reason to hope that the financial system and economy will experience fewer crises and recover from any future crisis more quickly, sparing households and businesses some of the pain they endured during the crisis that struck a decade ago.”
Fed Chair Yellen’s address is available via: https://www.federalreserve.gov/newsevents/speech/yellen20170825a.htm