Governor Daniel Tarullo’s resignation as governor of the Federal Reserve Board has important implications for future bank regulation and supervision. Its most likely medium-term effect is to reduce the priority the Fed has given to this component of its mandate. Governor Tarullo has played an outsized role during his eight years at the Fed. He effectively filled the vacant seat of Vice Chairman for Bank Supervision that the Dodd-Frank Act of 2010 created but to which President Obama never nominated a candidate. The Vice Chair is statutorily required to “develop policy recommendations for the Board regarding supervision and regulation of depository institution holding companies and other financial firms … and shall oversee the supervision and regulation of such firms.”
Historically, the Fed had not accorded bank regulation and supervision the high priority it has deserved. Chairman Greenspan was not a proponent of a strong regulatory approach to the banking system. The financial crisis of 2007-8, which graphically revealed the deficiencies of weak regulation and oversight of the banking industry, dramatically changed that policy priority. According to the legal historian of the Fed, Peter Conti-Brown, in creating the seat of the Vice Chair, Dodd-Frank significantly expanded the Fed’s entire regulatory apparatus. As for Governor Tarullo, Conti-Brown called him “arguably the most important non-chair governor in the history of the modern Federal Reserve System.”
One of Governor Tarullo’s most important contributions to the ability of the banking system to survive a future financial crisis and avoid a replay of the Great Recession is his advocacy of higher capital charges for the largest banks. These charges exceed international standards. But this fact by itself makes his legacy of bank capital regulation a potential target of the new administration, given its “America first” policy.
In spearheading the Fed’s regulatory framework, Governor Tarullo has also been cognizant of the burden it could impose on smaller banks. Regarding the Fed’s stress-testing program for the largest banking entities, he noted in a September 2016 speech that banks with less than $250 billion in assets that do not have significant international or nonbank activity would no longer be subject to the qualitative component of the Fed’s annual stress testing capital planning exercise. Banks have long complained that this component’s large discretionary element is costly and a challenge to satisfy. He has also differentiated the Fed’s expectations with regard to corporate governance and risk management by basing such expectations on a depository institution’s size.
Governor Tarullo’s departure offers another important lesson: given the Republicans’ bare majority in the Senate, one of the most effective ways to deregulate the U.S. financial system is through the powers of appointment. This is particularly true in Governor Tarullo’s case. No one would fill his shoes even if the policy winds were not blowing in a deregulatory direction. (He said he had been likely to retire early whoever had won the Presidential election.) Perhaps just as important as they will be for monetary policy, President Trump’s new and future appointments to the Fed could decisively move bank regulation in the direction of lower capital charges. It is hoped that the new appointees to the Fed – there will now be three vacant seats on the Board – will understand the importance of Governor Tarullo’s legacy for bank regulation and supervision.