Senator Shelby Skeptical of Fed as Systemic Risk Regulator

As the Senate Banking Committee begins to craft legislation overhauling the US financial regulatory system, Senator Richard Shelby (R-Alabama), the Committee’s Ranking Member, has cast doubt on whether the Fed can fill the macro prudential role envisioned for it by the Obama Administration. He also set forth the principles that should guide the financial reform legislation. One key principle laid down by the Senator is that the reform legislation must reduce expectations that some firms are too big to fail.

In his view, the many conflicting duties the Fed currently has, in addition to the quasi-public nature of the Federal Reserve banks, make the Fed ill-suited to be the systemic risk regulator. The Fed already handles monetary policy, bank regulation, holding company regulation, payment systems oversight, international banking regulation, consumer protection, and the lender of last resort function. According to Senator Shelby, these responsibilities conflict at times and some receive more attention than others. He cautioned that we cannot reasonably expect the Fed or any agency to effectively play so many roles.

Moreover, the structure of the Federal Reserve involves quasi-public Reserve Banks that are under the control of boards with members selected by banks regulated by the Fed. By design, the Board and the Reserve Banks are not directly accountable to Congress and are not easily subject to Congressional oversight. In his view, recent events have clearly demonstrated that this structure is not appropriate for a federal banking regulator, let alone a systemic regulator.

More broadly, the Senator said that the legislation must establish regulatory mandates that are achievable, especially with respect to the regulation of systemic risk. While conceding there is wide agreement that the crisis was a system-wide event, Sen. Shelby noted that Congress has spent very little time discussing the concept of systemic risk, determining how best to regulate it, or even establishing whether it can be regulated at all. Further, while risk management should, be improved, risk taking must remain an essential ingredient in the financial markets.

In addition, financial regulators should have clear and manageable responsibilities and be subject to oversight and proper accountability. The Ranking Member is concerned that we already have a number of regulators that do not currently meet these criteria and the Administration is contemplating giving them additional responsibilities.