Fed's Mester Warns Against Dismantling Post-Crisis Bank Reforms

(Bloomberg) -- Federal Reserve Bank of Cleveland President Loretta Mester warned against dismantling core reforms that have made U.S. banks better able to withstand a financial crisis.

“It would be a mistake to unwind the steps taken since the financial crisis that have led to a more resilient financial system,” Mester said in the text of a speech she’ll deliver Friday at a European Central Bank conference in Frankfurt. “I would like to see how the new settings perform throughout the cycle before making major changes.”

Her remarks come as the Fed’s new leadership, under Chairman Jerome Powell, is working on adjustments to financial rules aimed, they say, at tailoring them to the risks of specific institutions and making them more efficient. That has provoked protest from some Democrats in Congress worried the Fed and other regulators are forgetting the lessons of the crisis in their desire to ease the regulatory burden on banks.

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Mester said the best way to prevent or contain the next financial crisis is to make sure financial institutions are strong, which regulators have done by raising capital and liquidity requirements, subjecting banks to stress tests and requiring them to create plans for their own unwinding.

“Given some of the limitations on macroprudential tools and the complexity of financial system regulation, ensuring the structural resilience of the financial system throughout the cycle is the first line of defense in promoting financial stability,” Mester said.

Macroprudential tools -- which aim to limit system-wide risks -- are limited in the U.S. and of questionable effectiveness, Mester said. For that reason, the Fed must keep open the option of using interest rates to stifle financial instability, while developing a playbook for such an scenario.

“Monetary policy should be on the table as a possible defense,” she said. “If we assessed the risks to financial stability to be sufficiently great, achieving our dual mandate monetary policy goals would also be in jeopardy over the medium run.”

In her only comment on current economic conditions, Mester said the U.S. economy is “near both of our monetary policy goals of maximum employment and price stability, and the outlook is one of the most favorable we have seen in a long time.”

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