Fed's Brainard Warns on Softening Rules as Stability Risks Rise

(Bloomberg) -- Federal Reserve Governor Lael Brainard warned against dismantling banking regulations designed after the financial crisis as she identified growing threats to financial stability in the U.S. economy.

While calling recent economic gains “heartening,” she said tax cuts and new spending represented a rare case of pro-cyclical fiscal stimulus that could heighten risks of inflation or financial imbalances. In that environment, she cautioned against rolling back regulatory safeguards.

“At a time when cyclical pressures are building, and asset valuations are stretched, we should be calling for large banking organizations to safeguard the capital and liquidity buffers they have built over the past few years,” Brainard said in the text of a speech she will deliver Thursday in Washington.

Her remarks come as Fed Chairman Jerome Powell and Randal Quarles, the central bank’s vice chairman for supervision, are pushing ahead with a fine-tuning of post-crisis regulation that includes some rollbacks.

Brainard said she favored adjustments to the Volcker Rule that limits proprietary trading, but opposed any significant reduction of the capital and liquidity requirements imposed after the crisis that drove the U.S. into its worst recession since the Great Depression.

Rising Risks

She also backed a proposal made recently by Boston Fed President Eric Rosengren for the Fed to raise the counter-cyclical capital buffer for banks, which is currently set at zero.

Brainard pointed to “elevated” risks signaled by high asset valuations and business leverage. The risks they pose, however, were mitigated by regulation, she said.

“We continue to assess the overall vulnerabilities in the U.S. financial system to be moderate by historical standards in great measure because post-crisis reforms have strengthened the regulatory and supervisory framework for the largest U.S. banking firms,” she said.

She specifically defended capital buffers, against calls to decrease the levels imposed following the crisis.

“While there is a natural tendency to question the value of capital buffers when times are good, the severe costs associated with not having enough capital to absorb losses become all too evident in a downturn,” she said. “I would be reluctant to see our large banking institutions releasing the capital and liquidity buffers that they have built so effectively over the past few years, at a time when cyclical pressures and vulnerabilities in the broader financial system are building.”

--With assistance from Jeanna Smialek

To contact the reporter on this story: Christopher Condon in Washington at ccondon4@bloomberg.net.

To contact the editor responsible for this story: Brendan Murray at brmurray@bloomberg.net.

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