Banking

Although the Dodd-Frank Wall Street Reform and Consumer Protection Act creates a framework for financial stability regulation, it largely leaves the task of devising specific steps to promote stability and limit systemic risk to the regulatory agencies, Federal Reserve Governor Daniel Tarullo said in an October 10 speech in Philadelphia.

Main goal is to contain systemic risk
The 849-page law's "primary aim," Tarullo said, can fairly be judged as reorienting financial regulation toward protecting financial stability by containing systemic risk, which is a substantial change in the nation's approach to financial regulation. Most regulatory law instituted over the past couple decades, the governor noted, has largely ignored systemic concerns or removed or weakened existing regulations.

For example, the Sarbanes-Oxley Act of 2002 focused on investor protection. Reforms enacted after the savings and loan industry crisis of the 1980s emphasized the regulation of individual institutions. Most other new banking laws of the 1980s and '90s, culminating in the Gramm-Leach-Bliley Act in 1999, were essentially deregulatory, according to Tarullo.

"The law," Tarullo said of the Dodd-Frank Act, "explicitly in many provisions and implicitly in many others, directs the bank regulatory agencies to broaden their focus beyond the soundness of individual banking institutions, and the market regulatory agencies to move beyond their traditional focus on transaction-based investor protection."

Congress writing on a blank slate
This focus on financial stability and systemic risk is not surprising, given the severity of the financial crisis and the Great Recession. But entering the crisis, Tarullo said, "systemic risk and financial instability had come to seem more theoretical than real to many regulators, academics, and financial market participants."

Congress had likewise devoted little attention to systemic risk issues, he added. There had been some academics and a few central bank economists warning of systemic risks, but even those voices mainly issued warnings as opposed to offering recommendations on what to do.

"Congress was writing on a mostly blank slate in crafting an immediate legislative response to the financial crisis," Tarullo said.

While Dodd-Frank's attention to broad financial stability was a reversal of recent regulatory policy, it is not altogether new. Turning further back in history, Tarullo recalled that the creation of the Federal Reserve early in the 20th century was as much a financial stability measure as a tool of monetary policy.

October 26, 2012