At an event in early March, the arguably most powerful woman in the world stood before the Citizens Budget Commission, a nonpartisan group based in New York City that analyzes the financial services of the city and greater state. The group met to honor Janet Yellen, the woman who was appointed in early January 2014 to chair the Federal Reserve. Leading the nation’s central bank might not sound like the sexiest job ever, but power abounds: With Yellen’s guidance and the board’s approval, the Fed controls the money flow within the nation, regulates private banks, and works to keep unemployment low, prices consistent, and the economy growing.
Yellen, as the guest of honor at the commission’s annual dinner, gave a speech about what she and the Fed have been doing to increase the amount of oversight on big banks in the United States. Yellen yields an incredible amount of influence: Though everything is decided as a board, she leads the governing body that oversees more than 20,000 federal employees and a ledger worth trillions. With hindsight in her favor (her predecessor, Ben Bernanke, chaired the reserve during the recession), Yellen described the causes of the crisis and what the Fed is doing since that time to ensure large financial institutions are held to greater standards of accountability.
Big banks weren’t the only culprit, Yellen said. “Government agencies, including the Fed, failed to recognize the extent of the risks or how severely they could damage the financial system and the economy,” she explained. “Investors failed to anticipate and understand the risks of large financial institutions’ activities that materialized during the crisis.” But to keep the larger banks in check, the scope of the federal reserve has expanded, Yellen said. What used to be a focused, individual look at each banking institution now tries to account for large-scale, industry-wide trends to inform how well banks are stewarding their resources.
Though the Fed oversees the actions of all licensed banks, it monitors 16 institutions at “significantly higher levels of oversight,” according to Yellen. Those institutions, which include Bank of America, Wells Fargo, Morgan Stanley, JP Morgan Chase, Goldman Sachs, and Citigroup, among others, represent the larger portions of financial operations across the country. The eight banks on the list account for nearly 60% of all assets in the U.S. banking system, Yellen said.
To simplify matters, Yellen described the Fed’s increased oversight of those banks — and other large ones like them — into five main strategies. Take a look at the new rules on the following pages.
1. Increase available capital
In her speech to the commission, Yellen said the Fed’s oversight of all banks, including the largest ones, is focused on making sure the institutions are financially sound. Of the two core elements to ensuring financial stability, Yellen emphasized the need for more available capital first. In Yellen’s terms, capital is the funds provided by the bank’s shareholders that act as a buffer, so a firm can absorb unexpected losses. With the Fed putting an increased emphasis on the importance of capital since the recession, the eight largest banks have more than doubled their capital between 2009 and 2014, up to $500 billion, Yellen said.
2. Increase liquidity
The second of two core elements for financial soundness is liquidity, Yellen said. Referring to it as the “lifeblood” of a bank, Yellen described liquidity as a bank’s ability to meet current and future obligations to customers in financial transactions. In other words, cash needs to be on hand for withdrawals, transfers, and other actions. The standards for both liquidity and capital are on an international level, Yellen said, and the United States imposes even higher levels of responsibility for the country’s largest institutions.
3. Implement more frequent stress testing
To ensure the largest banks are following new regulations surrounding capital and liquidity, the Federal Reserve has begun a more frequent schedule of “stress tests” on banks, which is mainly when the banks go over their books and present a plan for how they would handle theoretical economic problems. These challenge scenarios often mirror the characteristics of the recession.
Stress testing happened in the past, but the Fed has implemented it “much more extensively since the crisis,” Yellen said. Banks are required to perform stress tests on their own and disclose the results to the public twice a year. The Fed conducts an independent test once a year, the results of which were just released for 2015.
Of the 31 banks required to participate in the United States, 29 passed. Bank of America received a warning, and the U.S. divisions of Deutsche Bank and Santander Holdings failed. Bank of America needs to resubmit a contingency plan by September, and the failing two banks are technically not supposed to increase dividends or share repurchases for the next year as a result.
4. Creating the “resolution”
In 2010, Congress passed a law that increased the oversight power of the Fed, which also included additional regulations that were intended to increase the country’s overall financial stability. The Dodd-Frank Wall Street Reform and Consumer Protection Act, named for the two Congressman who championed the bill, includes a new rule for a “resolution.”
In essence, banks have to come up with a plan for what would happen if they failed, so that whole system wouldn’t collapse. Under the provision, the Fed and the FDIC can require banks to have such a plan on hand, so that the entire system isn’t at risk for collapse.
5. Increased stability and oversight with new agencies
The Dodd-Frank Act also gave the Fed more power to monitor banking activity on a holistic scale, not just overseeing each bank in a separate sphere. To also make sure that financial oversight isn’t as fragmented as it once was, the Fed is part of a new agency called the Financial Stability Oversight Council, which Yellen said helps U.S. regulators work together more effectively and make sure there aren’t big errors falling between the cracks.
Though Yellen acknowledges the Fed and large banks still have a long way to go to ensure greater stability, the chairwoman said she’s seen great progress already. Yellen has seen improved levels of capital and liquidity, and overall a better approach to risk management. “We cannot eliminate the possibility of another crisis, but we can make a crisis less likely and less damaging by limiting excessive risk-taking by firms we oversee and by helping ensure that the most systemically important firms are better prepared to weather a crisis,” she said.
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