Bloomberg News
Federal Reserve Gov. Christopher Waller said he would be willing to support bank capital reforms provided they include a few key changes from the proposal issued this summer.
Waller was one of two dissenting votes on the Fed’s board of governors against the so-called Basel III endgame proposal in July. During a webcast conversation with Michael R. Strain, director of economic policy studies at the American Enterprise Institute, Waller said his primary concerns are with the operational risk components of the package.
“If there’s some willingness to move on operational risk and some other things, there is a possibility that this would be put forth in a revamped way that would be acceptable,” he said.
Waller noted that additional regulatory requirements for operational risk accounted for more than half of the total capital increase included in the proposal. The plan would increase capital requirements for banks with $100 billion of assets by an average of roughly 16%, with the largest banks accounting for the greatest share of the uptick.
The proposed framework aims to standardize the measurement of operational risk, replacing the internal models long relied upon by banks with uniform standards. But Waller said this category of risk focuses on single-instance threats such as lawsuits, cybercrimes and fraud, which are not usually considered systemic threats.
“Those are things that don’t typically occur at the same time as a financial meltdown due to a macroeconomic shock,” he said. “So, they’re not correlated with market risk, trading risk, all the other things that might bring a bank down.”
Given this distinction, Waller said he would be fine with banks relying on their existing capital to address operational issues as they arise.
“I just argue that because it’s not really a threat to this, we don’t need a separate bucket for this,” he said. “You can use operational risk, paid for out of your standard capital bucket.”
During the webcast, Waller also addressed his views on the economy and monetary policy. Harkening back to a speech he gave last month — in which he said either economic growth would have to slow or inflation would start to rise again — he noted that the economy appears to be cooling off during the final quarter of 2023, which he said was a welcome sign in the Fed’s ongoing effort to tamp down inflation.
Waller said he is “increasingly confident” that the Fed’s monetary policy is positioned to bring annualized inflation back to 2%.
“That said, there is still significant uncertainty about the pace of future activity, and so I cannot say for sure whether the [Federal Open Market Committee] has done enough to achieve price stability,” he said during prepared remarks. “Hopefully, the data we receive over the next couple of months will help answer that question.”
Separately, Fed Gov. Michelle Bowman, who spoke Tuesday morning at an event hosted by the Utah Bankers’ Association, struck a more decisive note when discussing next steps for the monetary policy. She noted that her “baseline economic outlook” is for the Fed to continue raising rates to make its policy “sufficiently restrictive.”
Bowman added that thanks to a number of variables — including government stimulus, educational trends and workforce dynamics — she anticipates that interest rates will not return to their pre-pandemic lows, as there has been a relative shift in consumer behavior away from saving and toward investing. She noted that a higher-rate environment could have positive implications for the economy and financial stability.
“In some respects, a higher longer-run level of the federal funds rate would be a welcome development, as this would allow the FOMC to more effectively respond to future negative economic shocks by lowering the policy rate,” Bowman said. “Structurally higher interest rates might also lead to less concern about the possible financial stability effects of reach-for-yield behavior, as higher interest rates ease pressure on institutions like life insurance companies and pension funds that manage extended-duration liabilities.”
In terms of potential destabilizing events, Waller said a shock is unlikely to occur in the segments of the economy being most scrutinized. He noted that weaker earnings and rising delinquency rates are signs that the Fed’s monetary policy tightening is working as planned. As for other often-discussed topics, Waller said the risk posed by the commercial real estate sector is overstated.
“Everybody knows there is going to be repricing in commercial real estate. Repricing occurs, somebody wins, somebody loses,” he said. “We all know repricing and refinancing is going to happen, so it’s not a shock. It’s well anticipated. Everybody sees it coming.”
Waller added that the repricing in the sector will take years to play out. He also acknowledged that it will cause some amount of pain, particularly for property owners who have to write down values and incur losses.
“That’s just the way markets work,” Waller said. “I’m not too concerned about commercial real estate.”
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