Document Type

Article

Publication Date

2018

Abstract

The authority of government officials to define and elimi­nate “unsafe and unsound” banking practices is one of the oldest and broadest powers in U.S. banking law. But this authority has been neglected in the recent literature, in part because of a movement in the 1990s to convert many supervi­sory judgments about “safety and soundness” into bright-line rules. This movement did not entirely do away with discre­tionary oversight, but it refocused supervisors on compliance, risk management, and governance – in other words, on inter­nal bank processes.

Drawing on the rules versus standards debate, this Arti­cle develops a taxonomy for parsing the various approaches to banking law and documents a shift in supervisory policy over the last thirty years. It shows how today’s focus on internal bank processes, a policy called risk-focused supervision (RFS), was the result of a deregulatory agenda that reconcep­tualized the role of banks in the economy and led to the emer­gence of large, complex banking organizations (LCBOs). Unlike traditional banks, LCBOs engage in a wide range of nonmonetary financial activities, including market making in derivatives and corporate securities and investing in private equity funds. The policymakers who designed this new sys­tem believed that government oversight of LCBOs was costly and unnecessary – if even possible. Therefore, they con­structed a new legal framework based on facilitating market discipline through RFS and risk-based capital requirements.

Although most officials today repudiate “market disci­pline” and the philosophy underlying the pre-crisis legal framework, the pillars of that framework remain intact. More­over, the future of the Fed’s innovative stress tests – which represent a resurgence in traditional safety and soundness oversight is in doubt. Ultimately, today’s conglomerates, which engage in both monetary and nonmonetary activities, may be, as policymakers in the 1990s first postulated, too big to supervise in the traditional sense. This is a problem be­cause a framework that relies on market oversight or rules alone is unlikely to prevent excessive risk taking and the pro-cyclical expansion of bank balance sheets. It is time, there­fore, to reconsider the proper role of banks in the economy and our legal strategies for ensuring a stable and efficient mone­tary system.

Disciplines

Banking and Finance Law | Law

Share

COinS