Volcker urges radical regulatory reforms

Businessman's Hands Reaching out for Pink Piggy Bank.jpgFormer Federal Reserve chair Paul Volcker has urged the US to streamline its financial industry regulation to end what he calls a “fragmented, outdated, and ineffective” system.

Volcker, who gave his name to the tougher regulation of Wall Street five years ago, is pushing for the US to follow the UK’s lead in reforming the regulatory structure.

Britain’s response to the financial crisis was to place more power with the Bank of England with the creation of the Prudential Regulation Authority. Mr Volcker believes the US should follow suit by strengthening the hand of the Federal Reserve and create a single Prudential Supervisory Authority (PSA) to do the job of "an alphabet soup" of regulatory bodies currently working.

In a new paper, the Volcker Alliance warned that reforming the regulatory landscape was an “unfinished task” that was long overdue completion.

“A multitude of federal agencies, self-regulatory organisations (SRos), and state authorities share oversight of the financial system under a framework riddled with regulatory gaps, loopholes, and inefficiencies,” the group said.

Mr Volcker, as the founding chairman of the Alliance, wants to abolish one of these agencies - the office of the Comptroller of the Currency, and for the Securities and Exchange Commission to be merged with the Commodity Futures Trading Commission.

Playing catch-up

The regulatory regime is always playing catch-up to the financial system it governs, Mr Volcker argues. This creates gaps and loopholes that could lead to the build-up of systemic risk and another financial crisis.

Volcker warns that despite progress, the regulatory structure “remains substantially the same as before the financial crisis”, with eight federal regulatory agencies, numerous SRos, and more than 100 state authorities sharing oversight of the financial system.

In short, it’s just plain out of date. As Hank Paulson said: “Our regulatory system remains a hopelessly outmoded patchwork quilt built for another day and age.”

Shadow banking

Volcker also warns of the growing risks from the shadow banking sector. Fed vice chair Stanley Fischer noted that the “unintended consequence” of tougher bank regulation is that risks may increase as it gives power to the shadow banking system.

In a sense Volcker’s proposals are to weaken the hand of the shadow banking sector by simplifying the oversight and regulation of banks.

“The less regulated market outside the traditional banking system, or shadow banking, has emerged as a bigger part of the whole financial system, with increased reliance on potentially unstable forms of short-term funding that create the risk of contagion and fire sales,” says Volcker.

Key recommendations of the Volcker Alliance:

  • Establish a new PSA as an independent agency. This would carry out the prudential supervisory functions currently performed by the Federal Reserve, the office of the Comptroller of the Currency (oCC), and the FDIC in respect to bank holding companies, branches of foreign banking organisations, financial market utilities, and SIFIs.
  • It would also take on the supervisory functions currently performed by the SEC and CFTC with respect to broker-dealers, swap dealers, DCos, clearing members, futures commission merchants (FCMs), and money market funds (MMFs).
  • SEC and CFTC would be merged and continue to perform their old functions covering the structure and integrity of securities and derivatives markets.
  • The Financial Stability oversight Council (FSoC) would continue its role as coordinating council and designation authority of systemically important financial institutions (SIFIs).
  • FSoC would establish a Systemic Issues Committee (SIC), composed of the heads of the Fed, FDIC, CFPB and FHFA, as well as the chair of the newly-created Capital Market Conduct Regulator.
  • SIC would designate SIFIs and require new or enhanced prudential standards and safeguards on all activities and practices that could pose a threat to systemic stability.
  • The OFR would be made an independent entity and its director would serve on the SIC.
  • The Fed would maintain its core function of promoting systemic stability. It would have authority for prudential rule making, including capital, liquidity and margin requirements, subject to PSA supervision or as authorised by SIC.