Federal Reserve’s Michael Barr discusses health of banking system, SVB failures, and more at Michigan Law Conference

By Bob Needham

Actions taken in the wake of last year’s stress in the banking system have left the sector fundamentally sound, Michael Barr, the Federal Reserve’s vice chair for supervision, said in a recent appearance at Michigan Law.

Following last year’s Silicon Valley Bank (SVB) collapse and related developments, questions have been raised about the health of banking around the globe. But Barr said that government actions responding to the crisis—such as an FDIC resolution protecting uninsured deposits and deciding to accept Treasury securities at face value for emergency borrowing—helped keep it contained.

“It was a highly effective set of interventions,” Barr said. “The kind of stress that was potentially spreading through the banking system abated pretty quickly. It created a sense of calm that was really quite helpful. Today we’re not seeing the kind of stress that we saw last March. The banking system overall is quite sound and resilient.”

Barr spoke as part of the Transnational Law Conference: The International Law of Money, sponsored by Michigan Law’s Center for International and Comparative Law. The two-day event featured a number of panel discussions on topics including international trade, sanctions, banking crises, central banking, and the future of monetary system design.

Currently, Barr is on leave from the University of Michigan, where he is the Roy F. and Jean Humphrey Proffitt Professor of Law and the Frank Murphy Collegiate Professor of Public Policy. He also is the former dean of U-M’s Ford School of Public Policy.

He addressed a number of topics in his Q&A-format talk. Some highlights included:

The “Basel III Endgame” rule

Barr said that the proposed new rule known as Basel III Endgame, which would increase the largest banks’ requirements for available capital, continues to move forward—but substantial changes are likely before final adoption.

A rule like this would have helped keep SVB solvent, Barr said: “If a bank has more capital, it is better able to withstand loss.” However, the proposal has drawn opposition from the banking industry and some Republican officials.

“We are in the middle of a process of reviewing all the comments. I can’t say exactly where we are going to land in terms of reviewing those comments, but…we are thinking through how we should adjust the rule across all the major areas of operational risk and credit risk and market risk,” Barr said.

“We’ve heard from banks and other organizations that capital levels (in the rule) should be lower. We’re taking those comments into account, and I do expect we’ll have a set of broad, material changes to the rule that allow us to have a broad consensus.”

Lessons from SVB

Barr further discussed the saga of SVB and what can be learned from it. In addition to the importance of stricter capital requirements, he mentioned several other takeaways officials should consider:

• Banks must be prepared to use the discount window—borrowing directly from the Federal Reserve—to improve their liquidity.

• Banks’ ability to convert held-to-maturity securities into ready cash, which some were unable to do, must be improved.

• Closer attention should be paid to run-off rates—which were higher than expected during the crisis, adding additional pressure on liquidity.

• Bank supervisors should be prepared to act quickly and firmly. “The supervisors did not act with the kind of speed, force, and agility that you would like when they recognized problems at the institution,” Barr said. “We want supervisors to be able to act with the right level of force to get a bank to change position, and we found that in SVB’s case, we didn’t see enough of that.”

• Banks need strong internal management of liquidity risk. “The bank really failed that basic kind of risk management that we expect,” Barr said.

Central bank portfolios and monetary policy

One question noted that central banks around the world expanded their balance sheets during the pandemic, and most, including the Fed, have seen those assets decline. Does that affect the central banks’ ability to set monetary policy?

“The accounting treatment of our portfolio has literally no impact at all on our ability to conduct monetary policy,” Barr said. “If we wanted to shrink the balance sheet, if we wanted to expand the balance sheet, if we wanted to raise interest rates, if we wanted to lower interest rates, we can do all of that without any difficulty at all. We have complete freedom to conduct monetary policy in whatever way we think makes sense for the economy.”

Fed independence

A questioner asked whether the Fed’s status as a politically independent agency is important to its effectiveness.

“One of the attributes of the Federal Reserve that I think is really critical is its independence,” Barr said. “The Federal Reserve Board and the Federal Open Market Committee both operate independent of any political judgment. We don’t talk about politics; we don’t make decisions based on politics. I think that is really important for our credibility. That’s true on monetary policy, it’s true on banking policy and supervision, it’s true in terms of our oversight of the payment system and the other work that we do on behalf of the country. It would actually make a very negative difference if that independence were in any way undermined.”

Digital currency

Another questioner asked about the possibility of the United States developing a central digital currency, as some other countries are doing. Barr said that although the Fed has a team researching the issue, it’s not close to moving forward any time soon.

“We would want to make sure that it is something that has broad support throughout our society,” Barr said. “I’m not especially worried about what other countries are doing in this space. Each country is figuring out what makes sense for their own society. We will see whether it makes sense for ours. One of the things that we are learning is that the work we’re doing in this realm also can help us make sure that we are keeping up to date and making sure our basic core payment systems are operating in a cutting-edge way—in a proper, safe, and secure way.”

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