Barr warns of deregulation risks in financial boom
Federal Reserve Governor Michael S. Barr warned that recent deregulation efforts are undermining bank safety and increasing financial stability risks. Speaking at American University, Barr highlighted concerns about weakening capital requirements and supervision.
Eroding capital buffers for large banks
Governor Barr expressed concern that the Federal Reserve and other agencies are weakening bank regulation and supervision.
He highlighted a series of regulatory proposals over the past year and a half that have lowered capital requirements, from which he has dissented.
These changes include reducing the stressfulness of bank stress tests, eroding the leverage ratio for large banks, and falling short of Basel III capital standards.
The Board also reduced the GSIB surcharge, a capital add-on for the largest, most systemically important banks.
In aggregate, these proposals reduce the capital required for the eight GSIB firms by 6 percent, translating to $60 billion less capital to protect against bank failure and instability.
Barr noted that U.S. capital standards are already at the low end of optimal levels estimated by academic research, and deviating from international accords could lead to a 'race to the bottom' globally, increasing systemic vulnerability.
Lighter touch, higher risk in supervision
Barr argued that weaker bank supervision compounds financial stability risks from deregulation.
He pointed to changes in the rating system for the 36 largest financial institutions, which he described as 'grade inflation' that could mask weaknesses in risk management.
Regulators are proposing to prioritize backward-looking financial conditions over risk management, a key indicator of future risk.
Furthermore, the issuance of 'matters requiring attention' (MRAs), a crucial supervisory input, has been curtailed, with levels at the end of 2025 falling to roughly half of what they were in 2024 for the largest banks.
The share of large banks deemed well-managed under the new rules doubled from 2024 to the most recent observation.
Barr also anticipated further weakening, including a push to lower liquidity requirements, which he fears could make bank runs more likely or severe, burdening deposit insurance funds and threatening financial stability.
These combined reductions in capital, liquidity, and supervision expose the economy to increased risks of bank stress, failures, or crises.
A costly sugar high
The current trend of deregulation, including declines in consumer protection, represents the most significant weakening of the banking system since the Global Financial Crisis.
While deregulation might offer a short-term 'sugar high' of increased lending and profits, history shows it often leads to devastating long-term costs for society.
The analogy of reducing insurance against risk is apt; the financial system is becoming dangerously 'underinsured' against future crises.
This imbalance prioritizes innovation over safety, increasing the probability of severe economic disruption.