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Daniel Tarullo Says Brexit Vote “Factor” For Fed’s June Rate

In a Bloomberg Television interview on Thursday, June 6, Federal Reserve Governor Daniel Tarullo talks about bank regulations, fed policy and the economy. He said the British vote on European Union membership was a “factor I would consider” at the central banks’ June meeting. He also said the Federal Reserve plans to make changes to its annual stress tests that will penalize Wall Street banks for being large and complex, while making the exams less burdensome on smaller competitors.

Daniel Tarullo Says Brexit Vote "Factor" For Fed's June Rate

Daniel Tarullo on Brexit:

“With Brexit, obviously, there’s just a lot of uncertainty,” Tarullo said in a Bloomberg Television interview Thursday, pointing to the question of whether the U.K. would vote in the June 23 referendum to remain in the EU or leave. “In the short term I think it’s more of a question of the immediate impact on markets. Obviously, if there are implications for growth over time, that’s something that would affect our ongoing monetary policy.”

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Daniel Tarullo on Stress Tests:

“We need to have those eight most systemically important institutions more resilient than other banks in the economy,” he said. “You can have a smaller bank fail, and the economy can absorb that, but with the larger institutions, obviously there’s much more of a systemic risk.”

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Full Transcript:

Tom Keene, Host, Bloomberg Surveillance: Why does the Fed have a lawyer on board with the governor?

Michael Mckee, Economics Editor, Bloomberg Television/Bloomberg Radio: Well, the Fed is always supposed to have had a broad cross section of people. They’ve had lawyers. They’ve had bankers. And lately, they’ve had a lot of economists, and so it is useful, they feel, to have a broad view of where they are and get more points of view.

Tarullo focuses on regulation – bank regulation at the Fed, but he does have a vote on the Open Market Committee. And so where he comes down –

Tom Keene: Yes.

Michael Mckee: – does matter. But where he comes down is probably where Janet Yellen is going to be.

Tom Keene: Absolutely.

Michael Mckee: So we’ll be interested in finding that out.

Now, we’re going to go to David Westin with Bloomberg GO for his interview with Fed Governor Daniel Tarullo.

David Westin, Anchor, Bloomberg GO: He has been called the most powerful person in banking today. Federal Reserve Governor Dan Tarullo began his term in January, 2009 at the height of the financial crisis and since then has taken the lead in federal banking regulation. We’re pleased to welcome Dan Tarullo to Bloomberg GO and Bloomberg Radio worldwide. Dan, thanks very much for joining us today.

Daniel Tarullo, Member-Board of Governors, U.S. Federal Reserve Board: Good to be with you, David.

David Westin: You’ve overseen a host of new regulations for the banks in the past seven years. Where do we go from here? What is left to be done from your perspective?

Daniel Tarullo: Well, as you say, we’ve been doing a lot both to implement the Dodd-Frank regulations and to put in place a quite new approach to supervision for the largest financial institutions in the country. And I think we’re at a point now where it’s appropriate to step back a bit and ask ourselves three questions.

First, how effective has the set of regulations and supervisory innovations that we put in place been in achieving the goals of safe and sound banks, addressing the too big to fail problem, and achieving financial stability more generally?

Second, to what extent have the things that have been put in place perhaps creating costs that are disproportionate to the amount of safety and soundness or financial stability that we’re buying?

So the first question is might we need to do more or different things? The second question is might some of the things that have been done go a little bit too far?

And the third question is to what degree are potential risks migrating outside the prudentially regulated sector?

So I think those are the three question we need to ask. At the Fed, our division of financial stability I think is constantly monitoring the third. But in the bank supervision and regulation area, there is increasing attention to those first two questions.

David Westin: So Dan, let’s be specific. Let’s take the first one first. Where might you need to go further than you’ve gone so far, specifically?

Daniel Tarullo: Well, David, that’s a good question. And I think at this juncture I’m quite confident that what we’ll be doing as part of our review of the stress test system that we have is to change the post-stress requirements for the amount of capital that banks need to have even after absorbing the losses that are hypothesized in the stress scenario.

And specifically – and we talked actually a little bit about this on your program last November, but I’m really quite confident now this is the direction in which we’re moving – specifically we will I think be requiring that even after we take the stress losses into account, that for the eighth largest U.S. institutions they will need both to have the straightforward minimum capital  levels that all banks have to have, but also they would have to be above the minimum capital plus the capital surcharge that we place on those eight institutions.

Now, there will be some offsets in other parts of the stress test so that it won’t be just a straight addition of the surcharge. But effectively this will be a significant increase in capital.

And to anticipate your next question, well, why, I think for the same reason we put the surcharges into place originally. We need to have those eight most systemically important institutions more resilient than other banks in the economy. You can have a smaller bank fail and the economy can absorb that. But with the largest institutions, obviously there is much more of a systemic risk. And we need to achieve that in a post-stress environment as well as in a pre-stress environment.

And the second thing I’d say is, you know, as rigorous as our scenarios are in stress testing, we can’t anticipate all things that might happen. There is the unknown unknown. And for that reason, we need to be a little bit humble about how much we’ve predicted and make sure that there is capital there to absorb unanticipated types of losses.

David Westin: We’re talking with Federal Reserve Governor Dan Tarullo.

Dan, going back for a moment, you have a surcharge already above what is required internationally in regular circumstances. You’re talking about a surcharge under stress situations. Would you anticipate it would be the same amount of surcharge or something less than what you require in normal circumstances?

Daniel Tarullo: What I would anticipate is that the surcharge addition will be the same amount that is required on an ongoing sort of static basis. But people shouldn’t jump from that conclusion to the proposition that you should just, for example, take last year’s stress test and add the surcharge as a required amount of capital because we will be making some other adjustments in the stress test.

You know, David, there are some things that have been put into the stress test over time that are really quite conservative assumptions that were meant to take into account some of these same factors – the unknown unknown, the fact that we need more resiliency in the biggest institutions.

Now that we’re doing that in a more explicit way, or assuming we do go forward in a more explicit way, some of those things that we put in place before might be adjusted as well. So although, as I said there will be a significant increase, it won’t be as it were dollar for dollar.

David Westin: If you do go ahead as you expect to, what would be the timing on when this would take effect? Would it be in effect in time for the next round of stress tests?

Daniel Tarullo: I’m not – I would suspect not, although we haven’t made a decision on that. I actually think it probably will be important for us to get a proposal out in enough time for institutions to begin planning for the increased surcharge. So just as originally with the stress tests we were phasing some things in, here they might be an effective phase in as well. But to be clear, that hasn’t been decided yet.

David Westin: Now, again, we’re talking about the eight largest banks here. We had President Kashkari from Minneapolis on a while ago on Bloomberg GO and he had some proposals or requests about the too big to fail problem. I want to play a little bit of the sound for you because we talked about you a bit, Dan, actually.

Neel Kashkari, President/Chief Executive Officer, Federal Reserve Bank of Minneapolis: So Dodd-Frank was passed very quickly because they wanted to reform the financial system, which I supported, but the more transformational measures were taken off the table.

Stephanie Ruhle, Anchor, Bloomberg GO: Like what?

Neel Kashkari: Like breaking up the banks or putting so much capital in the big banks that you turn them into utilities so they virtually can’t fail. There are a number of other options.

Well, here we are six or seven years later and in my view we’ve done some good. The banks are safer. They do have more capital. They’ve got deeper liquidity. But we have not taken the risk of a bailout off the table.

David Westin: Are you coordinating with Tarullo on this? Have you talked with him about it?

Neel Kashkari: I’m looking forward to getting his feedback.

David Westin: But you haven’t gotten it yet.

Neel Kashkari: Not yet.

David Westin: So Dan, there you heard it. He’s looking forward to your feedback. What has been your reaction to what President Kashkari has proposed?

Daniel Tarullo: Well, you know, David, since – during the financial crisis, after the financial crisis, there has been an ongoing discussion about a whole set of issues around too big to fail and financial stability. And I think it’s healthy to continue to have that discussion. There are – those of us in the policymaking community I think should welcome ongoing discussions and evaluations.

But also, I think we, in the policymaking community, have a responsibility to continue the path that we’ve been on with the substantial increases in capital, the substantial requirements on liquidity to make sure that we don’t get into run-like situations. And I think that’s what we have been doing.

You and I were just talking a moment ago about the latest innovation that we will be pursuing. So in general, I think those of us who have the responsibility for implementing Dodd-Frank and for putting capital rules in place, we need to continue to do what we’re doing. But I think we should always be open to new ideas that seem to demand some attention.

David Westin: By the way, Dan, I think we are waiting for the results of the stress tests that are ongoing right now. Do you have any sense of when we’ll hear – is it this month we’ll be hearing?

Daniel Tarullo: Yes, it will be later this month.

David Westin: Okay, thanks so much. We’re talking with Governor –

Daniel Tarullo: I think late this month, not just later, but late.

David Westin: Late this month. Okay, thanks. We’re talking with Federal Reserve Governor Dan Tarullo.

So Dan, let’s move on to where perhaps things have gone a little too far and you’re thinking about trimming a bit. Specifically, let’s talk about regional banks. Have you seen –

Daniel Tarullo: Yes, that –

David Westin: – maybe some overregulation there?

Daniel Tarullo: Well, there I think, as you probably recall, a couple of years ago I suggested that maybe the statutory threshold for what constituted the so-called systemically important banks that should be in the stress test was set a little bit too low. It’s $50 billion by statute. I thought maybe $100 billion would be a better cutoff.

That obviously is a decision for Congress to make. What we have also done though is part of our review of the stress test internal within the Fed in the last year where we’ve been talking to a lot of people – academics, market analysts, other colleagues in the government and banks themselves – is to – we think we’re going to make some changes in how the regional banks, which is to say banks that you would recognize as traditional lending and deposit taking institutions, how they are treated in the non-quantitative or the qualitative side of the stress test.

As I know you’re away, but just to remind your audience, when we do the evaluation at the end of what we call the CCAR, which includes the stress test, we look both to make sure that the bank has enough capital – would have enough capital in a post-stress situation, but also to see whether their own internal risk management, risk assessment, and capital planning processes are at the level of sophistication and accuracy that we think are important for the most systemically important institutions.

And as your audience probably knows, over the last several years, we have objected to a number of capital plans on the grounds that those qualitative elements were not as good as we would like to see them be. I think this feature of the CCAR has posed a particular challenge for some of the regional banks. And as we did our evaluation, the conclusion we came to was that we can achieve what we need on risk management and capital planning with those regional banks at the – in the normal supervisory program that we have over the course of the year.

So I think the direction in which we’re moving would be that for banks that are under $250 billion in assets and do not – and are basically very traditional banks, not that they can’t have a lot of international activities or a lot of capital market activities, but for that universe of banks I think the direction in which we’re probably going to move is to take them out of the qualitative side of the stress test and just, as we must by statute, include them in the quantitative side.

And I hope and expect that that will again relieve a lot of the compliance costs that a lot of the smaller regional banks with whom we’ve spoken thought were really quite burdensome, and, from our point of view, relative to what we got in terms of increased safety and soundness, we didn’t think that we needed at those banks whereas we very much think they’re needed at the largest institutions.

David Westin: We’re speaking with Dan Tarullo. He’s a Federal Reserve governor.

Dan, just on the last point of the regional banks, do you have a timeframe in mind about when this might happen, eliminations of the non-quantitative?

Daniel Tarullo: So this one I would hope that we would have this change in effect for the next stress test. That is the one that will take place in 2017.

David Westin: Okay, and finally on the banking regulation side, Dan, what about the community banks? Is there regulation that you want to trim back there?

Daniel Tarullo: So on the community, again, I have suggested that if and as Congress takes another look at where they’d like to make some changes, that it might be useful to exclude some of the smaller banks entirely from some regulations that have been put in place, again, with the same sense of how much safety and soundness you’re buying.

In terms of what we, the regulators, can do on our own, you know, with a substantial majority of community banks – that is those under $10 billion in assets – it’s not a question of having enough capital precisely because a lot of them aren’t in public capital markets, they do need to keep their capital levels quite high.

For many of them, the issue is the complexity of the reporting and calculations of capital ratios. So I think that’s the direction in which we’d like to move in trying to relieve some of that. The first think I think we can do – and by we, here, I mean the Federal banking regulators, the OCC, the FDIC, and the Fed – is to simply the CCAR reports, the reporting forms that the smaller banks have to use. This may seem prosaic to people listening, but it’s actually quite important for the smaller banks.

And the second thing is I think we should be actively considering an overall simplified capital regime. That is not just the reporting form, but how they actually calculate their capital.

So we’ve been talking again with the smaller banks, with our fellow regulators, to see if there is something that is consistent with the Collins Amendment that could apply to most banks – most of the smaller banks and that would be both safe and sound, and simpler.  And I hope we can move in that direction, but that’s something we really need to do together to make sure that it’s a win/win situation.

David Westin: We’re talking on Bloomberg TV and Radio with Federal Reserve Governor Dan Tarullo. Let me bring in my colleagues, Jonathan Ferro and Megan Murphy.

Dan, we can’t let you go, of course, without talking a little bit about monetary policy. There seems to be a meeting you have coming up with the FOMC. Can you give us any insight into what you think about the U.S. economy and where it’s headed at this point?

Daniel Tarullo: So I’m not going to comment on the posture that I would take at the next meeting or indeed any specific meeting. Maybe the most useful thing I can do is to suggest that there have been several ways in which, not just within the – certainly I’m not trying to parse the FOMC, but as you listen to people talking about monetary policy generally, I think there are basically four ways of looking at it right now, which probably indicates in and of itself how unusual the circumstances are.

There are those who basically say, well, we’ve got to normalize, get to some norm of monetary policy of interest rates. That’s not convincing to me. I don’t know how one knows what normal is in any particular set of circumstances. It’s not like the economy should be at 98.6 degrees.

Another approach is basically the one that says, look, we’re in a secular – we’re in a period of secular stagnation, excessively high savings, excessively low investment, which counsels keeping interest rates very low for very long. And while I think there are some important insights in that analysis that we should bear in mind, I don’t think at this juncture it’s the basis for policymaking.

So that really leaves us with trying to be more sensitive to the data as it affects our outlook on an ongoing basis. And here I think there is a little bit of nuance in how some people think about things. I think some have basically said, look, we’re close to full employment so why not raise rates and, unless there is a reason not to, let’s start to do it gradually in order to avoid any problems with inflation later on.

The second approach, which I’ve been a little bit more inclined towards, is to say, gee, it’s not clear what full employment is. We’re in a global environment that is not inflationary. We can perhaps get some more employment and some higher wages, which will be particularly useful to those more on the margins of the labor force. And so there it’s still a question of being data sensitive and gradual, but there it’s asking, well, why do we need, are we at a point where there is an affirmative reason to move?

So those are both data dependent approaches. And I think given where we are in the economy, each of us just will move into the June meeting and those thereafter asking ourselves those questions.

Jonathan Ferro, Anchor, Bloomberg GO: Governor, there will be an extra question that will be asked at the June meeting. There will be a referendum in the U.K. a week later. For you personally, will that be a factor in the decision that you make as part of the FOMC?

Daniel Tarullo: Well, for me personally, as you know from looking at our statements over the course of the last couple of years, when there are background factors that are not within the U.S. economy that could have some impact, we do and I personally have taken them into account.

With Brexit obviously there is just a lot of uncertainty. I mean there is uncertainty about the results obviously. But I think there is uncertainty even as to what would happen in the case of a leave vote or, for that matter, even a remain vote in markets. And so, yes, under those circumstances it is a factor that I would consider. Whether it’s a dispositive factor is a different question.

Jonathan Ferro: Governor, one of the things you always look at is financial stability and I wonder as you sit around the table on the FOMC in June is it a financial stability concern or a growth concern?

Which one is it for the referendum in the U.K. as far as you’re concerned?

Daniel Tarullo: Well, in the short term I think it’s more of a question of the immediate impact on markets. I mean obviously if there are implications for growth over time, that’s something that would affect our ongoing monetary policy.

But I think in terms of the upcoming meeting, to the degree it’s a factor, it’s a factor which is really trying to take into account what will be happening in financial markets, in the more or less immediate aftermath of the vote.

Megan Murphy, Anchor, Bloomberg GO: Governor, when you look at the – when we look at the labor market in particular, and ahead of tomorrow’s jobs data, what are you looking to see in terms of that part of the economy that has proven stronger?

Are we at a period where, as you said, we’re at a period of full employment and we can expect that number to fall?

And what should people really be looking at in terms of wages as well?

Daniel Tarullo: Well, I think it’s difficult to know in real time where full employment is. You know, the Fed’s statutory mandate is to achieve maximum employment that is consistent with price stability. And as you have alluded to, wage growth over the past few years has not been moving in the direction that you might expect where we are at full employment.

So although I think we need to continue to be and I certainly will be quite sensitive to developments in price inflation, which can, of course, be affected by wages, at this juncture I don’t think you’re seeing that degree of tightness in the labor market. And that’s what I was saying earlier is that there’s a possibility of perhaps getting some more employment and some higher wages.

But again, I want to emphasize that what I characterize as the second and third perspectives on monetary policy, both are premised on gradual increases in the Federal funds rate which would maintain substantial accommodation over a continuing period of time looking into the future.

David Westin: Dan, as you know, we have an ECB decision we’re waiting for in less than three minutes now. But let me get one last question in – just 30 seconds. There is a lot of discussion about whether we’ve actually asked too much of the central banks, including the Fed, as opposed to expecting more fiscal activity as well as reform. Do you feel too much pressure has been put on monetary policy at this point?

Daniel Tarullo: Well, I think, David, at present, as in all periods, central banks need to take the world as they find it with fiscal policy that may be stimulative, fiscal policy that may be contractionary, fiscal policy that may be neutral, just as we need to take structural circumstances – productivity performance – as a given in the sense that we have to make decisions based on all those background circumstances. And I think that’s the way we should be approaching, and that’s certainly the way I approach each of our meetings.

We might wish that things were going differently in other parts of the economy. But our responsibility and our authority is to make monetary policy and we just have to try to make the best monetary policy we can given all those things that are not in our control.

David Westin: Dan, thank you so much for sharing so much of your time with us today. That was Federal Reserve Governor Dan Tarullo coming to us on Bloomberg Television and Radio.

Tom Keene: David Westin with John Ferro and Megan Murphy talking with the Governor of the Federal Reserve System.

Daniel Tarullo

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