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For release on delivery
12:15 p.m. EST
February 11, 2020

Spontaneity and Order: Transparency, Accountability, and Fairness in Bank Supervision

Remarks by

Randal K. Quarles

Vice Chair for Supervision

Board of Governors of the Federal Reserve System
at
Yale Law School
New Haven, Connecticut

February 11, 2020

It’s a great pleasure to be with you today at Yale Law School to deliver this
Dean’s Lecture.
I first arrived here at the Yale Law School on a sunny September afternoon almost
40 years ago, and I have a very clear memory of the first time I sat in this hall, not long
after, to hear a lecture from a worthy public servant come to deliver wisdom to those who
thought they might one day follow in his footsteps. It was Gene Rostow, former Dean of
the Law School, former Under Secretary of State, then serving as head of the Arms
Control and Disarmament Agency in the Reagan Administration. I remember the
impression of erudition and experience he conveyed. I remember the sense of tradition,
sitting here in these wood-paneled surroundings, being addressed with respect on issues
of consequence. There was a sense then, in the early 1980’s—which turned out to be
correct — that the Cold War could be reaching its climax, and widespread concern
among the great and good in the country (not least among them the Yale Law School
faculty) that the more aggressive stance of the Reaganites (not least among them Gene
Rostow) greatly increased the odds of a miscalculation. And here was the man himself,
patiently but boldly discussing the state of the world with a group of first-year law
students. I remember that he referred more than once to Don Quixote, and this Brooklynborn American pronounced it in the British way—Dun Quixit—which I found oddly both
affected and endearing at the same time. And I remember absolutely nothing else of what
he said. Not a word. Which puts me in a properly humble frame of mind for my own
remarks today. You won’t remember for very long anything I say here today, but I hope
your time at the Law School gives you the same experience of patiently but boldly

-2examining matters of consequence that I found to be the most valuable and lasting legacy
of my own time here in New Haven.
The themes and goals of this speech are objectives I will be pursuing over the
next year and should resonate for this audience. I trust they will be helpful to you all and
foster further discussions about the importance of transparency, accountability, and
fairness in regulation generally and also in the increasingly important and increasingly
consequential topic of bank supervision.
Twenty years ago when I was in private practice, a lecture on bank supervision
would have been my cue to pull out my BlackBerry and start checking my emails. The
structure and content of regulation was both intellectually interesting and professionally
meaningful; I considered bank supervision, by contrast, as both too workaday and too
straightforward to merit the commitment of much legal horsepower or personal attention.
I could perhaps have been excused by the callowness of youth, yet it was a common view
at the time. Having now been immersed for the last two years both in the practice of
supervision and in the complementary relationship between the regulatory and
supervisory processes, I realize that this wasn’t true then, and is certainly not true now. It
is not a drafting accident that the Dodd Frank Act gave my position at the Federal
Reserve the title of Vice Chairman for Supervision. Notwithstanding the extensive
reform of bank regulation after the crisis, which has had much consequence for the
industry (most of it salutary), it is the process of examination and supervision that
constitutes the bulk of our ongoing engagement with the industry and through which our
policy objectives are given effect.

-3This division of labor is important for lawyers and policymakers to think about
deeply because the processes of regulation and supervision are necessarily different in
crucial respects. Regulation establishes a binding public framework implementing
relevant statutory imperatives. Because a rule is designed to apply generally, rules must
be based on general principles intended to achieve general aims, rather than reverseengineered to generate specific effects for specific institutions. Given their general
applicability, there must be a general process for all those with an interest—industry,
academics, citizens, Congress—to have notice of, and opportunity to comment on all
rules, ensuring that all potential effects and points of view are taken into account in the
rule’s crafting. And given their general function, rules must be clear and public: those
affected must know what to expect and what is expected.
Supervision, by contrast, implements the regulatory framework through close
engagement with the particular facts about particular firms: their individual capital and
liquidity positions, the diverse composition of their distinct portfolios of assets, their
business strategies, the nature of their operations, and the strengths and weaknesses of
their management. Bank supervisors review and analyze bank information and interact
with bank management, enabling them to make necessary judgments about the bank’s
safety and soundness. Much of the granular information used by supervisors is,
accordingly, proprietary and confidential, and many of their judgments and decisions are
closely tailored to specific circumstances.
Given the strong public interest in the safe, sound, and efficient operation of the
financial industry and the potential for hair-raising and widespread adverse social
consequences of private misjudgment or misconduct in that industry, close and regular

-4supervision of this sort can help us all sleep restfully. Yet, the confidential and tailored
nature of supervision sits uncomfortably with the responsibilities of government in a
democracy. In the United States, we have a long-standing, well-articulated framework
for ensuring that regulations conform with the principles of generality, predictability,
publicity, and consultation described above. Supervision—for good reason, in my
view—is not subject to this formal framework. But it is currently not subject to any
specific process constraint promoting publicity or universality. This leaves it open to the
charge, and sometimes to the fact, of capriciousness, unaccountability, unequal
application, and excessive burden.
Here, then, is a conundrum. We have a public interest in a confidential, tailored,
rapid-acting, and closely informed system of bank supervision. And we have a public
interest in all governmental processes being fair, predictable, efficient, and accountable.
How do we square this circle? In my time with you today, we will not do more than
scratch the surface of this question. It is a complex and consequential issue that, for
decades now, has received far too little attention from practitioners, academics,
policymakers, and the public. Evaluating this question will be a significant focus of mine
going forward, and I hope that there will be much discussion in many fora from which we
at the Fed, and at other regulators, can learn. So today, I simply want to open the
exploration of some these conceptual issues, and then offer some specific suggestions—
by no means comprehensive—on some obvious and immediate ways that supervision can
become more transparent, efficient, and effective.

-5The Importance of Transparency
Let me begin by delving a little more deeply into the distinction between
regulation and supervision and the process applicable to both. In granting to agencies
such as the Fed the significant power to write regulations, Congress has codified a
regulatory process that emphasizes transparency. This process was born in the 1930s, in
the tumult of government expansion that was the New Deal, when Congress began a
decade-long debate over how to manage the new regulatory state. The result was the
Administrative Procedure Act (APA). The APA continues to serve as the basis for the
public disclosure and participation required for agency rule-writing and for the judicial
review affected parties are guaranteed to challenge rules.
This transparency is intended to prevent arbitrary, capricious, and thus ineffective
regulation by inviting broad public participation and mandating a deliberate public debate
over the content of proposed rules. One obvious purpose of this transparency is to
provide clarity and predictability: it helps make clear how agencies are considering
exercising their discretion. The significant process protections in laws such as the APA
are also meant to ensure fairness. The wisdom behind this approach is that fairness both
helps bring forth more considered and effective regulations and builds respect for and
adherence to the law, which is essential for enforcement. Transparency is central to our
ability to assert that our rules are fair.
Not everything that government does, however, can be accomplished in exactly
the same way that regulations are written. One of these things is bank supervision.

-6Bank Supervision
Banks are subjected to supervision, in addition to regulation, as an additional form
of government oversight because of their complexity, opacity, vulnerability to runs, and
indispensable role in the economy, enabling payments, transmitting monetary policy, and
providing credit. The government provides a safety net to banks in the form of deposit
insurance, and in return, banks are subject to government oversight that mimics some of
the monitoring that the private sector would provide, absent the government safety net.
The bank regulatory framework sets the core architectural requirements for the banking
system, but it isn’t enough to set the rules and walk away like Voltaire’s god. The
potential consequences of disruption in the financial system are so far-reaching, and the
erosion of market discipline resulting from the government safety net sufficiently
material, that it is neither safe nor reasonable to rely entirely on after-the-fact
enforcement to ensure regulatory compliance. Supervisors are in a good position to
monitor individual firms’ idiosyncratic risks. And in addition to what they do at
individual banks, supervisors monitor for risk that may be building among clusters of
banks or across the banking system. These “horizontal” exams across multiple banks
help highlight new or emerging risks and help examiners understand how banks are
managing these risks.
Through their engagement with banks, supervisors promote good risk
management and thus help banks preemptively avert excessive risk taking that would be
costly and inefficient to correct after the fact. Where banks fall materially out of
compliance with a regulatory framework or act in a manner that poses a threat to their

-7safety and soundness, supervisors can act rapidly to address the failures that led to the
lack of compliance or threat to safety and soundness.
This is a crucial point: supervision is most effective when expectations are clear
and supervision promotes an approach to risk management that deters bad behavior and
decisions by banks. Clearly communicating those expectations is essential to effective
supervision, and in a larger sense, clear two-way communication is the essence of
effective supervision. Supervisors rely on banks to be frank and forthcoming, and
supervisors in turn can help secure that frankness by explaining what their expectations
are and why their expectations are reasonable, not arbitrary or capricious. Greater
transparency in supervision about the content of our expectations and about how we form
our expectations and judgments can make supervision more effective by building trust
and respect for the fairness and rationality of supervision.
I don’t believe the Federal Reserve has communicated as clearly as it could with
the banks we supervise. More transparency and more clarity about what we want to
achieve as supervisors and how we approach our work will improve supervision, and I
have several specific proposals, which I have discussed in more detail than I will get into
today and plan to implement expeditiously. Broadly speaking, these actions fall into
three categories: (1) large bank supervision, (2) transparency improvements, and (3)
overall supervisory process improvements.
Let me briefly touch on some of the specific changes I will pursue, and which
flow from the themes I have just discussed. And as a disclaimer, I should note that
previously I have mentioned more specifics, so this abbreviated list should not be taken
as a ranking or indication that certain ideas have fallen out of favor.

-8-

First, I would mention that we should pursue a clear and transparent standard that
aligns our supervisory portfolios, and by extension the intensity of our supervision, with
categories established in our recent regulatory tailoring rules. Last fall, we completed a
cornerstone of the recent banking legislation to tailor our rules for large banks. This
change would be entirely consistent with a principle at the heart of our existing work:
Firms that pose greater risks should meet higher standards and receive more scrutiny. To
carry forward this work aligning supervision with the regulatory tailoring rules, I believe
there is a compelling justification to make changes today to the composition of foreign
banks in our portfolio of the largest banks, known as LISCC.
Second, as I have discussed throughout my time at the Board, I continue to look
for ways to make our stress tests more transparent without making them game-able and
without diluting their potency as a supervisory tool. I expect that we will continue to
provide more transparency on the models we use for the stress tests, and on the
hypothetical scenarios. Additionally, I am advocating changes to our capital plan rule
that will allow banks to receive and study their supervisory stress testing results prior to
submitting their capital plans. Currently, banks have a very limited time to adjust their
capital distribution plans and only under limited circumstance.
Third, and principally as a transparency endeavor, I would endorse creating a
word-searchable database on the Board's website with the historical interpretations by the
Board and its staff of all significant rules. Regulatory interpretations by Board staff have
grown piecemeal over the decades and haven't consistently been treated as the valuable
resource they are. The Board's website has select interpretations of many laws but does

-9not provide a comprehensive, user-friendly collection of regulatory interpretations,
FAQs, and commentary.
Fourth, I endorse putting significant supervisory guidance out for public
comment. The Board already invites comments on its regulations, as required under the
APA, and regularly invites comment on some supervisory guidance and statements of
policy. This practice of seeking comment on significant guidance leads to better, more
informed supervision and better engagement by banks.
And fifth, the Board should adopt a rule on how we use guidance in the
supervisory process. I would expect the rule to state that the Board will follow and
respect the limits of administrative law in carrying out its supervisory responsibilities. In
particular, consistent with the September 2018 interagency statement on guidance, we
would affirm the sensible principles that guidance is not binding and “non-compliance”
with guidance may not form the basis for an enforcement action (such as a cease-anddesist order) or supervisory criticism (such as a Matter Requiring Attention (MRA)).
This rule would be binding on the Board and on all staff of the Federal Reserve System,
including bank examiners.
There are of course other ideas I have mentioned and will be pursuing, but this
partial list should be informative and helpful in illustrating the earlier themes I
mentioned.
Conclusion
The changes to supervision since the crisis have made the financial system
stronger and more resilient than it was before. The incremental changes I am
considering, to increase transparency, accountability, and fairness, would make

- 10 supervision more efficient and effective, and our financial system stronger and more
stable. Obviously, the incremental changes to our supervisory processes I am considering
do not completely answer the question with which I began my remarks today: how can
we square the public interest in agile supervision with the public interest in transparency
and accountability? This should be an ongoing question of high priority, both at the Fed
and more broadly among those who care about our system of financial regulation.
Equally obviously, however, these suggestions would strengthen our practice of
supervision and increase the vigor and credibility of our supervisors.