Governor Tarullo Bids Farewell

Today is Governor Daniel Tarullo’s last day at the Federal Reserve. The Fed will no longer have a shadow vice chairman for supervision. In his interesting farewell speech, Governor Tarullo largely embraced the post-crisis regulatory framework, but acknowledged the need for some changes. Governor Tarullo talked specifically of the Volcker Rule’s costly — to regulators and the regulated — complexity. In capital regulation, however, Governor Tarullo prefers the complexity of risk-based capital to the simplicity of non-risk-weighted, high capital requirements. And he advocates setting one-off capital buffers for the biggest banks through non-transparent stress-testing. While stress testing is an important component of bank risk management, regulator-designed stress testing can easily morph into regulators running the banks. Moreover, when regulators are making decisions across a wide swath of banks, financial institutions are more likely to become uniform and thus suffer similar harm in times of stress. Governor Tarullo recognized this homogenization danger in his speech, but argued that the solution is to keep government-run stress tests non-transparent and non-consistent over time.

The Woodrow Wilson School at Princeton, which hosted Governor Tarullo’s speech, referred to him as the Fed’s “Regulatory Czar.” Perhaps a more apt title would be Banking Czar, as he has championed an approach that has displaced private decision-making by banks and replaced it with his own. Despite his good intentions and years of hard work, such an approach means that determinations about how banks are run and ultimately who gets credit are being made from Washington, which hasn’t shown itself adept at making such decisions.