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Responding to the Financial Crisis
The Future of Supervision and Regulation
The recent financial crisis has prompted a fundamental rethinking of the supervision and regulation of banks and other institutions and markets that make up our financial system. After two decades of relatively stable economic and financial market conditions, the events of 2007–2009 painfully revealed several critical vulnerabilities lying within our financial system. Numerous studies analyzing the crisis have concluded that the vulnerabilities stemmed not only from problems in the private-sector, but also from shortfalls and gaps in our regulatory framework and supervisory oversight.1 As the crisis unfolded, the Federal Reserve and other agencies moved to bolster regulation and supervision within the scope of their existing authority. However, a consensus emerged on the need for more comprehensive reforms and an expansion of the scope of financial oversight.
The U.S. Congress enacted numerous changes in the Dodd-Frank Wall Street Reform and Consumer Protection Act, also known as the Dodd-Frank Act, which the President signed into law on July 21, 2010. The new law will have a profound impact on regulation and supervision of our financial system. Among the most significant changes is a major increase in the Federal Reserve’s responsibilities in this area. The Federal Reserve System has been actively modifying its supervisory programs in response to the Dodd-Frank Act requirements and to its own post-crisis assessment of financial regulation and supervision. The overall objective is to put in place a more robust supervisory framework that can effectively address both risks at individual institutions and vulnerabilities in the financial system as a whole.
The Federal Reserve and other authorities are aware that implementing more effective regulations and stronger supervision entails costs. These costs are tangible and can be significant for individual financial market participants who must comply with new rules as well as for their customers. Moreover, there is often a tradeoff between stronger regulation and financial innovation and efficiency which can be important contributors to economic growth. It is important to consider carefully all the costs and benefits of enhanced regulation and to find an appropriate balance. Clearly, the experience of the recent financial crisis and the related costs borne by the broader economy suggest a need to rebalance the system to incorporate more focused supervision and regulation. The Dodd-Frank Act attempts to find this balance and to strengthen the resiliency of the financial sector so that it will be less vulnerable to crises in the future.