Modernizing the U.S. Financial Regulatory System
The U.S. financial regulatory structure remains complex, with responsibilities fragmented among a number of regulators that have overlapping authorities. The current structure introduces significant challenges for efficient and effective oversight of financial institutions and activities. Moreover, in the decades leading up to the financial crisis of 2007—2009, the financial regulatory system failed to adapt to significant changes.
First, although the financial sector increasingly had become dominated by large, interconnected financial conglomerates, no single regulator was tasked with monitoring and assessing the risks that these firms' activities posed across the entire financial system. Second, entities that had come to play critical roles in the financial markets were not subject to sufficiently comprehensive regulation and oversight. Third, the regulatory system was not effectively providing key information and protections for new and more complex financial products for consumers and investors. Consequently, we added this area to the High-Risk List in 2009.
Modernizing the U.S. financial regulatory system and aligning it to current conditions is essential to reducing the likelihood that our nation will experience another major financial crisis.
Since our 2017 High-Risk Report, ratings for all five criteria remain unchanged. Actions are needed by financial regulators and Congress to address this high-risk area.
Leadership commitment: partially met. Since policymakers enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) in July 2010, financial regulators have shown leadership commitment by finalizing rules to implement most of the Dodd-Frank Act’s rule-making requirements. While the act included provisions to better position the financial regulatory system to address key financial stability risks, it generally left the financial regulatory structure unchanged. In February 2016, we reported that remaining fragmentation and overlap in the structure have created inefficiencies in regulatory processes and inconsistencies in how regulators oversee similar types of institutions. We also reported that while the Dodd-Frank Act created the Financial Stability Oversight Council (FSOC) to identify and address threats to financial stability, FSOC’s legal authorities may not allow it to respond effectively to systemic risks.
Capacity: partially met. The Dodd-Frank Act created FSOC and included other provisions intended to increase the capacity of the financial regulatory system to identify and address risks to the stability of the financial system. While most of these reforms have been implemented, rulemakings for certain reforms have only recently been finalized or taken effect, while others are currently being modified under the May 2018 Economic Growth, Regulatory Relief and Consumer Protection Act. In addition, FSOC and the Department of the Treasury’s Office of Financial Research (OFR) have not completed steps to clarify their respective responsibilities for monitoring financial stability risks.
Action plan: partially met. FSOC’s annual reports have served as the council’s key accountability document, as each report (1) discusses the progress regulators have made in implementing reforms, (2) identifies newly emerging threats, and (3) includes recommendations to address them. While FSOC can respond to certain potential systemic risks, primarily through its designation authority, FSOC cannot compel regulators to act with respect to other sources of systemic risk. This presents a challenge to holding FSOC and the financial regulators accountable for addressing systemic risk.
In addition, financial regulators are required to conduct retrospective reviews of the effects of their regulations. However, some have not yet developed plans for how these reviews will incorporate quantitative analysis and identify opportunities for streamlining bodies of regulation.
Monitoring: partially met. FSOC monitors and reports on indicators of financial stability and potential emerging threats to financial stability. Since the financial crisis, the Board of Governors of the Federal Reserve System’s (Federal Reserve) stress test programs have played a key role in supervisory efforts to evaluate and maintain financial stability. In November 2016, we recommended that the Federal Reserve enhance the effectiveness of these stress test programs by further assessing—and adjusting as needed—the severity of the stress scenarios and other aspects of the test design.
Demonstrated progress: partially met. The new agencies and oversight bodies created under the Dodd-Frank Act have taken actions to carry out their missions. For example, FSOC meets regularly to discuss issues related to risks to the U.S. financial system. The Federal Reserve and the OFR have taken steps to reduce potential duplication and ensure comprehensive efforts to monitor systemic risks. For example, the two agencies coordinated semi-annual meetings to jointly discuss views from their respective monitoring of the financial system. In our continuing work to monitor this area, we determined that federal financial regulators could take additional steps to improve the efficiency and effectiveness of the financial regulatory system. For example, additional progress is needed in the areas of planning for retrospective reviews of rules and implementing the Federal Reserve’s stress test programs.
Over the years since we added this area to our high-risk list, we have made numerous recommendations related to this area. As of December 2018, 26 of these recommendations remain open. FSOC and its member agencies should implement our open recommendations related to strengthening oversight of risks to financial stability and assessing the effectiveness of Dodd-Frank Act reforms:
- FSOC and the OFR should clarify their respective responsibilities to monitor risks to financial stability to avoid gaps and duplication in these efforts.
- To improve the effectiveness of its stress test programs, the Federal Reserve should further assess key aspects of stress scenario design and take steps to improve its ability to manage model risk (the potential for adverse consequences from decisions based on incorrect or misused model outputs). Although the Federal Reserve has taken responsive actions related to some of our recommendations in this area, taking the additional steps we recommended can help the Federal Reserve identify and manage the risks introduced into its models, and account appropriately for uncertainty and sensitivity of model results.
- Under their authority, FSOC should work with federal financial regulators to establish formal coordination policies that clarify issues such as when interagency coordination should occur around rulemakings and the role FSOC should play in facilitating that coordination.
- The Federal Reserve and the Office of the Comptroller of the Currency should develop plans for how they will conduct required retrospective analyses of rulemakings, including how and when they will collect, analyze, and report needed data.
Congressional Actions Needed
Addressing weaknesses in the U.S. financial regulatory structure will require additional congressional leadership in the following two areas as suggested in our reports:
Addressing fragmentation and overlap in the regulatory structure. Congress should consider whether additional changes to the financial regulatory structure are needed to reduce or better manage fragmentation and overlap in the oversight of financial institutions and activities to improve (1) the efficiency and effectiveness of oversight; (2) the consistency of consumer and investor protections; and (3) the consistency of financial oversight for similar institutions, products, risks, and services.
For example, Congress could consider consolidating the number of federal agencies involved in overseeing the safety and soundness of depository institutions, combining the entities involved in overseeing the securities and derivatives markets, and determining the optimal federal role in insurance regulation, among other considerations.
- Clarifying FSOC’s authorities and mission. Congress should consider whether legislative changes are necessary to align FSOC’s authorities with its mission to respond to systematic risks. Congress could do so by making changes to FSOC’s mission, its authorities, or both, or to the missions and authorities of one or more of the FSOC member agencies to support a stronger link between the responsibility and capacity to respond to systemic risks.
GAO-18-213: Published: Feb 13, 2018. Publicly Released: Feb 27, 2018.
Interviews and focus groups GAO conducted with representatives of over 60 community banks and credit unions indicated regulations for reporting mortgage characteristics, reviewing transactions for potentially illicit activity, and disclosing mortgage terms and costs to consumers were the most burdensome. Institution representatives said these regulations were time-consuming and costly to comply wi...
GAO-17-48: Published: Nov 15, 2016. Publicly Released: Nov 15, 2016.
The Board of Governors of the Federal Reserve System (Federal Reserve) has two related supervisory programs that involve stress testing but serve different purposes. Stress tests are hypothetical exercises that assess the potential impact of economic, financial, or other scenarios on the financial performance of a company. Stress tests of banking institutions typically evaluate if the institutions...
GAO-16-341: Published: Apr 12, 2016. Publicly Released: Apr 12, 2016.
The Federal Deposit Insurance Corporation (FDIC) and Federal Reserve System (Federal Reserve) have developed separate but similar review processes for determining whether a resolution plan is “not credible” or would not facilitate a company's orderly resolution under the Bankruptcy Code (the Code). Both regulators have processes for staffing review teams, determining whether a plan includes al...
GAO-16-169: Published: Dec 30, 2015. Publicly Released: Dec 30, 2015.
Federal financial agencies conducted required regulatory analyses for rules issued pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and also reported required coordination. These agencies also addressed key elements of Office of Management and Budget guidance for conducting cost-benefit analyses for rules considered major—rules likely to result in an ann...
GAO-15-51: Published: Nov 20, 2014. Publicly Released: Nov 20, 2014.
The Financial Stability Oversight Council (FSOC) uses committees comprising staff from member agencies to help it evaluate nonbank financial companies and determine if they will receive enhanced supervision. FSOC has developed and followed a process for making determination decisions that is, in part, systematic and transparent. FSOC published a final rule and guidance that establish a three-stage...
GAO-12-151: Published: Nov 10, 2011. Publicly Released: Nov 10, 2011.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) requires or authorizes various federal financial regulators to issue hundreds of rules to implement reforms intended to strengthen the financial services industry. GAO is required to annually study financial services regulations. This report examines (1) the regulatory analyses, including cost-benefit analyses, financia...
GAO-09-216: Published: Jan 8, 2009. Publicly Released: Jan 8, 2009.
The United States and other countries are in the midst of the worst financial crisis in more than 75 years. While much of the attention of policymakers understandably has been focused on taking short-term steps to address the immediate nature of the crisis, these events have served to strikingly demonstrate that the current U.S. financial regulatory system is in need of significant reform. To help...