Photographer: Andrew Harrer/Bloomberg

Fed Weighs Steps to Prevent ‘Regulatory Capture’ by Banks

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The Federal Reserve, criticized by lawmakers for being too cozy with Wall Street, is considering tougher measures to restrict bank examiners from leaving to take jobs at firms they have overseen.

Currently, the two most senior employees assigned to a bank are barred from joining a firm they examined for one year after leaving the central bank system. Fed officials are discussing whether to expand the prohibition beyond those top positions, according to a person with knowledge of the matter.

The Fed has been on the defensive from lawmakers led by Democratic Senator Elizabeth Warren of Massachusetts who say the regulator is too deferential to large banks. “It’s past time for the Fed to make enforcement a top priority,” Warren said in a speech Wednesday.

The change would have the biggest impact on the Federal Reserve Bank of New York, which oversees Wall Street firms such as Goldman Sachs Group Inc. and Morgan Stanley. It is also charged with carrying out the central bank’s monetary-policy directives.

The New York Fed is continuing a program to move employees from the banks they examine to the regulator’s Manhattan offices. The shift has been gradual over the past couple of years. It started with examiners gathering for one day a week on a day known internally as Maiden Lane Monday, for the street where visitors enter the New York Fed.

The idea is that examiners “spend a lot less time at the firms and a lot more time talking to one another,” New York Fed President William C. Dudley said Monday at the Bloomberg Americas Monetary Summit in New York.

He said he is rotating examiners to ensure that they aren’t supervising the same bank “for very long before they get moved to another firm, so they don’t get too comfortable.”

‘Right Direction’

The measures are “steps in the right direction to deal with the criticism, whether or not it’s valid,” said Ernest Patrikis, a partner with White & Case LLP’s regulatory practice. A “modest prohibition” on examiners leaving for banks they were assigned to is understandable, though the ban shouldn’t be absolute, he said.

“To understand the complexity of regulations today, if you’re a bank and you don’t have a former examiner on your team, you’re missing something,” Patrikis said.

The moves reflect an effort by regulators to fill gaps in supervision that were apparent in the wake of the 2008 bankruptcy of Lehman Brothers Holdings Inc. and the near-collapse of American International Group Inc. Fed spokesman Eric Kollig declined to comment on the measures under consideration.

Technology Advances

Advances in technology have enabled examiners to access banks’ systems remotely, eliminating one of the advantages of having them embedded at the institutions.

Moreover, bringing them back to base means employees assigned to Citigroup Inc., for example, can more effectively compare notes with those handling JPMorgan Chase & Co. That enhances the Fed’s understanding of system-wide risks.

The New York Fed has more than 450 examiners who evaluate and report on risks and compliance at bank-holding companies. About 200 of those have been based mainly at the banks they oversee. The examiners are being brought back to the home office in stages because of space limitations.

Other regional Fed banks also are considering removing examiners from banks, said the person, who requested anonymity because the information isn’t public.

Speaking Up

“The risk of regulatory capture is something the Federal Reserve takes very seriously and works very hard to prevent,” Fed Chair Janet Yellen said last month. “It is important that anyone serving the Fed feel safe speaking up when they have concerns about bias toward industry, and that those concerns be addressed.”

Regulatory capture was the subject of a Senate hearing in November following complaints by Carmen Segarra, a former examiner at the New York Fed, who said her colleagues had been too easy on Goldman Sachs Group Inc.

Warren told Dudley at the hearing that he needs to fix a “cultural problem” or “we need to get someone who will.”

Robert Hockett, a law professor at Cornell University in Ithaca, New York, said Monday the measures under consideration “certainly could help. I don’t know that it’s ultimately going to be enough.”

‘Cognitive Capture’

Hockett, who testified at the November hearing, said the potential problem isn’t examiners trying to get jobs with banks they supervise, so much as “cognitive capture, like a kind of Stockholm Syndrome where you identify with or come to see through the eyes of the party you’re regulating.”

Hockett, who worked as a part-time consultant for the New York Fed in 2011 and 2012, said he never saw evidence of New York Fed examiners being “captured” by banks.

Both Democratic and Republican lawmakers critical of the New York Fed have singled it out for potential changes in how the central bank operates.

A plan advanced in February by then-Dallas Fed chief Richard Fisher would strip the New York Fed president of a permanent vote on monetary policy. Such a change would reduce its influence, leaving it with a role in monetary affairs similar to that of other regional Fed banks, most of which only have a vote on policy every three years.

Senate Banking Committee Chairman Richard Shelby, an Alabama Republican whose panel is considering changes to financial regulations that could include the Fed, said in February he was looking “very strongly” at Fisher’s plan. Committee members are scheduled to meet May 14 to weigh legislation.

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