Too Big to Supervise : The Rise of Financial Conglomerates and the Decline of Discretionary Oversight in Banking

The authority of government officials to define and eliminate “unsafe and unsound” banking practices is one of the oldest and broadest powers in U.S. banking law. But this authority has been neglected in the recent literature, in part because of a movement in the 1990s to convert many supervisory judgments about “safety and soundness” into bright line rules. This movement did not entirely do away with discretionary oversight, but it refocused supervisors on compliance, risk management, and governance — in other words, on internal bank processes. Drawing on the rules versus standards debate, this Article develops a taxonomy for parsing the various approaches to banking law and documents a shift in supervisory policy over the last thirty years. It shows how today's focus on internal bank processes, a policy called risk focused supervision (RFS), was the result of a larger deregulatory agenda that reconceptualized the role of banks in the economy and led to the emergence of large, complex banking organizations (LCBOs). LCBOs engage in a wide range of nonmonetary financial activities, including making markets in derivatives and corporate securities and investing in private equity funds. The architects of this new system believed that government oversight of these activities was costly and unnecessary — if even possible. Therefore, they constructed a new legal framework based on facilitating market discipline through RFS and risk based capital requirements. Most officials today repudiate “market discipline,” but the pillars of the pre-crisis legal framework remain intact. Although the Fed's innovative Comprehensive Capital Assessment and Review (CCAR) represents a resurgence in traditional safety and soundness oversight, its future as a discretionary exercise is in doubt. Ultimately, today's conglomerates, which conduct both monetary and nonmonetary activities, may be, as policymakers in the 1990s first postulated, too big to supervise in the traditional sense. It is time, therefore, to reconsider the proper role of banks in the economy and our legal strategies for ensuring a stable and efficient monetary system