Brookings Papers on Economic Activity

ABSTRACT:

After the global financial crisis, bank regulation became more stringent, and as a result the traditional banking system was well capitalized leading into the COVID-19 pandemic. But these same regulatory changes also incentivized a continuing migration of traditional banking activities to nonbank financial institutions (NBFIs), where looser regulation allowed for dangerous buildups of systemic risk. These risks were then realized across many NBFIs and markets in 2020. While legislation to harmonize regulation across these different domains would be desirable, we do not believe it likely in the foreseeable future. In this paper we propose a congruence principle for financial regulation, whereby regulators use existing statutory authority to coordinate rules across economically similar instruments. We provide examples of how such congruence could work for the cases of nonprime mortgage finance and the markets for US Treasury securities.