Introduction
In July, the Government Accountability Office (GAO) issued a report that examined the scope and quality of regulatory analysis performed by the three banking agencies (FDIC, Federal Reserve, OCC) in promulgating bank regulations. The report found that “the analyses regulators conducted for many of the 22 major capital and liquidity rules (issued 2012–2021) that GAO reviewed did not consistently reflect leading practices.” Further, the GAO also found that “they did not always identify alternative approaches or quantify benefits and costs.” The findings of this report are important in light of the pending Basel III Endgame proposal and deserve significant attention from the public. In this blog, we briefly review the report and its findings, and discuss the implications for the Basel III Endgame capital proposal.

The GAO’s Key Findings and Recommendations
The GAO report is highly detailed and specific, but the key findings in the report can be summarized as follows.

First, the prudential agencies’ analysis did not always reflect key elements of good regulatory analysis. Importantly, the report states that the reviewed analyses did not always: 1) establish a baseline by indicating what would happen if the rule were not adopted, 2) consider and evaluate alternatives beyond the proposed regulation, and 3) assess the benefits and costs of a proposed regulation. Each of these elements is a critical aspect of good regulatory analysis that should be included in any rigorous analysis of a proposed regulation.

Second, the Federal Reserve and FDIC did not consistently document the regulatory analysis that was conducted. In effect, the analysis that was included in the agencies’ public rulemakings were not “backed up” with any significant or detailed documentation explaining how or why certain conclusions were reached. In describing its finding, the GAO indicated that “the Federal Reserve’s documentation of its regulatory analysis (other than descriptions in Federal Register notices) did not consistently include information that would allow a qualified third party to understand the basic elements of its analysis.” This finding is particularly concerning as it casts doubt on the entire process by which regulatory analysis is conducted and decisions are reached. Put simply, if analysis is not sufficiently documented so that a qualified third party can understand how conclusions were reached, how can those conclusions be relied upon to support durable regulatory policy?

Third, the agencies performed few retrospective reviews. In assessing whether a regulation is appropriate, it is critical to analyze the regulation on both a prospective and retrospective basis. Prospective reviews are critical, but are also, by their very nature, uncertain. Often, the impact of a rule will depend on future events that are difficult to forecast. This is where good retrospective analyses come into play. After a rule has been in place for a significant period of time, regulators should consider the impact of the rule as a means of cross-checking the initial prospective analysis. Such analyses have the potential to identify key areas for improvement that would have been difficult to identify before the regulation was put in place.

As a result of these findings, the GAO made two specific recommendations to the Federal Reserve and OCC (no recommendations were made to the FDIC).

Policies and procedures for consistently performing regulatory analyses that align with leading practices, including for documenting analyses, should be developed and implemented. (Recommendation made to the Federal Reserve)
Policies and procedures for systematically performing retrospective reviews of regulations should be developed and implemented. (Recommendation made to the Federal Reserve and OCC)
The Implications of the GAO Report for the Basel III Endgame Proposal
As discussed, the GAO report did not include the Basel III Endgame proposal in its scope, but the GAO’s findings and recommendations are highly relevant to the Basel III Endgame (B3E) proposal.

Importantly, as has been noted by a wide array of commenters including public interest groups such as the Urban Institute, the regulatory analysis contained in the B3E proposal is lacking in several respects, many of which were identified in the GAO report.

A key limitation of the B3E proposal is that in many cases, the proposal simply provides no cost-benefit justification for the rule other than an unsupported assertion that the benefits outweigh the costs. As discussed in the GAO report, it is critical that the agencies fully explain the analysis and methods that they use to arrive at their conclusions and that the analysis provide sufficient data so that a qualified third party can ascertain how the conclusions are reached.

Recently, Federal Reserve Chair Powell has discussed the possibility of a B3E re-proposal in light of the “broad and material” changes that are expected to be necessary in light of the received comments. In addition to re-proposing the rule, it is critical that any re-proposal of B3E be paired with an extensive cost-benefit analysis that adheres to the standards of good regulatory analysis identified in the GAO report.

In order to achieve this result, it will be necessary that the GAO’s recommendations are adopted and fully implemented before any re-proposals are made to ensure that the important shortcomings identified by the GAO are fully addressed.

Rigorous and transparent cost-benefit analysis is the hallmark of good, durable policymaking. The GAO report is important because it clearly identifies several key aspects in which banking agency regulatory analysis falls short of the mark. Adopting the GAO’s recommendations and fully implementing them in the context of any B3E re-proposal will help ensure that the resulting proposal is appropriate for the banking sector and the broader economy.

The GAO report also identified the need to conduct regular, retrospective reviews of regulations. This finding is directly in line with previous statements of Federal Reserve officials that a “holistic review” of large bank capital standards would be conducted. Despite these statements, however, the B3E proposal was issued without first conducting a holistic, retrospective review of the existing large bank capital framework. The lack of a holistic review is itself highly problematic because of the large number of capital and related reforms that have been adopted since the financial crisis. Ultimately, it is not possible to assess the adequacy of the B3E proposal without first rigorously assessing the state of the current large bank capital framework with a holistic, retrospective review.

Finally, the call for more regular retrospective reviews has wider implications well beyond B3E. As a specific example, the Federal Reserve has yet to perform a retrospective review of the GSIB surcharge as it indicated it would do when the rule was finalized in 2015. More broadly, the Federal Reserve has publicly committed itself to retrospectively review its monetary policy framework every five years. A similar, rigorous, review of the bank regulatory framework should be performed at a similar frequency.

Conclusion
The recent GAO report makes important findings that should have a significant impact on the approach that banking regulators take to promulgating regulations. Several of the findings contained in the GAO report are directly relevant to the current B3E proposal. Specifically, the B3E proposal does not adequately quantify the costs and benefits of the proposal, and the proposal was not paired with a holistic, retrospective review of the large bank capital framework. Any future re-proposal of B3E should fully conform with the recommendations of the GAO report. A comprehensive cost-benefit analysis of B3E that holistically accounts for the existing large bank capital framework will result in a more grounded, appropriate and durable capital framework for large banks and the broader economy.