The Supreme Court rewrites rules for Fed oversight of banks

The Supreme Court has redrawn the playbook for how the Federal Reserve oversees the nation's banks, raising questions about the future of financial services regulation.

In a recent ruling, the Supreme Court overturned a long-standing legal principle, called the Chevron deference, that had given the Fed substantial freedom to interpret banking laws.

This change now allows banks and industry groups to challenge the Fed's regulatory decisions in court.

As a result, the Fed's interpretations of banking regulations are now more vulnerable to legal scrutiny, potentially altering how it oversees the financial system.

"The Fed is used to enjoying an incredible amount of deference based in large part on its technical expertise. Those days are behind it," said Michael Held, a former top lawyer at the Federal Reserve Bank of New York.

New rules create an ‘increase in uncertainty’

Experts suggest the central bank may become increasingly gun-shy in its regulatory approach, potentially leading to less assertive oversight.

"(The Fed) may be less inclined to regulate aggressively out of fear that banks, being the more well-funded potential litigants, are more likely to fight back,” said Kathryn Judge, a professor at Columbia University's law school.

However, the judge notes there's no guarantee courts will consistently side with banks. The result, she says, is an "increase in uncertainty" in the regulatory landscape.

This uncertainty may embolden banks. Michael Held, a former top lawyer at the Federal Reserve Bank of New York, predicts "an increased willingness in the industry to pursue legal challenges to regulations they do not like."

In response, he expects future Fed rules will aim to be more "understandable and defensible" in court. A more timid Fed could inadvertently set the stage for future financial crises, some experts warn.

Graham Steele, a senior fellow at the Roosevelt Institute, argues that if the central bank becomes too hesitant to enforce rules or address emerging issues, it could allow risky banking practices to flourish unchecked.

"It's a matter of when, not if, that kind of risk actually materializes," Steele said.

The Fed’s emergency powers remain intact

Despite the regulatory upheaval, the Fed's role as a lender of last resort appears secure.

"The law giving the Fed its emergency lending powers is pretty explicit," said Steven Kelly, associate director of research at Yale's Program on Financial Stability, suggesting these powers are on firmer legal ground than day-to-day banking rules.

However, Christina Parajon Skinner from the University of Pennsylvania points out that the Fed's emergency actions aren't entirely immune to scrutiny. "Each of the Fed's emergency lending actions is distinctive," she said.

For instance, if the Fed were to create an emergency program that seemed to favor one industry over others - like offering special support to green energy companies - it could potentially face legal challenges.

So, while the Fed can still act in emergencies, it may need to be more careful about how it structures its support in the future.