The new Congress can ensure better, clearer financial regulation. Here’s how.

As a new year brings a new Congress, it also brings the question of what legislators – and more specifically the House Financial Services and Senate Banking Committees – should focus on. With both chambers closely and likely bitterly divided, it does not appear that major legislation is likely. Still, there are efforts to use financial regulation in new and aggressive ways — and there is much the committees can do to bring clarity and better both the quality of regulation and financial markets themselves.

Specifically, there is a lot of oversight, investigation and information development that the committees should do to help ensure that financial regulators are acting appropriately, and to help Congress engage with developing issues in ways that are productive rather than partisan.

Congressional oversight of regulators is critical. Congress is supposed to be one of the bulwarks against tyranny by ensuring that the executive branch remains within its legal and constitutional boundaries. Further, even if one supports an activist government, agencies exceeding their authority only to be reversed by the courts is a waste of time and resources. Finally, oversight helps Congress remain informed about where laws are being misused or are becoming inadequate, allowing it to legislate more effectively.

Exercising appropriate oversight over financial regulators is especially important because they have traditionally been given some degree of independence from Congress and broad discretion. The wisdom of this is debatable and often constitutionally problematic. While the courts have been active in keeping agencies in check, Congress should not abdicate its independent responsibility to protect the Constitution and rule of law.

One area where congressional oversight is badly needed is how bank regulators like the Federal Reserve and Federal Deposit Insurance Corporation (FDIC) assess risk. Bank regulators have built an elaborate system of risk ratings that range from obvious factors (like whether banks are complying with the law and are making too many bad loans) to the opaque (like whether the actions of a bank or its customers pose some sort of “reputational risk” to the bank). 

As University of Alabama professor Julie Hill has documented, regulators are not bound by objective or predictable criteria while assessing reputational risk. And while, after a wave of scandals, regulators have claimed to restrict the role reputational risk plays, it remains part of banking regulation with little transparency as to how it is assessed or used. Getting more information will help Congress determine whether legislation is appropriate to provide more clarity and objectivity to regulators’ assessments.

Congress’s interest in understanding how risk is defined and applied is even more acute now that banking regulators are paying more attention to issues like climate. While there may be legitimate overlap between environmental concerns and banking regulation, there is also the risk of overreach and abuse. Active oversight and probing will help Congress assess whether our laws are adequate to address emerging challenges and keep regulators on the straight and narrow.

Another area where oversight is vital is the role of the Securities and Exchange Commission (SEC) and securities regulation. The SEC has been extremely aggressive in the past few years, proposing rules at such a breakneck pace that its own inspector general found the agency was being strained. Under the banner of providing investors with information they want, the current and expected rules touch on a massive swath of issues, including environmental and human resources.

The problem is that the securities laws are not a blank check for the SEC to use to demand disclosures on any topic that might be of interest to some investor. As my colleague Andrew Vollmer explains, the type of information the SEC can require firms to disclose was limited by Congress. Congress should ensure that the SEC is not falling into mission creep or unduly expanding its purview to become a universal regulator.

To be clear, oversight need not always be adversarial. Congress and the administration are meant to work together to forward policy objectives consistent with the law and Constitution. Oversight driven by a “gotcha” mentality is counterproductive and prevents Congress from fulfilling its role to the best of its ability. Instead of trying to score partisan points, oversight should be driven by a desire to ensure agencies are doing their job consistent with the rules of the road.

Congressional oversight is essential to our constitutional system. Given the importance of financial services in the lives of Americans, oversight is all the more important in this area. Congress should take up that challenge in a serious and thoughtful way.

Brian Knight is the director of innovation and governance and a senior research fellow at the Mercatus Center at George Mason University.