• Key Insight: Federal Reserve Gov. Stephen Miran said certain bank regulations are preventing the Fed from further shrinking its balance sheet.
• Expert Quote: "Trying to settle the ongoing debates on how monetary policy is best implemented before settling the regulatory framework is putting the cart before the horse." — Federal Reserve Gov. Stephen Miran.
• What's at stake: As the central bank moves to streamline its oversight processes, concerns are emerging that reducing proactive supervision could allow risks to build in the banking system.

Federal Reserve Gov. Stephen Miran said further regulatory rollbacks could allow the central bank to continue shrinking its balance sheet in the future.

Speaking Wednesday at a Bank Policy Institute event, Miran stressed that monetary policy and regulation are intertwined and that regulation can ultimately dictate policy outcomes.

He argued that banks hold more reserves than necessary because regulations incentivize them to do so, leaving the Fed with a balance sheet that is larger than it needs to be.

"For all the talk about fiscal dominance of monetary policy, the reality is that the size of the balance sheet is a result of regulatory dominance," Miran said. "Regulations boost demand for reserves, which in turn requires us to end runoff or purchase securities for reserve management purposes."

He added that debating "how monetary policy is best implemented before settling the regulatory framework is putting the cart before the horse."

Miran's comments come as the Federal Reserve prepares to end its "quantitative tightening" on Dec. 1. The governor said during his BPI speech that he supported the move and had favored ending the runoff of the Fed's balance sheet "immediately" at the Federal Open Market Committee's October meeting rather than waiting until the end of the year. Miran highlighted that relaxing certain oversight measures, such as liquidity and capital requirements, would reduce banks' incentives to hold reserves and give the central bank more room to allow assets to roll off its balance sheet.

Miran said banks should be encouraged to hold Treasuries instead of reserves because it would allow them to earn more.

"A consequence of the Fed's large balance sheet is significant payments of interest to the banking sector," he said. "Now, this is little different for banks' income than if they held Treasuries directly, as would occur in a scarce-reserves regime. In fact, an upward-sloping yield curve would suggest banks would earn more from holding Treasuries rather than reserves."

He also said encouraging banks to hold Treasuries could reduce the perception that the Fed "is unfairly subsidizing the banking system with billions of dollars."

"These perceptions can affect the Fed's credibility and thus its effectiveness," said Miran. "Several times now, the Senate has debated whether the Fed ought to be stripped of its statutory authority to pay [interest on reserve balances] despite its necessity as a tool for managing the federal funds rate."

The regulatory arm of the Federal Reserve has already moved to loosen a number of oversight tools in recent months, including releasing the stress-testing models it uses to gauge the largest U.S. banks' resilience, as well as cutting back on bank supervision. The deprioritization of certain supervisory practices comes alongside plans to reduce the supervision and regulation division's staffing by 30% by the end of 2026.

Miran expects the Fed to continue making "more progress peeling back regulations," which as a result will cause the "optimal level of reserves [to] drop below where it is now."

"It is possible that in the future, it will be appropriate to resume shrinking the balance sheet; stopping runoff today does not necessarily mean stopping it forever," Miran added.