Fed governor Michelle Bowman, who has been nominated to head the division of bank supervision at the Federal Reserve, has a much more difficult task ahead of her than most Fed observers have recognized.

From its beginnings in 1913, the Fed has had general responsibility for overseeing the health and operations of the US banking system. Only later, in the 1950s, did it acquire an additional role: the ability and authority to stabilize the US economy through its control of the money supply and interest rates.

Thus, over time, without much thought in Congress about this issue, a potential conflict developed between these roles: efforts to keep the economy stable and growing could have an adverse effect on the banking system, while care for the health of the banking system could reduce the Fed’s ability to encourage and stabilize economic growth, making it impossible to carry out both responsibilities optimally.

For example, reductions in interest rates, which the Fed relies on to stimulate economic growth, will cause banks to acquire low-interest loans, which, when the economy recovers, lose their value quickly and thus weaken bank balance sheets. Conversely, in an inflationary period, the Fed may raise interest rates to slow and stabilize the economy, but this also weakens banks by reducing the value of the loans they already hold. In both cases, the Fed’s interest in managing the economy—the most important thing to the public and business—is counterproductive for the banking industry.

It would not be politic for the Fed to raise or lower interest rates in order to ease the pressure on the banking system, but it must weigh the minds of the Fed’s board members, as they raise and lower interest rates, that these steps could have an adverse effect on the banking system for which they are also responsible.

In general, when the Fed raises interest rates to slow the economy or combat inflationary trends, the value of the loans already on bank balance sheets declines. Those loans are devalued as newer loans at higher rates become available in the market, weakening the banks that are holding the older loans. Correspondingly, when the Fed lowers interest rates, the loans banks already hold increase in value, but can be frequently displaced if borrowers pay them back by borrowing at the new lower rates. So, banks are constantly managing their loan portfolios to cope with the consequences of the Fed’s financial management policies, but these policies are generally based on what will help the public and the economy, not the banks.

The safety and soundness of US banks are the responsibility of three government agencies: the Federal Reserve (Fed), the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC). The Fed is by far the largest of these—with the broadest responsibility—regulating and supervising over 4,900 bank holding companies, 839 state member banks, and 470 savings and loan (S&L) holding companies, among other institutions. The OCC supervises about 821 national banks, 53 federal branches and agencies, and 284 federal savings associations. Plus, the FDIC supervises about 3,900 state-chartered banks.

There have been three major financial crises involving regulated and supervised banks and S&Ls just since the 1980s—one centered in 1989 involving bank and S&L failures with aggregate losses of $390 billion, another in 2008 with aggregate losses of $515 billion, and a third in 2023 with losses of $319 billion, a total of more than $1 trillion. The most recent of these provides good examples of the Fed doing what it needs to do for the economy, even though it knew that the banks would take a hit.

In March 2023, three large US banks failed, and one was closed and liquidated. The most prominent failure was Silicon Valley Bank (SVB), a California-chartered bank for which the Federal Reserve was the federal safety and soundness supervisor. Two of the banks were among the 30 largest US banking organizations and had been considered “well capitalized” until the time of their failure.

The failures followed several years of increasing interest rates. They triggered runs on other banks around the United States, which the government was able to stabilize by promising to protect all deposits beyond the $250,000 limit already protected by the FDIC. This is obviously not good policy, but was necessary in the emergency created by the SVB failure without any significant advance notice to the public of the bank’s weakening condition. Here are the key circumstances that underlay the collapse of these three banks in 2023 and the weakening of several others that did not fail.

In 2008, when the economy was in the midst of a financial crisis and the US unemployment rate had reached 10 percent, the Fed cut interest rates, increased the money supply, and reduced bank reserve requirements between 2008 and 2014. Then, beginning in 2016, when market interest rates had reached a historic low of 0.25-0.50 basis points, the Fed began to raise rates again, probably to forestall what it saw then as inflationary pressures. Twenty-five basis point interest rate hikes began in late 2016 and continued through the end of 2018, when market interest rates had reached 2.25-2.50 percent. Obviously, these are the base rates in the market, not those available to most borrowers.

Then, unsatisfied with the growth in the economy and no longer worried about inflation, the Fed began to cut rates again, so that by October 2019 the rates were 1.50-1.75 percent. Rates remained low for a year until the Fed, to cool what was then a fully awakened and fast growing economy, began a series of increases in March 2022 (25 bps), May 2022 (50 bps), 75 bps in June, July, September, and November, and 50 bps in December.

While this several year period was a difficult time for investors, it was an even more difficult time for banks, as rates moved sharply up and down, and outstanding loans rose and declined in value.

As is well known now, SVB had a substantial portfolio of mortgage-backed securities and high-quality Treasury bonds on its balance sheet. These had been accumulated during the preceding years, and, even though many of these assets were US Treasury securities of very high quality, they rapidly lost value as interest rates rose. This was especially true when the Fed began to increase rates fairly rapidly in 2022 and 2023.

This is the conflict of interest inherent in the Fed’s assignment. As noted, to meet its responsibilities for the economy, it must inevitably weaken the banks at some point. An independent bank supervisor, one not connected with the Fed or concerned about inflation, would be able to make adjustments as the Fed proceeded that the Fed could not fully consider as a bank supervisor. Here, it has a different conflict of interest. One reason for this is that if the Fed began to tell banks that they had to prepare for higher interest rates, it would be a signal to the markets of what the Fed is likely to do in the near future.

That is one reason why it would be best for all concerned if the supervision of the banking system were completely separated from the policies of the Fed. Without having to worry about the banks, it could focus fully on what is good for the economy. Similarly, if the banking system were regulated and supervised by an organization that could focus all its attention on the health of the banks, it would be beneficial for the banking system itself. Then, when the Fed begins to raise or lower interest rates, the banking supervisor could and would survey the banks’ holdings and caution them about the consequences that lurked in their portfolios. This would be impossible for the Fed’s bank supervisor, who has access to everything the Fed is planning and cannot let the banks know where the Fed is going.

That may be why, in other countries where there is no direct link between the monetary authority’s interest rate policies and the regulatory policies of the bank supervisors, bank supervision has been more effective. In Canada, for example, the monetary policies of the country are managed by the Bank of Canada, which has all the general authorities of the Fed to raise and lower interest rates, but the oversight of banking organizations in Canada is done by the Office of the Superintendent of Financial Institutions (OFSI), which is an agency of the Department of Finance, managed by the Minister of Finance. Deposits in Canadian banks are insured by yet another independent agency.

Even though the Canadian economy is closely tied to the US economy, it may not simply be good luck that Canada has not had a single bank failure in the past 30 years, while the US has had three crises, totaling more than a trillion dollars. The ability of the Canadian OFSI—as an objective observer of the US economy and market—to counsel Canadian banks about when it would be prudent to lend and when not to lend, and at what rates, could be the reason for the good results in Canada.

Ms. Bowman has a difficult task ahead of her. It would be best for her to start by persuading the Fed to let another—and independent—US bank supervisor take over her responsibilities.