Thursday, May 07, 2009

Bernanke on Lessons Learned for Bank Supervision

by Bill McBride on 5/07/2009 09:36:00 AM

There is no question that the Fed failed to adequately perform their regulatory responsibilities during the housing and credit bubble. However part of the problem was supervisory responsibility were split between various state and Federal regulators. As Fed Chairman Ben Bernanke notes in this speech, under the Gramm-Leach-Bliley Act of 1999, the Fed "serves as consolidated supervisor of all bank holding companies, including financial holding companies." Although the Fed missed significant problems at these holding companies, many of the problems were at mortgage brokers, and commercial banks that were not regulated by the Fed.

The regulators that I spoke with in 2005, at various agencies, were all concerned about the impact of the housing bubble and lax lending standards. But it was difficult to get the various regulators to coordinate. And several people told me confidentially that the Fed and the OTS were blocking efforts to tighten lending standards. So more consolidated supervision is required - but part of the problem during the bubble was that a few key individuals were able to block the efforts of other regulators.

So I think a framework to identify systemic problems would be an important addition.

Fed Chairman Ben Bernanke offers some suggestions: Lessons of the Financial Crisis for Banking Supervision

Looking forward, I believe a more macroprudential approach to supervision--one that supplements the supervision of individual institutions to address risks to the financial system as a whole--could help to enhance overall financial stability. Our regulatory system must include the capacity to monitor, assess, and, if necessary, address potential systemic risks within the financial system. Elements of a macroprudential agenda include
  • monitoring large or rapidly increasing exposures--such as to subprime mortgages--across firms and markets, rather than only at the level of individual firms or sectors;
  • assessing the potential systemic risks implied by evolving risk-management practices, broad-based increases in financial leverage, or changes in financial markets or products;
  • analyzing possible spillovers between financial firms or between firms and markets, such as the mutual exposures of highly interconnected firms;
  • ensuring that each systemically important firm receives oversight commensurate with the risks that its failure would pose to the financial system;
  • providing a resolution mechanism to safely wind down failing, systemically important institutions;
  • ensuring that the critical financial infrastructure, including the institutions that support trading, payments, clearing, and settlement, is robust;
  • working to mitigate procyclical features of capital regulation and other rules and standards; and
  • identifying possible regulatory gaps, including gaps in the protection of consumers and investors, that pose risks for the system as a whole.
  • Precisely how best to implement a macroprudential agenda remains open to debate. Some of these critical functions could be incorporated into the practices of existing regulators, or a subset of them might be assigned to a macroprudential supervisory authority. However we proceed, a principal lesson of the crisis is that an approach to supervision that focuses narrowly on individual institutions can miss broader problems that are building up in the system.