“The U.S. banking system is facing some challenges”, Federal Reserve Vice Chairman Kohn said. “The problems in the mortgage and housing markets have been highly unusual and clearly some banking organizations have failed to manage their exposures well and have suffered losses as a result.”
Speaking before the Committee on Banking, Housing, and Urban Affairs, he said that “bank holding companies will continue to face challenging market conditions and persistent pressure on earnings.”
Kohn also predicted that for his group “more asset write-downs are likely”, and also for state member banks “we anticipate further increases in their loan delinquencies and charge-offs.”
Mismanagement of risk is a major source of the current turmoil. “From a supervisory perspective, it has become clear that some bankers did not adequately explore scenarios in which market liquidity could be disrupted, or in which there could be sudden demands for the institution's own liquidity”, Kohn said.
“However, problems stemming from recent events indicate that bank management in many cases was not fully aware of the latent risks contained in various structures and financial instruments, and how those risks could manifest themselves
The Fed is currently evaluating banks risk management practices. “Supervisors will be enhancing their focus on the capacity of a firm as a whole to manage risk and to integrate risk assessments into the overall decision-making by senior management”, Kohn said.
He noted that the Federal Reserve and other banking agencies have encouraged mortgage lenders and mortgage servicers to pursue prudent loan workouts through such measures as modification of loans, deferral of payments, extension of loan maturities, capitalization of delinquent amounts, and conversion of ARMs into fixed-rate mortgages or fully indexed, fully amortizing ARMs.
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