14 January 2009

Bernanke: too-big-to-fail firms violate level playing field among financial institutions

Strengthening regulatory oversight and improving the capacity of both the private sector and regulators to detect and manage risk are high on the list of the work agenda, Fed Chairman Bernanke said. The world is too interconnected for nations to go it alone in their economic, financial, and regulatory policies, he underlined. International co-operation is thus essential if we are to address the crisis successfully and provide the basis for a healthy, sustained recovery.

Particularly pressing is the need to address the problem of financial institutions that are deemed "too big to fail", he said. “It is unacceptable that large firms that the government is now compelled to support to preserve financial stability were among the greatest risk-takers during the boom period.

The existence of too-big-to-fail firms also violates the presumption of a level playing field among financial institutions. In the future, financial firms of any type whose failure would pose a systemic risk must accept especially close regulatory scrutiny of their risk-taking. Also urgently needed in the United States is a new set of procedures for resolving failing non-bank institutions deemed systemically critical, analogous to the rules and powers that currently exist for resolving banks under the so-called systemic risk exception.

Speaking at the LSE in London, he underlined that other policy measures will be needed to overcome the crises as well.  Fiscal package could provide a significant boost to economic activity, he said. However, fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system, he said calling for more capital injections and guarantees to ensure stability and the normalization of credit markets. 

“Should the Treasury decide to supplement injections of capital by removing troubled assets from institutions' balance sheets, as was initially proposed for the U.S. financial rescue plan, several approaches might be considered”, he said. These could be in form of:

- purchases of troubled assets,

- provide asset guarantees, under which the government would agree to absorb part of the prospective losses on specified portfolios of troubled assets held by banks, or

- capitalize so-called bad banks, which would purchase assets from financial institutions in exchange for cash and equity in the bad bank.

As for the US Bernanke called for “stronger supervisory and regulatory systems under which gaps and unnecessary duplication in coverage are eliminated, lines of supervisory authority and responsibility are clarified, and oversight powers are adequate to curb excessive leverage and risk-taking”.  However, regulatory oversight should be co-ordinated internationally to the greatest extent possible. 

“The supervisory authorities should develop the capacity for increased surveillance of the financial system as a whole, rather than focusing excessively on the condition of individual firms in isolation”, he said. “We should revisit capital regulations, accounting rules, and other aspects of the regulatory regime to ensure that they do not induce excessive pro-cyclicality in the financial system and the economy.”

Full speech

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