Bernanke Backs New Banking Oversight as Firms Are Told to Raise $75B

Published July 1, 2009

The ongoing financial crisis shows there is a need for revamped banking oversight, Federal Reserve Chairman Ben Bernanke told bankers at the Federal Reserve Bank of Chicago’s annual conference on bank structure and competition in early May.

“We have been closely monitoring [financial] firms’ capital levels relative to their risk exposures and discussing our evaluations with senior management,” Bernanke said. “We have also been revising our policies on capital.”

During the conference the Federal Reserve released a 38-page report on the results of “stress tests” (formally called the Supervisory Capital Assessment Program, SCAP) on the 19 largest financial firms.

The Fed announced 10 of the 19 banks “need to add $185 billion to capital buffers to reach the target SCAP capital buffer” but added “a number of these firms have either completed or contracted for asset sales or restructured existing capital instruments since the end of 2008 in ways that increased their Tier 1 Common capital,” leaving them with a need for $75 billion more capital.

Did Not Test Solvency

The so-called “stress tests” did not test solvency. They were instead tests of what banks might need to weather an economy in which unemployment hits 10 percent. Jack A. Ablin, chief investment officer at Harris Private Bank in Chicago, told the Associated Press the tests weren’t worth much.

“The problem is that the stress test wasn’t that stressful. They used a 10 percent unemployment rate as the worst-case scenario. Most people don’t think that’s very extreme,” Ablin told AP.

Banks need to have better risk management regardless of the economy, Bernanke said.

“Financial innovation can benefit consumers, the financial system, and the broader economy, but it also has risks that must properly be understood,” Bernanke said. “We are requiring banks to evaluate more comprehensively the possible unintended consequences of proposed new financial instruments as well as how those instruments are likely to perform under stressed market conditions.”

Need to Promote Financial Health

Citizen anger over billions of dollars of bonuses to executives and other key players in firms that have received government bailout money prompted Bernanke to say bonuses and other compensation should provide incentives for employees to promote the health of the institution.

“In this and in other areas, one of the key lessons for bankers has been the need for timely and effective internal communication about risks,” Bernanke said. “We are putting a high priority on ensuring that management and boards of directors are well informed about the various risks that confront the organization and are actively engaged in the management of those risks.”

Bernanke further said regulators must improve their own internal communications and supervisory procedures. Toward that end, the Fed is adopting “continuous supervision” of banks to “ensure ongoing and comprehensive monitoring of our largest state member banks,” he said.

“Although current reform of the system is necessary, much can be done within the current framework,” Bernanke added. “The Federal Reserve has engaged in extensive introspection and review of the lessons of the crisis and is working diligently to implement what has been learned.

“As the past two years have brought home to everyone,” Bernanke added, “the development of a more stable and a more sound financial system should be of the highest priority.”

Phil Britt ([email protected]) writes from South Holland, Illinois.