Bernanke Urges “Holistic” Approach to Financial Regulation

By Sarah Borchersen-Keto, CCH Washington News Bureau, Contributing Author, the CCH Federal Banking Law Reporter, March 10, 2009.

Federal Reserve Board Chairman Ben Bernanke called for a strategy that regulates the financial system in a “holistic way,” rather than focusing on its individual components.

“In particular, strong and effective regulation and supervision of banking institutions, although necessary for reducing systemic risk, are not sufficient by themselves to achieve this aim,” Bernanke said in a March 10 speech to the Council on Foreign Relations.

Bernanke said it will be imperative that policymakers seek to address the “enormous problem” of “too-big-to-fail” financial institutions by better supervising systemically critical firms and by strengthening the resilience of the financial system to minimize the impact when a large firm is unwound.

The Fed chairman defended steps taken so far to bolster major financial institutions, but acknowledged that the assumption that a particular firm is considered too big to fail has “many undesirable effects” such as excessive risk-taking and an unlevel playing field for smaller firms.

Bernanke said supervisors need to move vigorously to address the weaknesses at major financial firms in capital adequacy, liquidity management and risk management. He also called for a “robust framework” for consolidated supervision of all systemically important financial firms organized as holding companies.

Looking beyond the current crisis, Bernanke said, the United States needs improved tools to allow the orderly resolution of a systemically important nonbank financial firm, including a mechanism to cover the costs of the resolution. He noted that federal bankruptcy laws do not sufficiently protect the public’s interest in ensuring the orderly resolution of nondepository financial firms when their failure would pose substantial systemic risks. Improved resolution procedures for such firms would narrow the range of circumstances that might be expected to prompt government intervention to keep the firm operating, he said.

In terms of strengthening the financial infrastructure, Bernanke said the aim should be not only to help make the system as a whole better able to withstand future shocks, but also to mitigate moral hazard by reducing the range of circumstances in which systemic stability concerns prompt government action.