Federal Reserve Chairman Ben Bernanke on Thursday called for a holistic approach to strengthening oversight of the banking system and said information gleaned from big bank stress tests should pave the way for improvements on that front.
Regulators must not only sharpen their assessments of individuals banks, but also examine the financial system as a whole to detect risks that could endanger the normal flow of credit, market operations and commerce — critical elements to the smooth functioning of the U.S. economy, Bernanke said.
"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," the Fed chief said in remarks delivered via satellite to a Fed conference in Chicago.
The current financial crisis — the worst since the 1930s — has revealed "serious deficiencies" on the part of some financial institutions, which regulators are working to fix, Bernanke said.
Those deficiencies on the part of banks include not having adequate capital, or buffers, on hand against potential losses. Some banks also did not plan effectively to make sure they have easy-to-sell "liquid" assets if economic conditions worsen, and they did not have strong risk management policies in place to detect problems, he said.
"Increasing the effectiveness of supervision must be a top priority," Bernanke said.
In fielding questions after his remarks, Bernanke said he hoped stress test results would give Wall Street "greater confidence" that the nation's 19 largest banks will be "strong and able to lend even if the economy is worse than expected."
Going forward, Bernanke stressed the need for banks to build up a capital buffer in good times so that it can be drawn down if things turn sour. If banks had done this in the current crisis it might have provided "some assistance," although he didn't know if it would have prevented the financial debacle.
And he said regulators are putting more attention on assessing banks' liquidity positions. Regulators are monitoring this "more intensely" and on a daily basis, Bernanke said.
Bernanke didn't provide details about the results of "stress tests," to be released later Thursday, that will reveal which banks have enough capital and the right mix of it to weather a deeper recession.
If they don't, banks will 30 days to come up with plans to remedy the situation and then have six months to implement them. Bernanke earlier this week said he was hopeful banks could raise capital on their own, rather than having to rely on the government for aid.
Regardless, no bank will be allowed to fail, Fed officials have said.
Bernanke said all 19 banks are solvent.
Getting banks in a better position to lend more freely again is a prerequisite to turning around the economy.
The stress tests were "comprehensive, rigorous, forward looking and highly collaborative among the supervisory agencies," Bernanke said, noting that more than 150 examiners, supervisors and economists took part. "Undoubtedly, we can use many aspects of the exercise to improve our supervisory processes in the future."
Huge, globally interconnected financial firms whose failure could endanger the U.S. economy also should be subject to "a robust framework for consolidated supervision," he said.
Sheila Bair, the head of the Federal Deposit Insurance Corp., on Wednesday told Congress new powers are needed to oversee such companies and suggested the FDIC could share those oversight duties with other regulators.
Regulators also must keep an eye on bonuses and other compensation practices to ensure they provide incentives to behave in ways that promote the long-run health of the bank. "Certainly an important lesson of the crisis is that the structure of compensation and its effect on incentives for risk-taking is a safety and soundness issue," Bernanke said.
Earlier this year, public and congressional outrage was sparked by millions of dollars in bonuses paid to employees of American International Group, which has been bailed out by the government four times.
On other issues, Bernanke said a government program to jump-start consumer and small-business lending called the Term Asset-Backed Securities Loan Facility, or TALF, should help ease stresses in the commercial real-estate market but won't be a "panacea."
The TALF, he said, after a "somewhat slow start is looking like it is beginning to pick up steam."