Letter from Chicago Fed President Outlines Critical Elements of Financial Reform
CHICAGO — Federal Reserve Bank of Chicago President Charles Evans sent a letter March 2 to ten U.S. senators discussing three critical elements of financial reform requiring legislative action.
The letter was sent to the senators representing the five states in the Seventh Federal Reserve District, which consists of most of Illinois, Indiana, Michigan and Wisconsin and all of Iowa. These senators are: Chuck Grassley (R-IA), Tom Harkin (D-IA), Roland W. Burris (D-IL), Richard J. Durbin (D-IL), Evan Bayh (D-IN), Richard G. Lugar (R-IN), Carl Levin (D-MI), Debbie Stabenow (D-MI), Russell D. Feingold (D-WI), Herb Kohl (D-WI).
Here is the text of the letter:
Over the last two years, our country has experienced the worst financial crisis since the 1930s. These exceptional circumstances have created hardships for consumers and businesses and posed great challenges for policymakers. The Federal Reserve has responded with a variety of aggressive and innovative policy actions which, I believe, are helping to address the difficulties we face and have put us on the road to economic recovery.
The crisis has revealed some major weaknesses in our financial regulatory framework. If we truly hope to be able to say "never again," we need to address these deficiencies. Financial reform will not be easy. These are complex problems that will require comprehensive solutions, but reform is critical for ensuring the long-term economic stability of the nation. I am pleased that the Congress has taken up the debate.
I believe there are three critical elements requiring legislative action: consolidated supervision of all systemically important financial institutions; the need to have effective mechanisms to unwind these firms without unnecessarily exposing US taxpayers; and the important public policy benefits of including a robust role for the Federal Reserve in bank supervision.
Consolidated Supervision of Systemically Important Financial Institutions
The crisis has demonstrated the need for strong, consolidated supervision of all large, systemically important financial institutions, including banks and nonbanks. Given the interconnectedness of these firms and their impact on the overall U.S. economy, some regulatory entity must be responsible for gathering the necessary data and evaluating the financial strength of these institutions in order to identify potential problems for financial markets.
Such proactive supervision requires collaboration between economists and regulators as well as market and payments experts. The Federal Reserve has many well-trained and experienced economists and other experts gathering intelligence and analyzing incoming data to prepare the Federal Reserve System’s Governors and Bank presidents for their monetary policy decisions. I believe that these same macroeconomic insights can help promote financial stability by substantially improving regulators’ ability to identify and assess risks that are relevant to a range of financial institutions. No other agency has this range of perspective and insight.
We also need to ensure that no financial institution, bank or nonbank, is “too big to fail.” Many of the unprecedented interventions undertaken by the Fed, the FDIC and the Treasury occurred because we lacked viable alternatives that would have allowed for the orderly unwinding of these large, complex financial institutions. While mechanisms already exist to address large banking failures, we also need an effective process to resolve failing nonbank institutions that limits market disruption and minimizes moral hazard. These situations should not be dealt with on an ad hoc basis. The need for an advance plan is imperative... The need for an advance plan is imperative.
Role of the Federal Reserve
Supervision of Large Banking Organizations
The Federal Reserve was not alone in making mistakes in our supervisory activities; however, we are learning from these mistakes and have already taken steps to enhance the macro prudential oversight of our largest banking organizations
Even without new legislation, we have taken several important steps to improve our supervision of financial institutions and reduce the likelihood of a future crisis. We took the lead in the Supervisory Capital Assessment Program (SCAP), which reviewed the capital adequacy of the 19 largest bank holding companies under adverse stress scenarios. Using our staff of economists, market specialists and examiners we applied a multidisciplinary approach that combined our traditional onsite examinations with advanced quantitative and analytical tools. We are also reviewing compensation practices at large banks and working with international regulators to strengthen global standards for capital, liquidity and risk management. Importantly, the Federal Reserve continues to demonstrate its commitment to strengthening consumer protection through new actions on mortgages and credit cards.
Supervision of Small and Regional Banking Organizations
I am very troubled about reports of a proposed Senate bill that would reduce or eliminate the Federal Reserve’s role in supervising small and medium-sized banks and bank holding companies. The connection between community banks and finan¬cial system risks has not received much attention; however, community banks play a critical role as lenders to consumers, small businesses and agricultural enterprises. As a result, stresses and downturns among this group of banks can adversely affect local communities and the broader economy. Our supervisory role with community and regional banks provides us with grass roots information that ensures a balanced regulatory perspective and provides regional insights that are important to our monetary policy role. A recent example is the concern associated with bank lending to small and medium-sized businesses. Given the impact on the economy represented by this type of lending, we have asked our examiners to ensure that banks are appropriately balancing prudent underwriting standards with the need to make sure that credit-worthy borrowers have access to credit.
Importance of a Regional Perspective in Policymaking
The regional structure of the Federal Reserve System provides an unmatched resource for the Midwest economy and its citizens. To the extent that regional economics and banking performance foreshadows national developments or recovery prospects, this is useful in national monetary policymaking.
For example, our Seventh District economy is 50 percent more concentrated than the nation in overall manufacturing, typically produces 40 percent of the nation’s corn, soybeans, and hogs, and has a major concentration in auto manufacturing. In financing this economy, nearly 1100 individual banks meet the needs of Seventh District constituents. This includes the hundreds of small banks which serve the needs of consumers, small businesses and agricultural concerns as well as some of the largest banking and financial services companies in the country.
Regional Federal Reserve Banks also support many other initiatives that benefit our communities, such as our work with consumer and community groups to address the mortgage foreclosure crisis, enhance financial literacy, and increase access to banking services. The Chicago Fed has spent decades building outreach programs that combine conference forums, current analysis, and research to understand the region’s economy and its financial system, businesses and consumers. This allows important policy decisions to be made with input from those whose perspectives go beyond Washington and Wall Street and are focused on the needs of Main Street.
I would be happy to discuss these or any other issues of concern to you at your convenience.
Charles L. Evans
President and Chief Executive Officer
Federal Reserve Bank of Chicago