Statement of
Sheila C. Bair, Chairman,
Federal Deposit Insurance Corporation
On
Modernizing Bank Supervision And Regulation
before the
Committee on Banking, Housing and Urban Affairs
U.S. Senate; Room 534,
Dirksen Senate Office Building
March 19, 2009
Chairman Dodd, Ranking Member Shelby and members of the Committee, I appreciate
the opportunity to testify on behalf of the Federal Deposit Insurance Corporation (FDIC)
on the need to modernize and reform our financial regulatory system.
The events that have unfolded over the past two years have been extraordinary. A
series of economic shocks have produced the most challenging financial crisis since the
Great Depression. The widespread economic damage has called into question the
fundamental assumptions regarding financial institutions and their supervision that have
directed our regulatory efforts for decades. The unprecedented size and complexity of
many of today's financial institutions raise serious issues regarding whether they can be
properly managed and effectively supervised through existing mechanisms and
techniques. In addition, the significant growth of unsupervised financial activities outside
the traditional banking system has hampered effective regulation.
Our current system has clearly failed in many instances to manage risk properly and to
provide stability. U.S. regulators have broad powers to supervise financial institutions
and markets and to limit many of the activities that undermined our financial system, but
there are significant gaps, most notably regarding very large insurance companies and
private equity funds. However, we must also acknowledge that many of the systemically
significant entities that have needed federal assistance were already subject to
extensive federal supervision. For various reasons, these powers were not used
effectively and, as a consequence, supervision was not sufficiently proactive.
Insufficient attention was paid to the adequacy of complex institutions' risk management
capabilities. Too much reliance was placed on mathematical models to drive risk
management decisions. Notwithstanding the lessons from Enron, off-balance sheet-
vehicles were permitted beyond the reach of prudential regulation, including holding
company capital requirements. Perhaps most importantly, failure to ensure that financial
products were appropriate and sustainable for consumers has caused significant
problems not only for those consumers but for the safety and soundness of financial
institutions. Moreover, some parts of the current financial system, for example, over the
counter derivatives, are by statute, mostly excluded from federal regulation.
In the face of the current crisis, regulatory gaps argue for some kind of comprehensive
regulation or oversight of all systemically important financial firms. But, the failure to
Sheila C. Bair, Chairman,
Federal Deposit Insurance Corporation
On
Modernizing Bank Supervision And Regulation
before the
Committee on Banking, Housing and Urban Affairs
U.S. Senate; Room 534,
Dirksen Senate Office Building
March 19, 2009
Chairman Dodd, Ranking Member Shelby and members of the Committee, I appreciate
the opportunity to testify on behalf of the Federal Deposit Insurance Corporation (FDIC)
on the need to modernize and reform our financial regulatory system.
The events that have unfolded over the past two years have been extraordinary. A
series of economic shocks have produced the most challenging financial crisis since the
Great Depression. The widespread economic damage has called into question the
fundamental assumptions regarding financial institutions and their supervision that have
directed our regulatory efforts for decades. The unprecedented size and complexity of
many of today's financial institutions raise serious issues regarding whether they can be
properly managed and effectively supervised through existing mechanisms and
techniques. In addition, the significant growth of unsupervised financial activities outside
the traditional banking system has hampered effective regulation.
Our current system has clearly failed in many instances to manage risk properly and to
provide stability. U.S. regulators have broad powers to supervise financial institutions
and markets and to limit many of the activities that undermined our financial system, but
there are significant gaps, most notably regarding very large insurance companies and
private equity funds. However, we must also acknowledge that many of the systemically
significant entities that have needed federal assistance were already subject to
extensive federal supervision. For various reasons, these powers were not used
effectively and, as a consequence, supervision was not sufficiently proactive.
Insufficient attention was paid to the adequacy of complex institutions' risk management
capabilities. Too much reliance was placed on mathematical models to drive risk
management decisions. Notwithstanding the lessons from Enron, off-balance sheet-
vehicles were permitted beyond the reach of prudential regulation, including holding
company capital requirements. Perhaps most importantly, failure to ensure that financial
products were appropriate and sustainable for consumers has caused significant
problems not only for those consumers but for the safety and soundness of financial
institutions. Moreover, some parts of the current financial system, for example, over the
counter derivatives, are by statute, mostly excluded from federal regulation.
In the face of the current crisis, regulatory gaps argue for some kind of comprehensive
regulation or oversight of all systemically important financial firms. But, the failure to
utilize existing authorities by regulators casts doubt on whether simply entrusting power
in a single systemic risk regulator will sufficiently address the underlying causes of our
past supervisory failures. We need to recognize that simply creating a new systemic risk
regulator is a not a panacea. The most important challenge is to find ways to impose
greater market discipline on systemically important institutions. The solution must
involve, first and foremost, a legal mechanism for the orderly resolution of these
institutions similar to that which exists for FDIC insured banks. In short, we need an end
to too big to fail.
It is time to examine the more fundamental issue of whether there are economic
benefits to institutions whose failure can result in systemic issues for the economy.
Because of their concentration of economic power and interconnections through the
financial system, the management and supervision of institutions of this size and
complexity has proven to be problematic. Taxpayers have a right to question how
extensive their exposure should be to such entities.
The problems of supervising large, complex financial institutions are compounded by
the absence of procedures and structures to effectively resolve them in an orderly
fashion when they end up in severe financial trouble. Unlike the clearly defined and
proven statutory powers that exist for resolving insured depository institutions, the
current bankruptcy framework available to resolve large complex non-bank financial
entities and financial holding companies was not designed to protect the stability of the
financial system. This is important because, in the current crisis, bank holding
companies and large non-bank entities have come to depend on the banks within the
organizations as a source of strength. Where previously the holding company served as
a source of strength to the insured institution, these entities now often rely on a
subsidiary depository institution for funding and liquidity, but carry on many systemically
important activities outside of the bank that are managed at a holding company level or
non-bank affiliate level.
While the depository institution could be resolved under existing authorities, the
resolution would cause the holding company to fail and its activities would be unwound
through the normal corporate bankruptcy process. Without a system that provides for
the orderly resolution of activities outside of the depository institution, the failure of a
systemically important holding company or non-bank financial entity will create
additional instability as claims outside the depository institution become completely
illiquid under the current system.
In the case of a bank holding company, the FDIC has the authority to take control of
only the failing banking subsidiary, protecting the insured depositors. However, many of
the essential services in other portions of the holding company are left outside of the
FDIC's control, making it difficult to operate the bank and impossible to continue funding
the organization's activities that are outside the bank. In such a situation, where the
holding company structure includes many bank and non-bank subsidiaries, taking
control of just the bank is not a practical solution.
in a single systemic risk regulator will sufficiently address the underlying causes of our
past supervisory failures. We need to recognize that simply creating a new systemic risk
regulator is a not a panacea. The most important challenge is to find ways to impose
greater market discipline on systemically important institutions. The solution must
involve, first and foremost, a legal mechanism for the orderly resolution of these
institutions similar to that which exists for FDIC insured banks. In short, we need an end
to too big to fail.
It is time to examine the more fundamental issue of whether there are economic
benefits to institutions whose failure can result in systemic issues for the economy.
Because of their concentration of economic power and interconnections through the
financial system, the management and supervision of institutions of this size and
complexity has proven to be problematic. Taxpayers have a right to question how
extensive their exposure should be to such entities.
The problems of supervising large, complex financial institutions are compounded by
the absence of procedures and structures to effectively resolve them in an orderly
fashion when they end up in severe financial trouble. Unlike the clearly defined and
proven statutory powers that exist for resolving insured depository institutions, the
current bankruptcy framework available to resolve large complex non-bank financial
entities and financial holding companies was not designed to protect the stability of the
financial system. This is important because, in the current crisis, bank holding
companies and large non-bank entities have come to depend on the banks within the
organizations as a source of strength. Where previously the holding company served as
a source of strength to the insured institution, these entities now often rely on a
subsidiary depository institution for funding and liquidity, but carry on many systemically
important activities outside of the bank that are managed at a holding company level or
non-bank affiliate level.
While the depository institution could be resolved under existing authorities, the
resolution would cause the holding company to fail and its activities would be unwound
through the normal corporate bankruptcy process. Without a system that provides for
the orderly resolution of activities outside of the depository institution, the failure of a
systemically important holding company or non-bank financial entity will create
additional instability as claims outside the depository institution become completely
illiquid under the current system.
In the case of a bank holding company, the FDIC has the authority to take control of
only the failing banking subsidiary, protecting the insured depositors. However, many of
the essential services in other portions of the holding company are left outside of the
FDIC's control, making it difficult to operate the bank and impossible to continue funding
the organization's activities that are outside the bank. In such a situation, where the
holding company structure includes many bank and non-bank subsidiaries, taking
control of just the bank is not a practical solution.