The FDIC released Sheila Bair’s comments today regarding the new financial regulatory reform proposed by the Obama administration.
FDIC Chairman Sheila C. Bair said, “I commend President Obama for his leadership on financial regulatory reform and his inclusive approach to policy development. There are key areas of reform within our regulatory structure that should be addressed in any effort to strengthen the oversight of our financial markets, enhance consumer protection and promote market discipline. Of primary importance is addressing too big to fail. Market participants should understand that large institutions can and will fail and that an effective resolution mechanism will be uniformly applied to institutions in a fair, transparent and consistent manner. It is also important that we maintain a focus on assuring strong capital requirements for banks and their holding companies. As the ultimate insurer of over $6 trillion in deposits, the FDIC’s emphasis on capital has proven to be a crucial component in monitoring and preventing systemic risks. As we move through the reform effort, it will be important to take the lessons from the current financial crisis and apply them in a constructive and workable way.
Sheila Bair has been a proponent of regulatory reform of the banking system for some time. Based on the large amount of failed and troubled banks, it is obvious that the machinery in place that should have prevented a banking crisis is broken. What ultimate shape the new regulations take remains to be seen but unless the new rules grant regulators strong enforcement powers, a future banking crisis could reoccur.
Regulations and banking guidelines that could have prevented the current banking meltdown existed but the lack of enforcement by regulators rendered them ineffective – see FDIC lists causes for failed banks.
One weakness exposed by the banking crisis was the lack of formal plans for handling the collapse of a major US banking institution. Instead, an ad hoc policy was developed by the Government to save every large bank in trouble, regardless of the merits of keeping a weak bank in business. It is gratifying to hear Sheila Bair state that “large institutions can and will fail”.
With no risk of closure and the expectation that the Government will rescue every large institution that makes bad lending decisions, there is little incentive for a bank to lend responsibly or maintain adequate capital. The complexity of closing a large banking institution requires an “effective resolution mechanism” that does not exist today. Hopefully, the new regulatory reform plan will address the too big to fail issue as well as providing stricter and enforceable guidelines on bank lending policies.