Ben S Bernanke: The Federal Reserve's role in bank supervision
Testimony by Mr Ben S Bernanke, Chairman of the Board of Governors of the Federal
Reserve System, before the Committee on Financial Services, US House of Representatives,
Washington DC, 17 March 2010.
The original speech, which contains various links to the documents mentioned, can be found on the US Federal
Reserve System's website.
* * *
Chairman Frank, Ranking Member Bachus, and other members of the Committee, I am
pleased to have the opportunity to discuss the Federal Reserve's role in bank supervision
and the actions that we are taking to strengthen our supervisory oversight.
The Federal Reserve's role in supervision
Like many central banks around the world, the Federal Reserve cooperates with other
agencies in regulating and supervising the banking system.1 Our specific responsibilities
include the oversight of about 5,000 bank holding companies, including the umbrella
supervision of large, complex financial firms; the supervision of about 850 banks nationwide
that are both state-chartered and members of the Federal Reserve System (state member
banks); and the oversight of foreign banking organizations operating in the United States.
The Federal Reserve's involvement in regulation and supervision confers two broad sets of
benefits to the country. First, because of its wide range of expertise, the Federal Reserve is
uniquely suited to supervise large, complex financial organizations and to address both
safety and soundness risks and risks to the stability of the financial system as a whole.
Second, the Federal Reserve's participation in the oversight of banks of all sizes significantly
improves its ability to carry out its central banking functions, including making monetary
policy, lending through the discount window, and fostering financial stability.2
The financial crisis has made clear that all financial institutions that are so large and
interconnected that their failure could threaten the stability of the financial system and the
economy must be subject to strong consolidated supervision. Promoting the safety and
soundness of individual banking organizations requires the traditional skills of bank
supervisors, such as expertise in examinations of risk-management practices; the Federal
Reserve has developed such expertise in its long experience supervising banks of all sizes,
including community banks and regional banks. But the supervision of large, complex
financial institutions and the analysis of potential risks to the financial system as a whole
require not only traditional examination skills, but also a number of other forms of expertise,
including macroeconomic analysis and forecasting; insight into sectoral, regional, and global
1
In the aftermath of the crisis, the view that the involvement of central banks in bank supervision strongly
complements their roles as lender of last resort, guardian of financial stability, and monetary policymaker has
received increasing international support. For example, following the problems at Northern Rock in the United
Kingdom, the Bank of England was given statutory responsibilities in the area of financial stability, its powers
to collect information from banks were augmented, and many have called for it to be given increased
supervisory authority. In Germany, plans to shift bank supervisory powers from the financial services regulator
to the Bundesbank have received significant attention. In the European Union, a new European Systemic Risk
Board is being established under which national central banks and the European Central Bank will play a key
role in efforts to protect the financial system from systemic risk. More broadly, in most industrial countries
today the central bank has substantial bank supervisory authorities, is responsible for broad financial stability,
or both.
2
See Ben S. Bernanke (2010), letter to Christopher J. Dodd and Richard C. Shelby (with enclosure, "The Public
Policy Case for a Role for the Federal Reserve in Bank Supervision and Regulation"), January 13.
BIS Review 31/2010
economic developments; knowledge of a range of domestic and international financial
markets, including money markets, capital markets, and foreign exchange and derivatives
markets; and a close working knowledge of the financial infrastructure, including payment
systems and systems for clearing and settlement of financial instruments.
In the course of carrying out its central banking duties, the Federal Reserve has developed
extensive knowledge and experience in each of these areas critical for effective consolidated
supervision. For example, Federal Reserve staff members have expertise in macroeconomic
forecasting for the making of monetary policy, which is important for helping to identify
economic risks to institutions and markets. In addition, they acquire in-depth market
knowledge through daily participation in financial markets to implement monetary policy and
to execute financial transactions on behalf of the U.S. Treasury. Similarly, the Federal
Reserve's extensive knowledge of payment and settlement systems has been developed
through its operation of some of the world's largest such systems, its supervision of key
providers of payment and settlement services, and its long-standing leadership in the
international Committee on Payment and Settlement Systems. No other agency can, or is
likely to be able to, replicate the breadth and depth of relevant expertise that the Federal
Reserve brings to the supervision of large, complex banking organizations and the
identification and analysis of systemic risks.
Even as the Federal Reserve's central banking functions enhance its supervisory expertise,
its involvement in supervising banks of all sizes across the country significantly improves the
Federal Reserve's ability to effectively carry out its central-bank responsibilities. Perhaps
most important, as this crisis has once again demonstrated, the Federal Reserve's ability to
identify and address diverse and hard-to-predict threats to financial stability depends critically
on the information, expertise, and powers that it has as both a bank supervisor and a central
bank. Not only in this crisis, but also in episodes such as the 1987 stock market crash and
the terrorist attacks of September 11, 2001, the Federal Reserve's supervisory role was
essential for it to contain threats to financial stability.3
The Federal Reserve's making of monetary policy and its management of the discount
window also benefit from its supervisory experience.4 Notably, the Federal Reserve's role as
a supervisor of state member banks of all sizes, including community banks, offers insights
about conditions and prospects across the full range of financial institutions, not just the very
largest, and provides useful information about the economy and financial conditions
throughout the nation. Such information greatly assists in the making of monetary policy. The
legislation passed by the House last December would preserve the supervisory authority that
the Federal Reserve needs to carry out its central banking functions effectively.
Improving the Federal Reserve's supervision of banking organizations
The Federal Reserve strongly supports ongoing efforts in the Congress to reform financial
regulation and close existing gaps in the regulatory framework.5 While we await passage of
3
For further discussion, see the Bernanke letter to Dodd and Shelby in note 2.
4
Our ability to monitor key payment and settlement systems also depends critically on our supervisory powers,
as several key institutions involved in payments and settlements have state member bank or Edge charters.
Without bank supervisory authority, the Federal Reserve would have no ability to examine or regulate such
institutions.
5
Lack of strong consolidated supervision of systemically critical firms not organized as bank holding companies
proved to be the most serious regulatory gap. In addition, under the Gramm-Leach-Bliley Act of 1999, the
Federal Reserve's consolidated supervision of bank holding companies was both narrowly focused on the
safety and soundness of their bank subsidiaries and heavily reliant on functional supervisors of the bank and
regulated nonbank subsidiaries of these companies; in turn, the functional supervisors themselves were
statutorily focused only on the safety and soundness of the specific entities they regulated. None of the federal
regulators had sufficient authority to focus on the systemic risk that large banking organizations posed.
BIS Review 31/2010
comprehensive reform legislation, we have been conducting an intensive self-examination of
our regulatory and supervisory performance and have been actively implementing
improvements.
On the regulatory side, we have played a key role in international efforts to ensure that
systemically critical financial institutions hold more and higher-quality capital, have enough
liquidity to survive highly stressed conditions, and meet demanding standards for
companywide risk management. We have also been taking the lead in addressing flawed
compensation practices by issuing proposed guidance to help ensure that compensation
structures at banking organizations provide appropriate incentives without encouraging
excessive risk-taking.6 Less formally, but equally important, since 2005 the Federal Reserve
has been leading cooperative efforts by market participants and regulators to strengthen the
infrastructure of a number of key markets, including the market for securities repurchase
agreements and the markets for credit derivatives and other over-the-counter derivative
instruments.
To improve both our consolidated supervision and our ability to identify potential risks to the
financial system, we have made substantial changes to our supervisory framework. So that
we can better understand linkages among firms and markets that have the potential to
undermine the stability of the financial system, we have adopted a more explicitly
multidisciplinary approach, making use of the Federal Reserve's broad expertise in
economics, financial markets, payment systems, and bank supervision to which I alluded
earlier. We are also augmenting our traditional supervisory approach that focuses on
firm-byfirm examinations with greater use of horizontal reviews that look across a group of firms to
identify common sources of risks and best practices for managing those risks. To
supplement information from examiners in the field, we are developing an off-site, enhanced
quantitative surveillance program for large bank holding companies that will use data
analysis and formal modeling to help identify vulnerabilities at both the firm level and for the
financial sector as a whole. This analysis will be supported by the collection of more timely,
detailed, and consistent data from regulated firms.
Many of these changes draw on the successful experience of the Supervisory Capital
Assessment Program (SCAP), also known as the banking stress test, which the Federal
Reserve led last year. As in the SCAP, representatives of primary and functional supervisors
will be fully integrated in the process, participating in the planning and execution of horizontal
exams and consolidated supervisory activities.
Improvements in the supervisory framework will lead to better outcomes only if day-to-day
supervision is well executed, with risks identified early and promptly remediated. Our internal
reviews have identified a number of directions for improvement. In the future, to facilitate
swifter, more-effective supervisory responses, the oversight and control of our supervisory
function will be more centralized, with shared accountability by senior Board and Reserve
Bank supervisory staff and active oversight by the Board of Governors. Supervisory concerns
will be communicated to firms promptly and at a high level, with more-frequent involvement
of senior bank managers and boards of directors and senior Federal Reserve officials.
Greater involvement of senior Federal Reserve officials and strong, systematic
followthrough will facilitate more vigorous remediation by firms. Where necessary, we will increase
the use of formal and informal enforcement actions to ensure prompt and effective
remediation of serious issues.
In summary, the Federal Reserve's wide range of expertise makes it uniquely suited to
supervise large, complex financial institutions and to help identify risks to the financial system
as a whole. Moreover, the insights provided by our role in supervising a range of banks,
including community banks, significantly increases our effectiveness in making monetary
policy and fostering financial stability. While we await enactment of comprehensive financial
reform legislation, we have undertaken an intensive self-examination of our regulatory and
supervisory performance. We are strengthening regulation and overhauling our supervisory
framework to improve consolidated supervision as well as our ability to identify potential
threats to the stability of the financial system. And we are taking steps to strengthen the
oversight and effectiveness of our supervisory activities.
Thank you. I'd be pleased to respond to your questions.