mark w olson : loan quality and how it reflects the overall economy remarks by mr mark w olson, member of the board of governors of the us federal reserve system, at the government affairs conference of the credit union national association, washington, dc, 28 february 2005. * * * thank you for inviting me to speak here today. let me begin by congratulating all of you who take time away from your responsibilities in your respective institutions to participate in this government affairs conference. i am sure that some of your colleagues back home think you are on a junket, and there are elements of your trip to washington, d. c., that are a welcome respite from your day - to - day activities. nonetheless, you are taking time away from professional responsibilities and families to participate in this important event, and your efforts are both commendable and valuable. my talk today will address the sometimes complex interactions between business cycles in the economy at large and financial institutions like banks and credit unions. on the whole, these continue to be favorable times for the financial services providers, whether commercial banks or credit unions. returns, which continue to be attractive, have been driven recently more by loan volume than margins. household income has grown nicely while unemployment has remained low, and, together with low mortgage interest rates, these factors have contributed to appreciation in home values. a great number of households have used this historic opportunity to refinance their mortgages and reduce their debt service costs. many have sought the tax advantages of home equity loans as an alternative to credit cards or other consumer debt. and, despite the publicity accorded to several big mergers, smaller institutions - including credit unions and community banks - have fared quite well in this environment. risk - management strategies and processes of course need to adapt to these changing conditions. growth in mortgage loans and mortgage - backed securities requires lenders to monitor and manage the significant and sometimes complex interest rate risk profiles associated with such exposures, especially as market interest rates have risen over the past several months. compliance, too, has received more attention from both bankers and regulators. historically, however, credit risk has been the most affected by changes in the economic cycle. fortunately for financial institutions with a retail business focus, this time the growth opportunities have come in products that we don't usually associate with large potential credit losses, namely, conforming or jumbo mortgages and home equity lines of credit. our past experience, however, suggests limits as to how much

are too onerous and are choking off credit. but the evidence suggests otherwise : u. s. bank lending has been healthy over recent years and profits are strong. by any measure, u. s. banks appear very competitive relative to their international peers. in that regard, the current level of capital is a sign of strength. while 2 / 5 bis central bankers'speeches there is a natural tendency to question the value of capital buffers when times are good, the severe costs associated with not having enough capital to absorb losses become all too evident in a downturn. by the time losses are rising, it is generally too late to start building buffers, which became all too clear with devastating consequences in some countries during the last crisis. i support efforts to identify improvements that make regulations less burdensome. but it is vital to be prudent regarding any material changes to the core capital and liquidity framework, and not lose sight of the need to safeguard financial resilience through the cycle. prudence would argue for waiting until we have tested how the new framework performs through a full cycle before we make judgments about its performance. at this point in the cycle, it is premature to revisit the calibration of core capital and liquidity requirements for the large banking institutions. 3 history suggests that a booming economy can lead to a relaxation in lending standards and an attendant increase in risky debt levels. i would be reluctant to see our large banking institutions releasing the capital and liquidity buffers that they have built so effectively over the past few years, at a time when cyclical pressures and vulnerabilities in the broader financial system are building. indeed, if cyclical pressures continue to build and financial vulnerabilities broaden, it may become appropriate to ask the largest banking organizations to build a countercyclical buffer ( ccyb ) of capital to maintain an adequate degree of resilience against stress. the ccyb is an additional margin of capital that the nation ’ s largest banks can be asked to build to sustain resilience when there is an elevated risk of above - normal losses, which often follow periods of rapid asset price appreciation or credit growth. this buffer is intended to be released as the economy weakens in order to allow banks to lend more when it is most needed. countercyclical capital requirements can lean against rising financial vulnerabilities at a time when the degree of monetary tightening that would be needed to achieve the same goal would be