mr meyer ’ s remarks at the conference of state bank supervisors remarks by mr laurence h meyer, member of the board of governors of the us federal reserve, at the conference of state bank supervisors, williamsburg, virginia on 3 june 1999. moving forward into the 21st century it is a pleasure to be here, when — once again — the industry has enjoyed another year of strong performance. that is not to say bank supervision and regulation today is without its challenges, or that there are few risks to u. s. banks. perhaps to the contrary, as a result of market dynamics, both domestically and abroad, we can expect to see some loan losses and earnings pressures. some weaknesses have already surfaced. for the most part, though, we continue to be spared the crisis events that can be so disruptive. this “ lull ” in domestic financial problems has come at an opportune time, as u. s. and world financial systems adjust to the profound changes of the last decade. the number of insured commercial banks continues to decline — down 4 percent last year and by roughly one - third since the decade began. meanwhile, the scope and pace of financial innovation continues to expand, making many transactions increasingly difficult to manage and more opaque. risk management and measurement techniques throughout the industry have become much more quantified with greater integration of information systems and financial theory. large banks, in particular, have also become far more diversified, now that they can expand nationwide. these changes and the industry ’ s transition, in general, should be viewed as a continuous and natural response by banks to evolving market needs and new technologies. that the industry, itself, is changing is not a problem ; banks must adapt to survive. the fact that the industry, rather than the legislative or regulatory process, is leading the change is also appropriate ; the private sector should almost always show the way. the result, though, must be managed with care. during the 1990s, banking organizations have increased tremendously in size as a result of the consolidation process, and the complexity of many bank activities has grown as well. these developments have crucial implications for bank supervisors, including those pertaining to systemic risks. in many respects, they have also made bank supervision more difficult. we have not yet achieved “ financial modernization ” in terms of legislation, but we certainly have a far different banking and financial industry than existed a decade ago. undoubtedly, more change is on the horizon, as distinctions among financial institutions continue to erode. that fact

on many of these issues seems not the proper course. they have an obligation to enforce sound reporting and disclosure practices as best they can, and our financial markets have been well served in the process. the u. s. banking industry has its obligations, too, to manage its risks and to tell its story to bank supervisors, the sec, and the general public. if for no other reason than the fact that banks today are so large and complex and have the potential to present such widespread risk, these largest institutions, in particular, should be held to high performance and compliance standards. as bank supervisors, we should welcome the market ’ s help to identify and assess banking risks and to minimize the risk of moral hazard. one approach the federal reserve is exploring would enhance the role of investors in bank or bank holding company subordinated debt. unlike shareholders, who benefit from any gains from excessive risk, subordinated debt holders have only downside risk. as a result, their incentives are similar to those of supervisors and the bank insurance fund : they lose if the bank defaults but they don ’ t participate in outsized gains. a difficulty, however, in creating a greater role for subordinated debt is determining how to provide investors with adequate and timely information about a bank ’ s risks and with sufficient leverage to affect management decisions. from the supervisor ’ s perspective, another difficulty is separating market “ noise ” in changing yield spreads from meaningful signals they may provide. we will be collecting and analyzing these data in the months ahead and will be evaluating their potential usefulness, both as a tool for supervision and as a market mechanism for providing feedback to banking organizations. whether or not the exercise proves fruitful, it points in the right direction — providing incentives for greater market discipline and for sound management of banking risks. conclusion in closing, i would remind you that we are beginning to see slippage in important indicators of industry strength. though still low by historical standards, the volume of nonperforming assets increased last year for the first time since 1991, with the deterioration concentrated within commercial and industrial loans. delinquencies in agricultural loans have also risen, as a result of extremely weak markets for many farm products. continued weakness in much of this sector could begin to weigh on some community banks. the next stress - point for any particular bank may come from poor credit quality, from structural and competitive pressures within the industry, or from many other sources. fortunately, the u. s. commercial banking system has demonstrated a