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Banking

Lockhart: Trust Vital to Financial System

photo of Atlanta Fed Chair LockhartThe economy and individuals' financial security both benefit if Americans take part in and trust the nation's formal financial system. But in the wake of the 2008 financial crisis and subsequent recession, regulatory authorities and financial firm managers need to rebuild public trust in the system, Federal Reserve Bank of Atlanta President Dennis Lockhart said in an October 7 speech in Atlanta.

"As individuals, we must see a financial system that is well governed and well managed," Lockhart said in his keynote address at the Town Hall on Financial Capability at Emory University. "In other words, we must see a system we can trust."

Identifying areas to boost trust
Lockhart noted that a recent survey by the University of Chicago and Northwestern University found that only one in four Americans trust the financial system.

To improve that number, Lockhart believes there are five key areas in which regulators and company managers must be responsible. These areas are regulatory oversight, ensured liquidity, controlled leverage at the system and firm level through adequate capitalization, sound lending and business practices along with healthy incentives for managers, and transparent markets and institutions.

In terms of regulatory oversight, Lockhart said the ideal is a system in which no single financial institution is too big to fail. He said that we are not there yet but the Dodd-Frank Act at least created "a framework for the orderly unwinding of a large, complex financial institution." Lockhart added: "Here's how I think of my responsibility as a banking supervisor: collectively, the community of regulators must judiciously supervise individual institutions and vigilantly monitor the health of the overall system, to guard the public trust and, above all, avoid a systemic crisis."

Risk remains, but can be managed
The last of those five areas, especially, also directly involves regulators. Ensuring transparent markets and institutions, Lockhart emphasized, does not mean eliminating risk. "There's no moving forward without taking risk," he said. "But risk decisions should not be blind guesses or herd-following impulses. They should be based on sufficient information about the working of markets and the condition of market participants."

In order for regulators to effectively guard against severe disruptions in systemically important financial markets, there must be transparency of trading, position taking, and settlement, Lockhart concluded.

October 27, 2011