Fed Chairman: Macroprudential Regulation a "Major Innovation"

Fed Chairman: Macroprudential Regulation a "Major Innovation"

Photo of Ben BernankeFederal Reserve Chairman Ben Bernanke said in a recent speech that the nation's central bank has already begun instituting the macroprudential approach to financial regulation embodied in the Dodd-Frank Act.

In a May 5 speech in Chicago, Bernanke said a more comprehensive regulatory strategy makes the nation's financial oversight regime better suited to adapt to future changes in the financial industry. He described the new approach as one "that supplements traditional supervision and regulation of individual firms or markets with explicit consideration of threats to the stability of the financial system as a whole." The goal, the chairman noted, is to lessen the chances of financial disruptions severe enough to harm the broader economy.

Multiple safeguards under way
To that end, the Fed has already undertaken several projects, Bernanke said. For one, it has created a working group of experts from various disciplines to oversee the supervision of large financial institutions. This group, the Large Institution Supervision Coordinating Committee, uses "horizontal, or cross-firm, reviews" to track industry practices, investment or funding strategies, changes in financial interconnectedness, and other events that affect systemic risk.

The Federal Reserve Board of Governors has also set up a group to coordinate work involving financial stability. Among its duties, the Office of Financial Stability Policy and Research helps monitor international financial risks and analyze how those risks might affect financial stability.

Third, the Fed is regularly taking a macroprudential approach to analyzing significant economic events at home and abroad. Bernanke cited Europe's public debt problems as an example. As the crisis unfolded, Fed supervisors examined U.S. banks' exposures to European banking firms and sovereign debt. "In addition to evaluating direct exposures, we analyzed scenarios under which sovereign debt concerns might lead to broader financial volatility," Bernanke said. "Our focus was on the possibility that financial disruptions might impede credit flows and economic activity in both Europe and the United States."

More work lies ahead
That work demonstrates the Fed's efforts to enact a primary lesson of the financial crisis. That lesson: financial regulation should account for overall financial stability and the soundness of individual firms, Bernanke pointed out. He noted that while progress has been made since Dodd-Frank passed nearly a year ago, considerable work remains to better understand sources of systemic risk and to reduce those risks.

"These are difficult challenges," Bernanke said, "but if we are to avoid a repeat of the crisis and its economic consequences, these challenges must be met."

May 31, 2011