Financial Update (Third Quarter 2008)

Fed Chief Discusses Reducing Systemic Risk

photo of Fed Chair Ben Bernanke Federal Reserve Chairman Ben Bernanke recently laid out two broad strategies for reducing risk in the nation's financial system: strengthening the financial infrastructure and adopting a broader approach to financial supervision and regulation.

Although the financial market turmoil that began in 2007 is not over, the nation must explore how to bolster the system to make such bouts of instability rarer and less severe in the future, Bernanke said during an August 22 speech at the Federal Reserve Bank of Kansas City's Annual Economic Symposium in Jackson Hole, Wyo.

Shoring up financial infrastructure is a key
The chairman said that the Federal Reserve is collaborating with the private sector and other regulators to strengthen the financial infrastructure.

For example, the Federal Reserve Bank of New York is leading a public-private initiative to improve arrangements for clearing and settling trades in credit default swaps and other over-the-counter derivatives.

Bernanke's speechoff-site image

The Fed also continues to monitor systemically important payment and settlement systems and compares their performance with international standards for reliability, efficiency, and safety, the chairman said. At the same time, he noted that—unlike most other nations' central banks—the Fed does not have general authority to oversee these systems.

Broadening the supervision and regulation umbrella
On a second front, Bernanke discussed the notion of a more systemwide approach to supervising and regulating financial institutions. Under the current system of safety-and-soundness regulation, supervisors often focus on the financial conditions of individual institutions in isolation.

"An alternative approach, which has been called systemwide or macroprudential oversight, would broaden the mandate of regulators and supervisors to encompass consideration of potential systemic risks and weaknesses as well," Bernanke said.

At the same time, the chairman cautioned that such reforms must be carried out carefully. "The adoption of a regulatory and supervisory approach with a heavier macroprudential focus has a strong rationale, but we should be careful about overpromising, as we are still rather far from having the capacity to implement such an approach in a thoroughgoing way," he said.


September 29, 2008