In an effort to avert future financial crises, Federal Reserve Chairman Ben Bernanke said Friday the Fed and the Federal Deposit Insurance Corp. are working together to implement a new regime for "resolving" insolvencies among the largest banks.
Bernanke, in remarks prepared for delivery to an International Monetary Fund conference in Washington, said it is critical to rein in the "moral hazard" of excessive risk-taking by "systemically important financial institutions," or SIFIs, and thereby make financial crises "less likely" and "less costly."
Since the financial crisis, under the Dodd-Frank legislation, he noted steps have been taken to "fireproof" the financial system by increasing supervision of the "shadow banking system" and reducing reliance on short-term wholesale funding.
"As we try to make the financial system safer, we must inevitably confront the problem of moral hazard," he said. "The actions taken by central banks and other authorities to stabilize a panic in the short run can work against stability in the long run, if investors and firms infer from those actions that they will never bear the full consequences of excessive risk-taking."
To limit "moral hazard," Bernanke noted that reforms such as increased capital and liquidity requirements and stress tests have been taken.
But these measures are insufficient, Bernanke suggested.
"Of course, market discipline can only limit moral hazard to the extent that debt and equity holders believe that, in the event of distress, they will bear costs," he said, adding that the "orderly liquidation authority" mandated by Dodd-Frank is needed "to impose costs on the creditors of failing firms and the need to protect financial stability."
Bernanke said "the FDIC, with the cooperation of the Federal Reserve, has been hard at work fleshing out this authority."
"A credible resolution mechanism for systemically important firms will be important for reducing uncertainty, enhancing market discipline, and reducing moral hazard," he said.
Bernanke said "our continuing challenge is to make financial crises far less likely and, if they happen, far less costly."
Bernanke did not talk about the economy or monetary policy in his prepared remarks.
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