WASHINGTON — Despite "considerable progress" made by regulators to address too-big-to-fail, markets still attach "some probability to the government bailing out the creditors of a [systemically important financial institution]," Federal Reserve Governor Jeremy Stein said Wednesday, illustrating the need to continue efforts.
In fact, rating agencies are giving an "uplift" to large banks due to the assumed government support from which systemically important financial institutions are likely to benefit.
"While this uplift seems to have shrunk to some degree since the passage of Dodd-Frank, it is still significant," Stein said in remarks prepared for a conference sponsored by the International Monetary Fund.
"All else equal, this uplift confers a funding subsidy to the largest financial firms," he continued in a speech entirely focused on the regulation of large financial institutions, without reference to the economic outlook or the Fed's monetary policy.
Even assuming there is no probability of a government bailout for such large institutions, the issue of spillover is the other key challenge in addressing too-big-to-fail, Stein said.
Overall, progress has been "considerable," he said, adding, "If a SIFI does fail I have little doubt that private investors will in fact bear the losses — even if this leads to an outcome that is messier and more costly to society than we would ideally like."
That being said, "We're not yet at a point where we should be satisfied."
While recognizing the need for further improvement, Stein dismissed the idea of returning to the drawing board by adopting a different approach or returning to a Glass-Steagall-type of regulation limiting banks' activity.
"While I agree that we have a long way to go, I believe that the way to get there is not by abandoning the current reform agenda, but rather by sticking to its broad contours and ratcheting up its forcefulness on a number of dimensions," he said.
"In this spirit, two ideas merit consideration: (1) an increase in the slope of the capital-surcharge schedule that is applied to large complex firms, and (2) the imposition at the holding company level of a substantial senior debt requirement to facilitate resolution under Title II of Dodd-Frank."
"In parallel with the approach to capital surcharges, a senior debt requirement could also potentially be made a function of an institution's systemic footprint," Stein added.
Turning to the orderly liquidation authority that Dodd-Frank granted the Federal Deposit Insurance Corp in case of a SIFI failure, Stein expressed support for the FDIC's "single point of entry" approach, which he called "encouraging."
"I believe this approach gets the first-order economics right and ultimately has a good chance to be effective," Stein said.
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