NEW YORK - New York Federal Reserve Bank President William Dudley Monday evening said that commercial real estate loan problems are continuing to hurt small and medium size banks and, in turn, credit availability for both consumers and small business.
And he said those problems are apt to persist "for some time to come."
Dudley, in remarks prepared for the Reserve Bank of Australia's 50th Anniversary Symposium in Sydney, Australia, said the "raging" financial crisis seems to be over, but said the work of strengthening the global financial system to prevent future crises is "not close to complete."
Dudley said "the U.S. financial system is in much better shape today than it was a year ago," and he pointed to a number of areas of improvement.
"The capital markets are generally open for business -- with the important exception of some securitization markets -- and the major securities dealers that survived the crisis have seen a sharp recovery in profitability," he said.
"The largest U.S. bank holding companies, which went through the Supervisory Capital Assessment Program exercise, have more and better quality capital, having raised more than $100 billion of common equity over the past year in the capital markets and generated nearly as much common equity via preferred stock conversions and from gains on asset sales."
However, he went on, "many smaller and medium-sized banks remain under significant pressure."
Dudley attributed this partially to the fact that "such institutions hold assets that are carried mainly on the books on an accrual basis," and "compared with mark-to-market assets, such assets adjust much more slowly to changes in market conditions and the economic environment."
Secondly, he said, "many of these banks have a much more concentrated exposure to commercial real estate, a sector that remains under considerable pressure."
"Not only have capitalization rates risen sharply -- meaning the investors will pay much less for a dollar of rental income than before -- but the rental income streams on these properties also have declined as the performance of the U.S. economy has declined," said Dudley.
"Together, these two factors have pushed U.S. commercial real estate prices down by about 40% to 50% from the peak reached in 2006," he continued. "Loan losses in commercial real estate and consumer and mortgage loans seem likely to continue to pressure smaller banks for some time to come."
And that, he suggested, has broader economic consequences: "This in turn means that credit availability to households and small businesses will still be curtailed."
As he has before, Dudley talked about the need for financial reform.
"As the crisis has abated, our attention has shifted to what we need to do to prevent another crisis in the future," he said. "We need to take the necessary steps to build a strong and resilient financial system."
He called for action in three broad areas:
1) "Effective macroprudential supervision. By this, I mean conducting supervision not just vertically institution by institution, but also horizontally across institutions and markets. We need to better understand how the system operates as a whole and how problems in one area can affect financial stability elsewhere. This means both how the overall system affects individual firms and how the activities of a single firm or market affects the entire financial system.
2) "Make financial institutions and market infrastructures more robust to withstand shocks and become less prone to failure," including stronger capital requirements and liquidity buffers.
3) "Change the system so that no financial firm is 'too big to fail.'"
To strengthen financial market infrastructures, Dudley said the Fed "is working with a broad range of private-sector participants, including dealers, clearing banks and tri-party repo investors to dramatically reduce the structural instability of the tri-party repo system."
"Similarly, over-the-counter (OTC) derivatives clearance activity is being pushed toward central counterparties and exchanges," he said. "In addition, the Federal Reserve and others are evaluating how greater transparency with respect to OTC derivatives prices would improve financial stability."
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