NEW YORK – If regulators can’t fix the too-big-to-fail situation, “we will ultimately have to take more draconian measures and simply break up the largest banking organizations to eliminate the threat they pose to financial stability and economic growth,” Federal Reserve Bank of Dallas President and CEO Richard W. Fisher said Monday.
“I trust regulators will rise to the challenges posed by the financial crisis and too big to fail, leaving a legacy of success and providing a practicable infrastructure for next-generation supervision and regulation,” Fisher told a seminar in New York City, according to prepared text of his comments.
While prior attempts failed, Fisher said those “revamp the regulatory framework” using Dodd-Frank need to avert “unintended consequences and time inconsistencies” or it will lead to big banking organizations’ break up. “That is my contrarian view, and I‘m sticking with it,” Fisher said.
Additionally, Fisher said, without effective regulation, there is no financial stability, and without financial stability the Fed can’t meet it’s dual mandate “to foster maximum employment growth while constraining inflation and its alter ego, deflation.”
But the details and decision-making from Dodd-Frank is not contained in the law, it’s left to regulators. “Most regulatory reform initiatives applied since the Banking Act of 1864 have missed the mark,” Fisher said. “They looked good on paper and appeared to solve the problems of the day but later proved not up to the task. This is especially true with efforts to solve the too big to fail problem, in which an unwillingness to follow through on prior policy commitments to actually close down large failures and impose losses on their uninsured creditors has led to what economists call time inconsistency in policy. Let‘s hope this time will be different; that regulators will make their commitments credible and consistent with future rather than past needs.”
Success, he said, will come if regulators “identify the leverage points” – areas where decisive action would have “profound positive effects and avoid time inconsistency” – and act on those while avoiding areas that will provide little benefits and great risk of counterproductivity.
Fisher said he doesn’t mind if risk-takers are “rewarded with large compensation packages,” but he objects to the public underwriting through deposit insurance or subsidizing “through protective regulation the risk-taking ventures of large financial institutions and their executives.”
With the largest banks now controlling more assets than before the crisis, Fisher said, if further consolidation leads to “the largest institutions predominating even more than in the past, such an outcome would appear to me contrary to the stated spirit and goal of the act. A more consolidated industry would only magnify the challenge of dealing with systemically important institutions and offsetting their historically elevated too-big-to-fail status.”
The small-bank exceptions granted have alleviated some of Fisher’s concerns about community banking, “Unfortunately, the same cannot yet be said for the case of regional banks. The act indicates that all banking organizations with more than $50 billion in assets should be subject to enhanced supervision.” He added, “few really believe a $50 billion bank poses a systemic threat to our $17 trillion banking system. Nor is a $50 billion bank qualitatively similar along risk dimensions to the very largest ones that exceed $2 trillion in size. The top 10 banking organizations have a cutoff point of $300 billion. I posit that this group should constitute the primary target for enhanced supervision. Interestingly, despite its large share of industry assets, this group holds only about 20 percent of the small-business loans on bank books. Clearly, these institutions are engaged in substantial activities outside the traditional banking role. It is within these very largest banks, and perhaps a few slightly smaller yet highly complex or interconnected ones, that systemic risk is concentrated.
“If the enhanced-supervision requirements are not highly graduated and imposed primarily on the very largest banks, it is not difficult to imagine how the costs associated with such supervision could lead mid-tier banks that exceed the $50 billion threshold—yet fall well short of megabank status—to seek merger partners in order to achieve sufficient scale by which to help cover the cost of regulation. This would compound the problem rather than alleviate it,” he said.
“With regard to enhanced standards for such important factors as capital and liquidity requirements, leverage limits and risk management, Dodd–Frank instructs regulators to differentiate among these banks. Enhanced supervision can be implemented on a graduated scale, based on the extent of assets beyond $50 billion and possibly other factors. Let us do that fully, then, applying these measures along a highly graduated scale, with only minimal added mandates directed at mid-tier banking organizations.”
For the top 10 banks, Fisher said, “I would apply Dodd–Frank extensively and vigorously. I would apply all the elements of heightened supervision—from enhanced standards for capital and liquidity requirements, leverage limits and risk management to the additional measures of living wills and credit-exposure reports, concentration limits, extra public disclosures and short-term debt limits—with full force.”
He said he would also require annual Fed stress tests, “along with the additional tools and procedures of macroprudential supervision, including in-depth horizontal reviews across large companies.”
