Bernanke: More Financial Reform May Be Needed

WASHINGTON — Federal Reserve Board Chairman Ben Bernanke said Wednesday that regulators may need to take further action in order to keep the financial system safe.

Over the past year, the banking agencies have tried to speed up the rulemaking process required under the Dodd-Frank Act in the hopes of staving off pressure by Congress to act on its own. During his final press conference as chairman, Bernanke cited progress made over the past 12 months, but said more reforms were on the way.

"We are not done," said Bernanke during the press conference, which followed a two-day Federal Open Market Committee meeting. "We have still some important rules to complete."

In 2013, regulators finished tougher capital rules under Basel III; proposed requirements to strengthen the types of liquid assets banks would have to hold to absorb shocks during times of crisis; introduced a second proposal to require the most globally active banks to have an extra cushion of leverage; and finalized a rule that prohibits banks from making risky trades with taxpayer money under the Volcker Rule.

Bernanke said those changes will have an impact.

"Certainly the system is safer and one indication of that is the amount of capital that large banks hold," said Bernanke.

The chairman also lauded the Fed's annual stress test exercises, which are applied to the 30 largest financial institutions, as one of the "main innovations" by regulators.

"I think that has been a very important test of both bank's ability to survive a bad situation, but also ability to measure their risk, which is something that was very inefficient going into the crisis," said Bernanke.

But more remains to be completed before the regulatory reform effort is completely finalized, said Bernanke. For example, a batch of rules considered a core element of the 2010 law that will set up guardrails for bank holding companies with $50 billion and more as well as foreign institutions operating in the U.S. are still left incomplete.

"Although all of them are well advanced and as we get these rules done and implement them, I am sure they will make a very substantial difference in the safety of the system, but whether more needs to be done I leave that as an open question," said Bernanke. "I think we will be working on this for some time."

Regulators have detailed plans to go beyond the Dodd-Frank Act to address potential risks tied to the so-called shadow banking system, which has fallen outside the bounds of traditional bank regulation. Fed officials are pushing to release a concept proposal aimed at addressing potential threats tied to short-term wholesale funding to reduce the risks of fire sales and liquidity runs.

They also are hoping to take steps to strengthen new authorities under the regulatory reform law to unwind failing institutions. The Fed, in consultation with the Federal Deposit Insurance Corp., is expected to unveil a plan to require large firms to issue long-term debt in an effort to facilitate their potential resolution.

Over the course of the last year, top Fed and administration officials have approached the issue of "too big to fail" in a twofold manner by insisting that the current reform process be allowed an opportunity to be seen through to completion and by showing a willingness to do more if problems remain unsolved.

"We need to see where the process ends in order to be able to answer the question whether we have fully solved the problem," Treasury Secretary Jack Lew said during a Senate Banking Committee hearing in May. "It is certainly the objective to be able to say that we have ended 'too big to fail' and that we have eliminated any subsidy that might exist."

Lew, Bernanke and other top officials have argued that new regulations must be given enough time to work before conclusions can be drawn on whether the reform effort has fallen short.

"We will see if we are comfortable at that point, when this is all done, if we believe that the 'too big to fail' problem has been solved," said Bernanke during a speech in May. "If not, certainly one direction that we could go forward would be in my view, one constructive direction and a number of my board colleagues have talked about this, is through the capital direction."

The outgoing central banker, who will leave his post on Jan. 31, has disapproved of setting arbitrary limits on the size of institutions to eradicate "too big to fail," but has endorsed requiring banks to hold more and better quality capital to buffer against potential stress events.

"Rather than arbitrarily saying the banks can be no larger than such and such a size, for example, I would argue that what we need to do is make sure that larger institutions have to have more and better quality capital," said Bernanke in his May speech at a conference hosted by the Chicago Federal Reserve.

Determining whether policymakers should impose a size cap on the largest institutions has been a key question in the debate over "too big to fail."

Regulators have repeatedly argued that size can't be the only factor, while some lawmakers have insisted that megabanks should be broken up.

Sens. Sherrod Brown, D-Ohio, and David Vitter, R-La., introduced a bill in April that would require banks with more than $500 billion in assets to hold a 15% capital ratio as well as scrap more complex Basel III capital standards.

Other critics, like Sen. Elizabeth Warren, D-Mass., have said regulators have not done enough to rein in Wall Street banks that receive billions of dollars in subsidies because the market continues to believe they will be saved in the event of the next financial crisis.

To help ease concerns, Bernanke and other Fed officials have argued that additional requirements on financial institutions will inevitably raise the cost of funding, thereby incentivizing them to shrink and seemingly become less risky.

Capital requirements and extra capital buffers on the largest banks would help to "both equalize their cost of funding with other banks and make them safer so that the risk of their failure is limited," Bernanke said at a press conference in March following a two-day FOMC meeting.

Compounding the pressure on regulators has been the often slow, lengthy rulemaking process that has given critics of the reform law ample ammo to call for additional legislative fixes or eliminate parts of it altogether.

Proving "too big to fail" is over, however, will take time, and most likely another crisis for it to be a certitude.

"There is no precise point at which you can prove with certainty that we have done enough. If, in the future, we need to take further action, we will not hesitate," Lew said in a speech in December.

Instead, Lew and others have stressed it will be a continued process whereby regulators will continue to keep a vigilante eye on emerging risks.

"This is not about writing a set of rules, and then walking off the field," said Lew. "This will require ongoing attention - ongoing fact-finding, review, analysis, and action."

But, Bernanke, who acknowledged he and other regulators were slow to recognize the crisis, said Fed policymakers have made it a priority to keep a vigilant eye on possible risks to financial stability in the future.

"We have done everything we can think of essentially to strength then Fed's ability to monitor the financial markets to take actions to stabilize the economy in the financial system," said Bernanke. "Going forward we are much better prepared to deal with these events than we were when I became chairman in 2006."