WASHINGTON — Thomas Hoenig, the president of the Federal Reserve Bank of Kansas, said Tuesday that it is important to winnow the breadth of commercial banking activities to help offset risk in the financial system.
"You have to narrow the scope of commercial banking around the payments system and the intermediation process and move the high risk out where it can be managed and price properly," said Hoenig, speaking at an Independent Community Bankers Association conference.
But Hoenig acknowledged that eliminating all risk in the banking system would be improbable.
"We're always going to have cycles," said Hoenig. "We're always going to have a crisis. It's the scope and depth and consequences of the crisis that you want to deal with. You can't prevent them, and when you try to regulate them you tend to build it up and make it worse."
The outgoing president said that regional and community banks were just as important to the success of the U.S. economy as the largest banks — a line that earned him loud applause from the ICBA audience.
Narrowing the number of permissible activities would help level the playing field between large and small banks, Hoenig said.
"We're not going to get rid of large, important institutions of course, but it simplifies their structure and makes the ability to resolve more possible than what we have today," said Hoenig. "Because the risks are so deep and the consequence are so wide. We have to narrow the scope of the institutions around the protection of what they are afforded, that's the nature of commercial banking."
Pointing to the recent crisis, he said the idea of credit default swaps or structured investment vehicles came from the commercial banking industry, which helped propel risk in the financial system.
"Do you want that protection around these hedge fund activities? Do you want to pay that cost?" said Hoenig.
Hoenig, acknowledging concerns raised over the possibility of domestic financial institutions leaving the U.S. and going overseas, said it was possible, but unlikely under a flourishing U.S. economy.
"Financial institutions want to be where a successful economy is, and if the U.S., which I think it is, can continue to be a successful economy with the right banking system to help it, then that's where institutions want to be," he said.
Even if that's not the case, such a prospect must be weighed carefully.
"If you are going to go offshore, let's think about whether the country you are going to can afford you," said Hoenig. "I would want a guarantee if it's Ireland, can it afford the additional $800 billion? I don't think so, or the U.K., or Europe, or even China. It comes with a cost unless you narrow the scope."
