WASHINGTON — Federal regulators defended themselves Wednesday against charges in a government report that supervisors knew of weaknesses in risk management at large financial institutions but did not demand changes.
In a Senate Banking subcommittee hearing, the Government Accountability Office said banking, thrift and securities regulators found problems with the models and stress tests financial institutions employed to gauge their risk, but the agencies continued signing off on positive examinations.
Timothy Long, the senior deputy comptroller for bank supervision policy at the Office of the Comptroller of the Currency, rejected the notion that regulators should have done more to strengthen bank models, many of which proved unreliable once the financial crisis began.
"Unless we believe the model deficiency is so severe as to undermine the bank's safety and soundness, we will allow the bank to continue to use the model as it makes necessary refinements or adjustments," he said. "Given the iterative process of testing and validating risk models, it simply is not realistic to suggest that a bank suspend its operations or business whenever it needs to make enhancements to those processes."
Roger Cole, the director of banking supervision and regulation at the Federal Reserve Board, which was criticized for its hands-off approach to supervision before the financial crisis, said it is now forcing changes at institutions.
"We are aggressively challenging those assumptions in firms' contingency funding plans that may be unrealistic," he said. "We are forcefully requiring institutions to retain strong capital buffers — above the levels prescribed by minimum regulatory requirements — not only to weather the immediate environment, but also to remain viable over the medium and long term."
But lawmakers clearly were not buying regulators' arguments.
"Welcome back from your vacations that you've been on for the past few years," Sen. Jim Bunning, R-Ky., told the regulators. "If we had good regulation, we wouldn't be in the crisis we're in now."
Sen. Jack Reed, D-R.I., who chaired the hearing, agreed.
"During the good times when all the excesses were building up, regulators were not pressing hard enough," he said. "The regulators should be asking hard questions."
The Senate hearing focused on the lessons learned from the financial crisis about risk management. The GAO's report for the hearing did not name the institutions involved in their review or the agencies that conducted the exams in question. But several examples symbolized the fundamental weaknesses in risk management that contributed to the financial crisis.
In one case, a regulator told an institution's board in 2006 that an exam found senior managers were not adequately overseeing risk management, financial reporting and internal audits.
"We found that the regulator continued to find some of the same weaknesses in subsequent examination reports, yet examiners did not take forceful action to require the institution to address these shortcomings," Orice Williams, the GAO's director of financial markets and community investment, said in prepared testimony. "When asked about the regulator's assessment of the holding company in general and risk management in particular, given the identified weaknesses, examiners told us that they had concluded that the institution's conditions were adequate, in part because it was deemed to have sufficient capital and the ability to raise more."
Such assumptions proved false for many financial institutions when the credit markets began to freeze in mid-2007.
Regulators also admitted to the GAO that they relied too heavily on an institution's assessment of its own risk.
One examiner relied on a manager's subprime mortgage risk review that, the GAO said, was based on a "lack of historical losses."
The regulators acknowledged in their testimony that improvements still need to be made to risk management systems at institutions, but some warned that bankers still need flexibility to run their business.
"Banks must be able to respond to customer and investor demand for new and innovative products and services," Long said.
