Auditors can do a better job supervising banks than regulators, according to Jerry Jordan, president of the Federal Reserve Bank of Cleveland.
"Some might think regulation must be done by government agencies," Mr. Jordan said on Tuesday. "I don't think that is right."
Speaking at the Bank Administration Institute's annual auditing and compliance conference here, Mr. Jordan said the system of government control, which dates to the 1930s, no longer works. Derivatives and the globalization of credit make centralized supervision nearly impossible, he said.
The solution is to rely more on internal and external auditors, who can ferret out problems better than examiners. The role of examiners should be to ensure auditors are doing their job, he said.
Investors "need to know that the risks are being monitored and periodic exams can't do that," he said.
Other financial services providers, such as insurers and securities firms, operate safely without the regulatory burden placed on banks, he said. Borrowing former President Reagan's famous comment on arms control treaties, Mr. Jordan said the Fed should, "Trust, but verify."
Mr. Jordan acknowledged the changes would require legislative and regulatory action, neither of which is likely any time soon.
Endorsing a February proposal by Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, Mr. Jordan said supervisors should quit overseeing banks that use complex derivatives and other innovative instruments. These institutions, in turn, would give up deposit insurance and access to the Fed's discount window.
Banks not interested in dealing with complex instruments could keep deposit insurance and the safety-and-soundness regulations that come with it.
Mr. Jordan said he supported Mr. Hoenig's plan because it "blended more market freedom with political plausibility."
In the interim, Mr. Jordan said, examiners should do more than criticize a bank - they should propose better ways of handling problems. "I look forward to the day when bankers say, 'Oh good, the Fed is here. I'm going to have a better bank,'" he said.
Mr. Jordan said responsibility for sound audits lies with a bank's chief executive officer, who must ensure that this department is independent and effective. He criticized bankers who outsource their internal audit work, a growing trend among small and medium-size banks.
"This is a contradiction in terms," he said. "How can you outsource internal audit?"