Federal Reserve Bank Governor Laurence H. Meyer on Monday urged bankers to stress-test credits vigorously to see whether borrowers could withstand the reduction in operating revenue an economic downturn would bring.
"Lenders are relying too much on the continuation of good times,'' he said. "They're assuming a very optimistic view of their borrowers' operating prospects."
While noting that loan portfolios remain sound, Mr. Meyer said problem loans at the nation's top 50 banks increased from 0.76% of all loans in 1998 to 0.81% in the first half of 1999.
"These are the kinds of developments that get the attention of bank supervisors and ought to get the attention of bank and other lenders," he said in a speech sponsored by the Institute of International Bankers.
Comptroller of the Currency John D. Hawke Jr. issued a similar warning last week, saying record profits may be blinding bankers to risks posed by weak underwriting standards.
In his speech, Mr. Meyer also praised efforts by international regulators to overhaul capital requirements. But he said the June 3 proposal from the Basel Committee on Banking Supervision is too complicated for small and midsize banks.
"As useful as a more risk-sensitive standard would be, the fact is most banks already hold capital well in excess of the regulatory minimum," he said. "I do not believe this more complex system is warranted or appropriate for the overwhelming majority of U.S. banks."
As a result, he said, the Fed is considering a two-pronged system that would impose simpler capital rules on smaller banks.
Federal Reserve Bank of New York President William J. McDonough, chairman of the Basel Committee, also addressed the international bankers. The two-prong plan, which would use external ratings agencies to assess a bank's exposure to credit risk, may be flawed, he said, but it is the best one regulators could devise.
Mr. McDonough argued that the current "club rule," which assumes most major industrialized nations are "extraordinarily creditworthy," ought to be scrapped.
"Is the use of external credit rating better than the club rule? Yes. Is it ideal? No," he said. "We are particularly anxious that those of you in the private sector try to come up with a better answer.
"When you look at the external ratings of private-sector credit, essentially what we are trying to achieve is a break away from the present accord in which an AAA borrower and the worst credit on your books have the same capital charge," Mr. McDonough continued. "Obviously that doesn't make any sense."
Comments on the proposal are being accepted through March 31.
The goal, Mr. McDonough said, "is a capital encouragement to you to do business with high-quality firms and a tax -- in a capital sense -- on doing highly risky business. That's certainly how you run your own banks."
On Monday, the Shadow Financial Regulatory Committee criticized the move toward external ratings agencies. It said, "The goal of moving away from arbitrary, categorical measures of risk is laudable; but, in practice, neither commercial ratings agencies nor banks' internal risk ratings are reliable regulatory tools."