Federal Reserve Board Chairman Ben Bernanke on Monday rejected calls to break up large depository institutions, either on the basis of their size or the products they offer.

At a speech sponsored by the Economic Club of New York, Bernanke dismissed a recommendation by Bank of England Governor Mervyn King to break up large banks. Bernanke argued that simply making banks smaller would do little to ensure they did not pose risks to the financial system.

"I don't think simply making banks smaller would do it because banks can still be systemically critical even if they are somewhat smaller, if they are heavily interconnected with other banks, if they provide critical services to the financial industry or if risk of various sorts go across a whole range of things," he said.

Bernanke also said commercial banking activities should not be split off from proprietary trading, an idea endorsed by Paul Volcker, the head of the president's Economic Recovery Advisory Board. But Bernanke did say that regulators ought to be able to scale back activities on a case-by-case basis as regulatory reform proposals pending in Congress would allow.

"I do think there would be circumstances on which a supervisor or a regulator would force an institution to cut back on these kinds of activities," he said. "I find it difficult to draw a bright line" because some investment banking activities complement commercial banking and customer-related activities.

Rather than breaking up institutions, Bernanke said, reforms should create disincentives to becoming too large and should expand on the government's ability to resolve large institutions.

Addressing the ability to prevent the next crisis, Bernanke said predicting asset bubbles is extremely difficult.

"It is inherently extraordinarily difficult to know whether an asset price is in line with its fundamental value or not... The problem still arises that identifying those misalignments [is] very difficult and knowing how much to move your interest rate tool and how to avoid bringing the rest of economy down remains very, very challenging."

His solution? "A macro prudential systemwide regulatory system that will give us the best possible chance to try to identify emerging risk, including asset price misalignments, and try to restrain that risk," he said.

"So I do think the best approach here, if at all possible, is to use supervisory regulatory guidance to restrain undue risk-taking and to make sure the system is resilient in case [of] an asset-price bubble burst."

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