WASHINGTON — Federal Reserve Board Chairman Ben Bernanke on Wednesday rejected calls to break up the big banks, arguing that the best way to eliminate "too big to fail" is to remove enticements to become larger, riskier and more complex.
A "more market-responsive way to address this problem is to eliminate the incentives to be 'too big to fail,' " Bernanke said at a press conference after a two-day Federal Open Market Committee meeting.
Regulators are able to "take away the benefits" of being "too big to fail" through tougher supervisory oversight, higher capital requirements, greater liquidity requirements and restrictions on interconnectedness, he said.
Firms would then be forced to "internalize the costs of being large and complex," he said.
The Dodd-Frank financial reform law is intended to prevent a repeat of the bailouts of the recent financial crisis.
But in recent months prominent officials have argued the law did not go far enough. Richard Fisher, president of the Federal Reserve Bank of Dallas, and Sheila Bair, the former chairman of the Federal Deposit Insurance Corp., have both suggested the best way to move forward is to break up the big banks.
"Hordes of Dodd-Frank regulators are not the solution; smaller, less complex banks are. We can select the road to enhanced financial efficiency by breaking up TBTF banks — now," Fisher wrote in a recent op-ed in The Wall Street Journal.
Bernanke acknowledged that there may be cases where doing so might be necessary, but didn't agree with what has become a growing sentiment in certain circles.
"There may be circumstances where a bank or a financial institution is artificially large and in that context were posing a severe threat to financial stability I suppose that considering breaking it up would be something that regulators should look at," Bernanke said.
But regulators' ability to seize and unwind firms on the brink of failure is the best tool to convince investors and the market that large banks are no longer "too big to fail," he said.
"If we can safely unwind a failing firm then we no longer have 'too big to fail,' obviously," Bernanke said. "I think that's a very, very important objective."
Market indicators can also give a sense of whether investors are confident that the government will not save an institution in the event of a bailout.
"The test would be that the financial markets that lend to large firms base their bond spreads and what they're willing to pay for the stock of those firms solely on the risk-taking and on the business model of those firms and not on the fact that there is some anticipation of a government bailout," Bernanke said. "So I think market indicators will help us see our progress towards ending 'too big to fail.' "