WASHINGTON — The Federal Reserve Board may be the world's economic powerhouse, but Chairman Ben Bernanke said Friday the central bank can rely on little more than "moral suasion" to convince banks to reform the nation's payment systems.
That has to change, Mr. Bernanke said at the Federal Reserve Bank of Kansas City's annual economic symposium.
"As part of any larger reform, the Congress should consider granting the Federal Reserve explicit oversight authority for systemically important payment and settlement systems," he said in a speech in Jackson Hole, Wyo.
While most other central banks have power over payment systems, the Fed, Mr. Bernanke said, must "rely on a patchwork of authorities, largely derived from our role as a banking supervisor, as well as on moral suasion, to help ensure that the various payment and settlement systems have the necessary procedures and controls in place to manage the risks they face."
Mr. Bernanke is seeking power to centralize over-the-counter derivatives transactions and strengthen the market for triparty repurchase agreements. If Congress were to take up the Fed chief's request, it would add to a growing list of powers the central bank has gained or is requesting during the financial crisis.
The Fed has examined investment banks since it opened the discount window to the firms in March and gained consultative powers over Fannie Mae and Freddie Mac after the government arranged a rescue of the companies last month. The Treasury Department has offered a blueprint for regulatory reform that would establish the Fed as a systemic-risk regulator, a concept Mr. Bernanke supports as long as it does not curb his bank supervision power.
The Federal Reserve Bank of New York has zeroed in on the derivatives market for nearly three years.
The goal is to strengthen counterparties, encourage electronic transaction recording to reduce errors, and develop a system for managing defaults.
On June 9, Timothy Geithner, the president of the New York Fed, convened a meeting to discuss reforms with 17 financial firms. Executives from the firms, which included Bank of America Corp., Wachovia Corp., Citigroup Inc., and JPMorgan Chase & Co., sent a letter to Mr. Geithner on July 31 to announce their commitments to process more derivatives trades electronically.
The Fed is asking Congress for more influence in the market for triparty repurchase agreements because regulators have become concerned that banks rely on the instruments too much for overnight liquidity.
In the long term, "we need to ensure that there are robust contingency plans for managing, in an orderly manner, the default of a major participant," he said. "We should also explore possible means of reducing this market's dependence on large amounts of intraday credit from the banks that facilitate the settlement of triparty repos. The attainment of these objectives might be facilitated by the introduction of a central counterparty but may also be achievable under the current framework for clearing and settlement."
Mr. Bernanke again argued the financial system has become so complex that systemic-risk regulation is "inevitable and desirable." He said regulators might conduct systemwide stress tests instead of simply judging the weaknesses of individual banks.
"Doing so might reveal important interactions that are missed by stress tests at the level of the individual firm," he said. "For example, such an exercise might suggest that a sharp change in asset prices would not only affect the value of a particular firm's holdings, but also impair liquidity in key markets, with adverse consequences for the ability of the firm to adjust its risk positions or obtain funding."
Though the central theme of the Kansas City Fed's symposium was maintaining stability, Mr. Bernanke did not mention the struggles at Fannie or Freddie by name in his speech. He may have been hinting at the government-sponsored enterprises, however, by mentioning systemically important non-banks.
He said the Treasury Department should be given power "to intervene in cases in which an impending default by a major nonbank financial institution is judged to carry significant systemic risks."
He argued such an intervention would "limit moral hazard by allowing the government to resolve failing firms in a way that is orderly but also wipes out equity holders and haircuts some creditors, analogous to what happens when a commercial bank fails."