WASHINGTON -- Comptroller of the Currency Eugene A. Ludwig on Friday challenged a bedrock principle of bank supervision: that detailed examinations forestall systemic catastrophes.
In the luncheon address at a seminar his agency sponsored on systemic risk, Mr. Ludwig explained research that challenges "some of the most cherished beliefs of regulators concerning the fundamental importance of systemic risk as a justification for detailed regulation of depository institutions."
While the comptroller was not calling for an end to bank exams, Mr. Ludwig did say that there is a gap between current bank supervision practices and academic research on the nature and significance of systemic risk.
"This gap is most evident," he said, "in the agencies' continued reliance on detailed supervision of bank product offerings and lending policies and the examination process to control bank risktaking."
This approach has been supported by Congress, he said, noting: "Witness recent proposals on derivatives."
Two OCC economists, Philip Bartholomew and Gary Whalen, presented a paper at the conference that defines systemic risk as "a sudden, usually unexpected, collapse of confidence in a significant portion of the financial system with potentially large real economic impacts."
The authors argue that early regulatory intervention at a troubled bank and, if necessary, early closure have gone a long way toward taming systemic risk.
Traditionally, people have believed that the failure of a large bank or a number of smaller banks could spark the collapse of the banking system. But that has not been the case, Mr. Ludwig said.
"Bank runs are typically motivated by accurate information about the condition of particular banks, not by rumors or general uncertainty following bank failures," he said. "Contagion has been both rare and, generally, highly localized.
"Financial markets are less fragile than many of us had been led to believe."
Mr. Ludwig said regulators need to gain a better understanding of the ways in which banks are tied to each other, the banking system as a whole, and the broader financial market.
This information will help regulators get a grip on the real risks that can affect the entire system, Mr. Ludwig said.
