lawmakers got the public approval of a top banking supervisor Monday.

"This historic legislation ... would fundamentally alter our financial landscape," said Richard Spillenkothen, the Federal Reserve Board's director of banking supervision and regulation. It would clear the way for "for more efficient, dynamic, and broader combinations of banking, securities, and insurance firms."

In a speech to the New York State Banking Department, Mr. Spillenkothen said the financial modernization bill, a final version of which is now being examined by members of a House and Senate conference committee, would also affect banking regulation.

He said bank regulators would need to be more "flexible" and would depend increasingly on "market discipline" to keep banks from engaging in overly risky behavior.

The size and diversity of the new financial services companies spawned by the bill may make them more resistant to failure, he noted, but also makes the possibility of failure more alarming. "The probability of a troubling event may have declined as banks have consolidated and diversified, but even the unlikely failure of a large financial institution today could well be more significant than ever before," he said.

This, he added, creates a dilemma for regulators. They must simultaneously "fundamentally strengthen our supervisory approaches" and "avoid the appearance or reality of the kind of government intrusion or oversight that could undermine market discipline, increase moral hazard, or result in excessive burden or micromanagement."

Asked for an example of the sort of "intrusion or oversight" that could have such an effect, a Federal Reserve Board spokesman said a bank that is perceived as extremely tightly regulated may create the false impression that it is free of the risk of failure.

As large banks improve their internal risk measurement and risk management processes, Mr. Spillenkothen said, regulators will probably switch their focus, not to measuring risk themselves, but to validating the banks' internal systems and seeing that they are followed.

Mr. Spillenkothen also called for "better and more meaningful" public disclosure of banks' internal processes -- such as the parameters of their risk rating systems -- so that market discipline, in the form of creditors and investors, can help assure that banks do not take excessive risks.

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