When it comes to planning for the future, a top Federal Reserve official said her advice to bankers is to "hope for the best and plan for the worst."
"That means anticipating a range of bad and worst-case scenarios that reflect local economic conditions and a bank's particular risk profile," Janet Yellen, the president and chief executive of the Federal Reserve Bank of San Francisco, told the Idaho Bankers Association on Tuesday. "It can be helpful to perform stress tests based on these scenarios to assess potential effects on earnings and capital, and to develop appropriate contingency plans."
She added that "banks would be well advised to have in place well-tested backup plans before any potential funding crisis, including procedures for using the Fed's discount window."
Yellen, who worked as a Fed governor from 1994 to 1997, is increasingly being mentioned as a potential candidate to lead the central bank should President Obama decide against renominating Chairman Ben Bernanke, whose term expires in January.
She noted the White House's effort to revamp financial regulation but did not take a firm stand on some of its more controversial provisions, including the creation of a new consumer protection agency.
Consumer protection is an "area where our current system failed in many respects," she said. "Given what we've learned about the pernicious effects of consumer loan defaults on the banking sector and the economy, it's critical that we strengthen our regulation and supervision in this area for both bank and nonbank financial players."
Yellen also supported stronger systemic risk oversight but stopped short of saying such powers should be housed at the Fed.
"Focusing on systemic risk is different than our traditional institution-oriented approach to supervision," she said. "It has become painfully clear that when regulators focus exclusively on individual institutions, they can miss broader risks building in the system."