Charging that regulation stymies innovation, Federal Reserve Board Chairman Alan Greenspan said Thursday the government should rely more on the market to police financial institutions.
"We have no choice but to harness market forces," Mr. Greenspan said. "The appeal of market-led discipline lies not only in its cost- effectiveness and flexibility, but also in its greater adaptability to changing financial environments."
For instance, Mr. Greenspan said, regulators last year had considered adopting specific capital requirements for interest rate and asset- concentration risk. But they realized that formal rules would quickly become outdated and could discourage banks from developing products to mitigate these risks. The solution was to review these risks during exams, he said.
To help the market discipline banks, Mr. Greenspan said financial institutions should publicly disclose the results of their risk-management models. This would allow investors to "reward good bank performance and penalize poor performance," he told bankers and regulators at the Federal Reserve Bank of Chicago's annual bank structures conference.
Regulators also must move away from "one-size-fits-all" approaches to measuring bank safety and soundness, he said. "Our supervisory policies should become more tailored to that bank's specific needs and internal management processes," he said.
Mr. Greenspan pointed to the Fed's experiment with the pre-commitment approach to market risk capital requirements as an example of this new approach. Under this technique, a bank uses its own systems to estimate its capital requirements for the coming quarter. If it uses more capital than it sets aside, it must pay the government a penalty.
Bankers at the conference applauded Mr. Greenspan's remarks. "This is encouraging," said R. Jeffrey Brooks, executive vice president at First Commerce Corp., New Orleans. "Any time you set a regulation, it is going to create rigidity and stifle innovation and growth."
William M. Randle, senior vice president at Huntington Bancshares, Columbus, Ohio, said Mr. Greenspan's idea makes particular sense for emerging electronic payment products. "It would be premature to regulate something that is trying to bloom," he said.
Mr. Greenspan said greater reliance on market forces is only feasible because banks have centralized their risk-management functions. Institutions now can use derivatives to hedge their risks and they can securitize assets to solve liquidity problems, he said.
Centralized risk-management, however, also affects regulators, he said. The old system of functional regulation-where banking agencies supervised banking activities, the Securities and Exchange Commission oversaw securities sales, and insurance commissioners reviewed insurance sales-no longer works, he said.
The risks inherent in all three businesses today are managed by a single set of executives. The only way to ensure they are running the firm in a safe and sound manner is to have a single, umbrella regulator responsible for examining the holding company, he said.
"Regulation must fit the architecture of what is being regulated," he said.
Responding to questions, Mr. Greenspan warned against immediately combining banking and commerce, saying, "We do not yet fully understand how the safety net and the subsidy will spill into various other different activities."
Mr. Greenspan also dismissed the need for a global central bank to handle international financial crises, saying the current system works fine.