CHICAGO -- Capital may no longer be king at the Federal Reserve Board.
Fed Chairman Alan Greenspan said Thursday that bank supervisors should be paying more attention to risk management systems at individual banks and less attention to their capital positions.
"At least part of the solution to the increasing complexity in bank risk positions may be to rely less on the writing of rules - such as capital regulations - that apply generally to all banks, and to concentrate more on the development of supervisory procedures that can accurately distinguish risks on a bank-by-bank basis," Mr. Greenspan said.
Increasingly, he added, the "basic unit of evaluation" in bank supervision should be the "evaluation and stress-testing of the bank's overall risk position, along with evaluation of the current value of individual bank assets."
Mr. Greenspan's remarks echo the message Comptroller of the Currency Eugene A. Ludwig has been putting out for the last few months.
Joining Mr. Greenspan at the Federal Reserve Bank of Chicago's bank structure conference Thursday, Mr. Ludwig reiterated his belief that supervision of the largest banks must be customized.
"For each of our largest banks, we now develop an individual risk profile based on all the risks the bank takes on," he said. "We then try to determine whether the risks are appropriate for the individual institution, given its resources, and whether the controls the institution has in place are appropriate to the risks."
The Fed conference, which convened Thursday and ends today, is focused on the oft-mentioned lament that the banking industry is in decline.
When considered in the narrowest context, this sentiment may be true, Mr. Greenspan said. But, he added, "it is far from clear that banking considered in its widest context really is a declining industry."
Mr. Greenspan said pursuing this new supervisory strategy will help regulators ensure that they "both continue to maintain a safe and sound banking system and do not result in banking becoming a truly declining industry," the Fed chairman said.
A recent Fed study shows that banks' share of "total value added by financial intermediaries" has remained constant for decades, he said. What is more, he said, banks' value-added as a share of gross domestic product has been increasing.
"Are these signs of a declining industry?" he asked.
An Inadequate Strategy
While regulatory capital standards have grown increasingly complex, and the temptation continues to make them even more so, the Fed chairman said this approach to supervision will be inadequate.
"So long as capital regulations are written in piecemeal fashion, by placing weights on individual balance sheet or off-balance-sheet categories, they will not solve the problem of how much capital is appropriate to the overall portfolios of risk positions of the bank," he said.
"The bottom line, it would appear, is that increasingly intricate and supposedly elegant capital requirements would, at a minimum, cause inefficiencies resulting from banks' attempts to avoid uneconomic capital regulations," he added. "At worst, efforts to avoid inappropriate requirements could lead to less measurable and perhaps greater risks."
Movement Under Way
Mr. Greenspan said the Fed and other agencies have already begun moving away from a primary focus on capital and toward the risk management systems of banks. He cited his organization's new trading activities exam manual as an example.
But the new focus of bank regulation in an incresingly complex industry will demand that the agencies retain "high-trained and capable staff," Mr. Greenspan said.
'That's no small task, he said, "given what appears to be a widening gap between the returns that the brightest financial minds can make in the private marketplace compared to what they can make in government."