No federal bank supervisor did an effective job of recognizing and dealing with systemic risk over the past several years, but I believe this was a result of a weakness in the current supervisory and regulatory system rather than a weakness of the supervisors. The current system divides bank supervisory and regulatory authority among the Fed, the Comptroller of the Currency, the FDIC and state bank supervisory agencies with a resultant lack of authority and accountability for systemic risk and of the means to collect and share the broad range of bank and nonbank information necessary to identify, assess and address systemic risk. Not surprisingly, this division of authority has also resulted in an inadequate degree of transparency.
On July 22, the Obama administration delivered to Congress proposed legislation that would address systemic risk by granting the Fed supervisory and regulatory authority over Tier 1 financial holding companies and establishing a Financial Services Oversight Council of financial supervisors "to identify systemic risks and improve interagency cooperation." This proposal is currently the subject of intense debate among the federal bank supervisors and members of Congress.
To this debate, and believing that the Fed should be the sole systemic supervisor, I add my suggestion for the adoption of a system that would enable the Fed to carry out this role.
My suggestion has two key components: First, that the Fed be made the sole systemic supervisor by granting to it supervisory and regulatory authority over Tier 1 financial holding companies as proposed by the administration. I believe systemic risk supervision and regulation by the Financial Services Oversight Council or any other committee would defuse the authority and fail to produce the accountability that are critical components of an effective supervisory and regulatory system.
Second, that the Fed exercise its central bank (monetary policy) function and its supervisory and regulatory function through two separate divisions of the Fed. The central bank function would be led by the chairman of the Fed and conducted as it is currently. The supervisory and regulatory function would be led by a new vice chairman of supervision and regulation who would be nominated by the president as a governor of the Fed for a normal 14-year term and as vice chairman of supervision and regulation for a five-year term. This vice chairman would be responsible for the supervisory and regulatory division of the Fed and, consistent with current Fed practice, would serve on a three-governor committee for Fed Board oversight of supervision and regulation.
The supervisory and regulatory division would have its own full-time staff and access to economists and others in the central bank division. Its staff would conduct examinations of Tier 1 financial holding companies, as well as bank holding companies, foreign banks with U.S. banking operations and state member banks. As is done today, the examiners would be housed at the Federal Reserve banks.
The new vice chairman would develop and propose systemic risk regulations for action by the Federal Reserve Board. The board would oversee the activities of the division through the three-governor committee, and decisions of the vice chairman could be appealed to the board under appropriate circumstances.
This system would provide sufficient delineation between the central bank function and the supervision and regulation function, would provide a desirable level of authority and accountability for the supervision and regulation function, would enable the Fed to collect and share with the Financial Services Oversight Council and other regulators the information necessary to identify, assess and address systemic risks posed by both large banking and nonbanking financial organizations and would result in greater transparency in the systemic risk system.
Also, having the new vice chairman nominated by the president would put the new vice chairman in a position to deal effectively at the international level with the other national and multilateral authorities whose cooperation will be needed to achieve the coordination of supervision and regulation that will be required to avoid cross-border confusion of supervisory and regulatory regimes.
I do not suggest that the Fed become all-powerful, and I believe that creating a separate supervision and regulation division at the Fed will make it easier for Congress to evaluate the effectiveness of that division, to have direct access to the new vice chairman and to obtain better information than in the past about systemic risk. Creating the separate function will also make it easier to transfer it to another supervisory authority in the future if Congress were to determine that to be appropriate.