By Steven K. Beckner
CHICAGO (MNI) – The Federal Reserve Board’s chief bank supervisor
emphasized Thursday the need to restore “market discipline” and to limit
the interconnectedness of the largest, most systemically important
financial institutions.
Patrick Parkinson, head of the Fed’s supervision department, told a
Chicago Federal Reserve banking conference that “addressing the
too-big-to-fail problem requires reinvigorating market discipline as
well as strengthening regulation.”
“Indeed, the two are intertwined,” he said. “An important step in
restoring market discipline is enactment of legislation that would
provide the government with resolution authority to help avoid the
disorderly failure of a large firm while imposing meaningful losses on
its creditors.”
“To help ensure that this new resolution authority works as
intended,” Parkinson said important changes in regulatory policy are
needed.
“Restoring market discipline on the major financial firms and
protecting financial stability depend on it,” he said.
Among other things, Parkinson said that “going forward, it is
imperative that we reduce the interconnections among our major financial
firms and improve the transparency of such interconnections.”
The regulatory reform legislation moving through the House and
Senate would subject major firms to a single-counterparty concentration
limit in order to limit the risks that the failure of one major firm
could pose to other major financial firms and to the stability of the
U.S. financial system, he noted.
For example, proposed legislation would prohibit each major
financial firm from having credit exposure to any single company that
exceeds 25% of the firm’s regulatory capital (or such lower amount as
the Federal Reserve determines would be appropriate to constrain
systemic risk).
There are also proposals that would mandate that standardized OTC
derivatives between dealers and major market participants be cleared
through well-regulated central counterparties.
What’s more, new regulatory capital rules proposed by the Basel
Committee in December would increase capital requirements on
non-centrally cleared OTC derivatives and more generally on credit
exposures and equity investments between large financial firms.
“Although there may be arguments about whether these specific
proposals are the best way to reduce linkages among our largest
financial firms, there is widespread agreement that the linkages must be
reduced to protect financial stability,” Parkinson said.
“Moreover, supervisors should collect information about these
interconnections on a high-frequency basis,” he said. “Supervisors
should be continuously analyzing the explicit and implicit connections
among the major financial firms and the dependence of the major
financial markets on such firms.”
Parkinson said that to conduct this analysis, “each major financial
firm should be required to regularly report to supervisors the nature
and extent to which they are exposed to other major firms and the nature
and extent to which other major firms are exposed to it.”
“To use the new resolution authority effectively, the government
must be able rapidly to assess the consequences of a firm’s failure and
of creditor haircuts on other major firms,” he said, adding that
thererfore the Fed is “taking steps to improve the regulatory
transparency of the interdependencies” among major bank holding
companies.
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