By Brai Odion-Esene and Ian McKendry

WASHINGTON (MNI) – In Congressional testimony Tuesday, both Federal
Reserve Chairman Ben Bernanke and U.S. Treasury Secretary Timothy
Geithner agreed that requiring banks to hold contingent capital would
help in easing the impact of future crises.

Asked to comment on the importance of contingent capital as a
“shock absorber” for banks, Geithner told the House Financial Services
Committee that it is a tool “that can be used in crisis to create more
capital.”

If designed appropriately, — and put in place on top of new
capital requirements — Geithner argued that contingent capital can play
a “very useful, stabilizing role” when financial firms slip towards the
edge of a crisis.

Bernanke agreed, calling it an interesting idea and one the central
bank is looking at “very carefully.”

However, there are some design issues surrounding any requirement
that banks hold contingent capital, he added, such as what would trigger
the conversion into capital.

This could be addresses in one way, Bernanke said, if Congress
grants regulators resolution authority that required all capital
instruments — including subordinated debt — had to take losses.

“That would effectively make subordinated debt into a contingent
capital form,” he said. “I think it would have helped considerably
during the crisis.”

If designed appropriately, Geithner added, contingent capital can
provide a very useful market signal early on of a firm that is facing
the risk of losses.

Lehman’s use of repurchase agreements and the accounting and
disclosure of these transactions was one of the main purposes of the
hearing, and Geithner argued that the consequential role played by repos
and derivatives in Lehman’s collapse should not be ignored.

The financial system needs to be made strong enough to cope with
the next time an innovative financial instrument “goes astray,” he told
lawmakers.

“We will never know soon enough in the future what particular
innovation might pose catastrophic risks,” Geithner warned. “The best
thing we can do is to make sure the system runs with the kind of shock
absorbers that can allow it to withstand those mistakes in innovation.”

** Market News International Washington Bureau: 202-371-2121 **

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