By Steven K. Beckner

ATLANTA (MNI) – Boston Federal Reserve Bank President Eric
Rosengren said Wednesday that the financial crisis shows the need for
more bank capital.

Rosengren, speaking to the Atlanta Fed’s annual Financial Markets
Conference, said “macroprudential supervision” is needed to reduce the
likelihood of failure of large, systemically important institutions.

Rosengren, a voting member of the Fed’s interest rate-setting
Federal Open Market Committee, confined himself to financial supervisory
issues and did not talk about the economy or monetary policy. But he did
say that the fall-out from the financial crisis continues to “impede”
the recovery.

“Financial institutions (not just banks) did not hold enough
capital for the size of this economic shock,” Rosengren said as he drew
lessons from the crisis. And “large financial institutions were the
first to experience problems despite their investment in risk
management.”

He observed that “financial problems had a broad impact on the
length and severity of the recession and likely will impede the strength
of the recovery.”

The Fed would be tasked with playing a greater role in
macroprudential supervision under financial reform legislation making
its way through Congress.

Rosengren said the purpose of macroprudential supervision is to
“reduce the likelihood that problems at financial institutions (not just
banks) negatively impact the real economy” and to “reduce the negative
economic impact should problems at financial institutions (not just
banks) nonetheless occur.”

To reduce the likelihood of problems in the future, Rosengren said,
“holding more capital will reduce the probability of insolvency,” which
he said is “particularly important if failure has broad ramifications.”

So he recommended raising minimum capital standards. He said banks
should “reserve for more than just accrued loss,” which he said is “too
influenced by accounting standards.”

He said banks should “retain capital as problems emerge” and should
“limit dividends and stock buybacks earlier” than they did in the recent
crisis.

Rosengren said that mandatory convertible debt — bank-issued bonds
that would convert to equity in the event of approaching insolvency —
has “a lot of positive attributes.”

Financial institutions are bound to fail, and so there need to be
“multiple weapons” to “reduce the severity of failure,” Rosengren said.

He agreed there needs to be a “resolution” mechanism by which large
systemically important institutions can be put into government
receivership and unwound in an orderly manner. But he said it is not “a
panacea.”

“We also need to incent more responsible behavior,” he said,
suggesting that large banks should be required to have “living wills” —
a plan for what will be done if they get into trouble.

He said there should be “higher capital for firms that don’t have
living wills” so that their risks would be “offset with higher capital
requirements.”

Rosengren further said that “institutions that are international
should hold more capital than banks that are domestic” and there should
be “higher capital for institutions that are large.”

Maintaining that “executive bonuses have a big impact on behavior,”
Rosengren said, “we need to think a little bit more under what
circumstances should bonuses be pulled.”

If banks “start breaching certain capital buffers,” bonuses should
be reduced or eliminated, he suggested.

Earlier, Atlanta Fed President Dennis Lockhart asked what the
financial landscape would look like “if you could wave a magic wand and
you had no too big to fail institutions.”

Lockhart noted that, among the 19 banks that were subjected to
capital “stress tests” last spring, “even within that group it was very
top heavy with a relative few that are extremely big with assets as well
as internationally active.”

Former Atlanta Fed chief economist Robert Eisenbeis said that
regional bank mergers that occurred after the advent of interstate
banking resulted in greatly concentrated bank assets.

If banks had more limited charters “you would have institutions
large enough to achieve economies of scale,” he said, “but you wouldn’t
have three institutions controlling 80% of deposits.” He added, “You
would have a much flatter structure and more competitive.”

Noting that more than half of primary dealers are foreign bank
affiliates, Eisenbeis said, “I don’t think you want to encourage that.”

** Market News International Washington **

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