Fed Admits Missteps on Banks

"U.S. and foreign bank supervisors are taking a second look at risk-management practices at banks, in part because most of the big recent blowups have occurred at financial institutions closely supervised by regulators.

U.S. regulators at the Senate hearing said they expected to make changes to new international rules that govern how much capital banks must hold, among other areas. Nout Wellink, chairman of the Basel Committee on Banking Supervision, the body that devised the new rules, said yesterday in a speech in Singapore that such changes were likely in light of the lessons learned from the global market disruption."


Fed Admits Missteps on Banks

By Damian Paletta
March 5, 2008
Source

A top Federal Reserve official said the central bank failed to fully appreciate risks that financial institutions were taking before the recent credit problems, and it is reviewing its regulations.

During a sometimes-contentious Senate hearing, Fed Vice Chairman Donald Kohn said the central bank is likely to become "more forceful" with the financial institutions it supervises. Mr. Kohn didn't explain what new actions the Fed might take, but he did warn banks to rely less on the assessments of credit-rating agencies.

After years of watching the banking industry make record profits, regulators are now scrambling to deal with turmoil stemming from problems in the U.S. housing market. Large U.S. banks have had to write down the value of assets by billions of dollars, including slivers of mortgage-backed debt that many believed were almost risk-free.

Mr. Kohn's comments mark one of the few times that a top Fed official has acknowledged shortcomings in regulation as a cause of the mess.

"I don't know that we fully appreciated all the risks out there," he told the Senate Banking Committee. "I'm not sure anybody did, to be perfectly honest." Later, he said the Fed "did not perform flawlessly -- I absolutely agree with that."

U.S. and foreign bank supervisors are taking a second look at risk-management practices at banks, in part because most of the big recent blowups have occurred at financial institutions closely supervised by regulators.

U.S. regulators at the Senate hearing said they expected to make changes to new international rules that govern how much capital banks must hold, among other areas. Nout Wellink, chairman of the Basel Committee on Banking Supervision, the body that devised the new rules, said yesterday in a speech in Singapore that such changes were likely in light of the lessons learned from the global market disruption.

The Fed is just one of several government entities that oversee the banking industry. It is charged with regulating the parent companies of most of the country's largest banks.

Mr. Kohn said Fed officials tried to convey during the recent housing boom that certain risks weren't being priced appropriately, but he suggested that banks ignored the Fed's message. "It's a very hard sell to the banks," Mr. Kohn said.

Sen. Richard Shelby, an Alabama Republican, responded: "It's a hard sell to the banks, yes, but you are the supervisor of all the bank holding companies, and you are also the central bank." He added: "So you have not just a little bit of power -- but a lot of power."

Sen. Shelby asked Mr. Kohn if the Fed "was afraid of the banks they regulate." Mr. Kohn quickly responded, "No."

Mr. Kohn and Comptroller of the Currency John Dugan said regulators and banks should push forward with implementing the new standards, known as Basel II, which U.S. banks could begin using on a test basis later this year.

"Basel II actually addresses some of the issues that have come to light," Mr. Kohn said, referring to how the new standards would require banks to hold capital against off-balance-sheet assets.

Federal Deposit Insurance Corp. Chairman Sheila Bair and several lawmakers at the hearing said the standards governing banks' use of capital and risk relied too much on models that banks developed internally and didn't adequately test.