Thursday, 2 February 2012 – I want to use the occasion of this week’s Financial Stability Oversight Council meeting to review the progress made on financial reform to date and to outline our priorities and challenges for the year ahead. I am providing this assessment in my capacity as Chair of the Council, but do not speak for its individual members.
This is a critical year for financial reform. In 2012, we expect to put in place key elements of the new framework of safeguards for the financial system. And we expect this year to make progress building the foundations of reforms to the housing finance system.
Much of the basic framework of these reforms is already in effect. New global agreements to limit leverage have been reached. The FDIC has finalized rules for managing the failure of a large firm. The CFPB is up and running and providing better disclosure for consumers. We are deploying new authority and greater enforcement resources on a more coordinated basis to go after fraud and abuse. The majority of the new safeguards for derivatives markets have been proposed.
First, banks now face a much tougher set of limits on how much risk they can take. New rules on capital and liquidity will limit leverage by requiring banks to hold more financial reserves against risk and to fund themselves more conservatively. These new safeguards are critical to reducing the risk of large financial failures and limiting the damage those failures can cause to the broader economy. In 2012, we will focus on defining the new liquidity standards and on making sure that capital risk-weights are applied consistently.
These new safeguards are tougher on the largest banks than they are on the rest of the banks that make up our banking system, recognizing that community banks pose a much smaller risk to the broader economy. These reforms are being complemented by other safeguards to limit risk-taking, such as the Volcker Rule and a new limit on the size of firms and the concentration of the financial system. And the core constraints on leverage will apply not just to banks, but also to other large financial institutions that could pose a threat to the stability of the financial system. This year, the Council will make the first of these designations.
Second, the derivatives markets, for the first time, are coming under a comprehensive framework of transparency requirements, margin rules, and other safeguards. These reforms, the balance of which will be outlined this year, are designed to move standardized contracts to clearing houses and trading platforms, which should lower costs to those who use these products. They are complemented with more conservative safeguards applied to the more complex and specialized products that are less amenable to central clearing and electronic trading. These reforms will help preserve the economic benefits of allowing businesses, farmers, and investors to hedge against risk, while limiting the potential for abuse.
Third, we are putting in place a carefully designed new set of safeguards against risk outside the banking system and enhanced protections for the basic “infrastructure” or plumbing of the financial markets:
· Money market funds will face new requirements designed to limit their vulnerability to “runs” like the one that took place in 2008, with the SEC planning to propose significant reforms this year.
· Important funding markets like the tri-party repo market are now more conservatively structured.
· International trade repositories are being developed for derivatives, including credit default swaps.
· Designated financial market utilities will be subject to comprehensive oversight and required to hold stronger financial cushions against risk.
Fourth, we now have a much stronger set of protections in place against the “too big to fail” problem, which is the concern that large firms, having been rescued in this crisis, will take too much risk in the future in the expectation that taxpayers will protect them from failure.
The key elements of this strategy are:
· Capital and liquidity rules that impose much tougher limits on leverage by the largest firms to both reduce the probability of failure and strengthen their ability to withstand the pressures of other institutions’ failures;
· New protections for derivatives, funding markets, and for the market infrastructure that together will help limit contagion across the financial system;
· Tougher limits on size, which will prevent the largest banks from becoming too large relative to the size of the financial system.
· And a bankruptcy-type framework to manage the failure of large financial firms, which in the United States we call “resolution authority,” that prohibits bailouts for private investors, protects the taxpayer, and forces the financial system to bear the costs of future crisis.
