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June 1, 2000

Fed plans bank disclosure system
By Sathnam Sanghera, Financial Times

Too Big To Fail?...Weiss comments

WASHINGTON - Large US banks are lagging behind in their risk-measuring systems and the Federal Reserve intends to put disclosure policies into place to give the market more information, Laurence Meyer, a Federal Reserve Board governor, said on Wednesday.

Speaking at the Federal Institutions Examination Council in Arlington, Virginia, Mr Meyer said the US central bank intended to harden regulations on bank risk disclosures, and that the requirements would probably come from the recommendations of a 13-member, public sector advisory group set up last month.

The group, set up in co-operation with the Office of the Comptroller of the Currency and the Security and Exchange Commission, was given the job of coming up with "best practices" to make banks and financial institutions more open about their market risk profiles.

Composed of senior executives of banking and securities companies, the group is to compile a report by the end of the year.

"While I have no idea what will be in the report, it is my hope and expectation that we will learn more about how to use market discipline, both to strengthen our banking system and to avoid additional regulation and supervision of global financial institutions," Mr Meyer said.

"At the Federal Reserve, we plan, however, to require that at least the large, complex banking organisations establish and implement a disclosure policy to provide stockholders with information that can be used to evaluate the organisation's risk profile."

Regulators have become concerned that the recent wave of mergers and acquisitions in the banking industry have created huge banks - called "large, complex banking organisations" or LCBOs by the Fed - which mistakenly presume they are "too big to fail". The global reach of these banking organisations makes it increasingly difficult for regulators to assess whether their capital reserves are adequate for the risks they take in their lending, Mr Meyer said.

"Indeed, some large banks are, surprisingly, behind the curve in developing their own internal risk classifications," he said, noting that they sometimes used too little historical data or employed overly simple models.

By encouraging more disclosure, the Fed hopes that market discipline will effectively regulate banks without the need for too many regulators, who rely on fixed capital rules and periodic exams.

In the future, Mr Meyer said, financial institutions' own internal risk models could also be used by regulators as part of the supervisory scheme.

Last week, the Fed announced that it was looking into the bad lending practices of smaller banks - and we said, 'it's about time'. Now, the Fed is taking a look at the risk profiles of large banks. Banks that believe they are 'too big to fail'. Turns out, some of these large banks are more lax than their smaller counterparts when it comes to risky lending.

Banks of all sizes have been lending willy-nilly in this low interest-rate environment. But, are they prepared for their cost of borrowing to rise with rising rates? Are they prepared for an increase in declared bankruptcies from their clients when the economy begins to slow and debt is harder to pay back? These are the questions that the Fed will be asking. And some of the banks won't have answers.

The Fed has waited too long to ask these questions, and the banking system will be ill-prepared to deal with a slow down in the economy. The Fed needs to enforce lending regulations and make it harder for big banks to bypass these regulations. More importantly, the Fed has to remind banks that they will never be 'too big to fail'.

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