Federal Reserve Chairman Alan Greenspan said yesterday that a one-size-fits-all bank regulatory scheme can't protect the financial system from the failure of one of the industry giants created through mergers, and that the government will focus on customized supervisory rules tailored to the risks and health of individual banks.
The new approach, which Greenspan discussed in a speech to the American Bankers Association, is intended to give bank regulators better tools to assess the stability of all banks, but especially a group of about 30 companies that are so big and complex that officials have a name for them: large complex banking organizations, or LCBOs.
"Even among the largest banks, no two institutions have exactly the same risk profiles, risk controls, or organizational and management structure," Greenspan said. "Accordingly, prudential policies need to be customized for each institution: The more complex an institution's business activities, the more sophisticated must be our approach."
These large institutions--which include such well-known names as Citigroup, Bank of America Corp., Chase Manhattan Corp. and J.P. Morgan & Co.--are considered by federal officials to be so essential to the economy that their failure could disrupt markets here and around the world.
As a result, many economists believe that federal regulators consider these institutions too big to fail--despite statements to the contrary by Greenspan and others--and would orchestrate a bailout or other rescue rather than risk a major disturbance to the economy.
A too-big-to-fail policy--or even a perception that such a policy exists--could encourage managers of large institutions to make unwise, overly risky investments if they think regulators are afraid to shut them down, many economists argue.
By focusing on customized supervisory rules, the Federal Reserve hopes to better regulate banking behemoths and keep problems under control as they crop up. Some economists and lawmakers hope the moves will help dispel the belief that some institutions are too big to fail. Greenspan also emphasized the importance of increased public disclosure of their business activities and the risks involved so that investors are better informed.
In two letters to banks in mid-summer, the Fed outlined its plan to emphasize customized supervision over the one-rule-for-all model, which historically has been favored by U.S. banking regulators.
The letters said the Fed will require all banks to have an internal system for measuring their risks and determining how much capital they need to keep on hand as a cushion against potential losses. Until now such systems were voluntary.
Fed regulators for the first time will keep a written record of each bank's internal system and will grade banks on how well their systems are managed, and their adequacy.
"This is extremely important because it requires some large banks that hadn't been focusing on this to spend a lot more effort and money than they have been doing," said John Mingo, a senior adviser to the Federal Reserve Board who left in June to become co-managing director of Mingo & Co., a Bethesda bank consulting firm.
Greenspan said the Federal Reserve is working with bank regulators in other countries to adopt similar standards.
Greenspan's comments come as bank regulators find themselves increasingly concerned about a deterioration in the standards banks use to evaluate the credit quality of loans. Though they emphasize that in general banks are healthy, especially in light of the continued strength of the economy, they say a slight increase in problem loans has prompted them to warn banks to tighten their screening procedures.
The announcement also comes as members of Congress prepare to unveil as early as today a compromise bill that would revamp banking law and make it easier for financial services companies to merge. The bill blends versions of legislation passed earlier this year by the House and the Senate.
The compromise is largely the work of Republicans on the House-Senate conference committee. Democrats on the committee complained that they were largely frozen out of the process and protested last week to the conference chairman, Rep. Jim Leach (R-Iowa). White House Chief of Staff John D. Podesta also wrote Leach, repeating that President Clinton "will not hesitate to veto" any bill that fails to provide the consumer and privacy protections the White House favors, that weakens the Community Reinvestment Act or that favors the Federal Reserve over the Office of the Comptroller of the Currency, a unit of the Treasury, to regulate banks.
Senate Banking Committee Chairman Phil Gramm (R-Tex.) has battled to weaken the Community Reinvestment Act requirements. Though he is believed to have backed off considerably in the conference, it may not be enough to win support from Democrats.