Observations on Defining the Objectives and Goals of Supervision
Speaking in New York on large-bank supervision, Boston Fed President Eric Rosengren emphasized making financial institutions resilient and helping to prevent problems at financial intermediaries from damaging the real economy and public well-being.
He added that "well-functioning financial intermediaries are essentially the lubricant for the real economy," without which economic activity seizes up. "A central focus of regulation and supervision should be to help improve public welfare by maintaining the efficient and effective conduct of intermediary services despite economic cycles" and shocks.
Rosengren said bank regulation and supervision should help make financial intermediaries sufficiently resilient so that even severe economic shocks would not badly impair their role in credit provision. He specifically cited higher capital, and rigorous stress tests.
Maintaining standards for loss-absorbing capital has long been central to bank regulation, but the specifics of how that regulation is implemented can have very different implications for the broader economy.
"There are trade-offs to carefully consider," Rosengren said. "Policymakers need to balance the resilience that higher capital ratios bring against the possibility of pullback in the provision of credit, and downstream impacts on the ability of firms and households to borrow and invest."
"I am in favor of using bank supervision to more quickly insulate the largest financial institutions from adverse economic shocks that may emerge. But ideally, this would be done in ways that also encourage financial intermediaries to continue lending," Rosengren added.
He noted that in the U.S., the recession in the early 1990s was exacerbated by a credit crunch resulting from the approach to binding capital requirements. "Less collateral damage to borrowers may have occurred if supervision had taken the tack of more forcefully requiring retention of earnings or the raising of new equity capital."
Rosengren observed that in the United States of late, banks have been able to significantly improve capital ratios while still expanding their lending.
Rosengren was speaking at the Federal Reserve Bank of New York's Conference: "Supervising Large, Complex Financial Institutions: Defining Objectives and Measuring Effectiveness"