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By Ronald Fink
A Federal Reserve Board member voiced support on Thursday for new measures to reduce systemic financial risk and control banks that are too big to fail. The measures would include special capital charges for such banks and a requirement that they regularly issue capital that would automatically convert to equity during times of stress.
The measures would be designed "to counteract the systemic and too-big-to-fail problems that became so embedded in our financial system," Fed governor Daniel K. Tarullo said in a speech in Phoenix.
The first measure he described was a special charge that would be calibrated to what Tarullo described as "the systemic importance of a firm." He, however, conceded that developing a metric for such a requirement would be a new and "not altogether straightforward" exercise.
The second proposal -- which Tarullo said had "particular promise" -- would be to require large financial institutions to have specified forms of "contingent capital." For example, he said, firms might be required to regularly issue special debt instruments that would convert to equity during times of financial stress.
"If well devised, such instruments would not only provide an increased capital buffer at the moment when it is most needed," Tarullo said, "they would also inject an additional element of market discipline into large financial firms, since the price of those instruments would reflect market perceptions of the stability of the firm."
Tarullo also mentioned other proposals under consideration for dealing with systemic risk and too-big-to-fail institutions that Fed chairman Ben Bernanke and Treasury Secretary Timothy Geithner have described in Congressional testimony. Those include new authority for winding down banks deemed too big to fail, and higher capital reserve requirements for such institutions.
But the former Georgetown University law professor who joined the board last January and served as an economic advisor to the Clinton administration seemed to go further than Bernanke and Geithner have done in stressing the need to control the risk that big banks pose to the financial system. Reform, he said, "cannot succeed until it substantially reduces systemic risk and the too-big-to-fail problem." While he acknowledged that "it is unrealistic to think that these concerns can be eliminated, it is critical that they be addressed head-on."
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