By Robert Schmidt
Aug. 4 (Bloomberg) -- The Federal Reserve plans to strengthen its examinations of banks’ lending practices and financial health with new teams composed of experts in everything from law to economics and markets.
Fed Governor Daniel Tarullo outlined the step in testimony to a Senate Banking Committee hearing in Washington today. The overhaul, which would make reviews more uniform across the banking system, builds on the stress tests the central bank completed on the biggest 19 banks in May, he said.
The initiative comes as criticism spreads of President Barack Obama’s proposal to give the Fed powers to oversee systemic financial risks. Treasury Secretary Timothy Geithner last week told regulatory chiefs -- including Sheila Bair, the Federal Deposit Insurance Corp. chairman who opposes making the Fed the sole systemic-risk agency -- they should stop attempts to campaign against the administration’s revamp of rules for the industry, a person familiar with the matter said.
“We are prioritizing and expanding” the examination process to “assess key operations, risks and risk management activities of large institutions,” Tarullo said in his testimony today. “This program will be distinct from the activities of on-site examination teams so as to provide an independent supervisory perspective.”
Regulatory Lapses
The Fed, like other bank agencies, has come under criticism by lawmakers and investors for not curbing excessive risk taking on Wall Street that led to the worst financial crisis since the Great Depression. Congress is weighing the administration’s proposals to toughen oversight and set new rules for banks, the biggest overhaul in decades.
Regulators have each opposed some aspect of the Obama plan. Fed Chairman Ben S. Bernanke has sought to retain authority for protecting consumers of financial products after the administration sought to create a new agency for the task.
Bair and Securities and Exchange Commission Chairman Mary Schapiro have favored a council of agencies -- rather than the Fed -- to have powers to rein in risk-taking at financial firms so large or interconnected their failure would threaten the system.
Geithner, in a July 31 meeting aimed at cracking down on dissent, used strong language with the regulatory heads, reflecting concern at the fate of the administration’s proposals, the person briefed on the matter said on condition of anonymity.
Tarullo, Bair and other regulators at today’s hearing said in response to a lawmaker’s question that they were giving their own views independent of Geithner’s direction.
Fed Staff
“The only people I discuss this with is the other members of the board and the staff of the Federal Reserve,” Tarullo said.
The Obama plan has drawn fire from both Democrats and Republicans who argue that the central bank should focus on monetary policy. They have pointed out that the Fed, as the regulator of bank holding companies, supervised some of the biggest lenders that required rescuing, including Citigroup Inc. and Bank of America Corp.
Tarullo, 56, the first Fed governor appointed by Obama, has become the central bank’s coordinator on revising the examination process. Within the Fed, he has become an advocate for increasing the board’s control over supervision.
The Senate banking panel also plans to hear testimony from Bair and other regulators about how to improve bank oversight.
‘Significant’ Deficiencies
“The crisis has revealed significant risk-management deficiencies at a wide range of financial institutions,” Tarullo said. “It has also challenged some of the assumptions and analysis on which conventional supervisory wisdom has been based.”
While not giving many details on the supervisory overhaul, Tarullo indicated that the examinations, now run largely by Fed district banks across the country, will be bolstered by the board in Washington.
He said the Fed is “creating an enhanced quantitative surveillance program that will use supervisory information, firm-specific data analysis and market-based indicators to identify developing strains and imbalances that may affect multiple institutions, as well as emerging risks to specific firms.”
“This work will be performed by a multidisciplinary group composed of our economic and market researchers, supervisors, market operations specialists and accounting and legal experts,” Tarullo said.
Losses Soared
Banks and other financial institutions have reported more than $1.5 trillion in credit losses and writedowns worldwide since the global credit crisis began. Many of those losses stemmed from mortgage-related investments that declined with the collapse in the housing market.
Tarullo didn’t discuss the outlook for the U.S. economy or monetary policy in his testimony.
He said the central bank will soon release guidance on how to “promote compensation practices that are consistent with sound risk-management principles and safe and sound banking.”
The Fed governor also said that General Electric Co. and companies that already own finance arms or industrial-loan businesses, known as ILCs, should be able to retain them without being subject to Fed oversight of manufacturing and nonbank operations. While the Fed favors not adding more ILCs, existing structures should be “grandfathered” and not forced to separate “in the interest of fairness,” he said.
GE has supported no changes to the status quo so that it can keep its manufacturing operations along with its GE Capital finance arm without having to separate under a bank holding company structure. Last week, Representative Barney Frank, a Massachusetts Democrat and chairman of the House Financial Services Committee, supported Fairfield, Connecticut-based GE’s stance. GE has said it is in favor of systemic regulations and expects change in the rules governing its finance arm.
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