Reserve Bank of New York President William C. Dudley said that government plans to wind down large financial firms, while helping reduce the odds of a taxpayer bailout, don’t eliminate the need for increased capital and oversight of financial institutions.

“These two paths — reducing the financial-stability costs associated with the failure of a systemically important financial firm versus applying tougher capital and liquidity standards for such firms that reduce the probability of failure — are complements not substitutes,” Dudley said in a speech in Washington today.

“We need to keep pushing forward with both approaches in order to make the financial system more resilient and robust,” he said at a conference on how to handle failing banks, which was sponsored by the Federal Reserve Board of Governors and the Richmond Fed.

The 2010 Dodd-Frank Act requires large lenders to prepare living wills that describe how they would be wound down in a bankruptcy. Richmond Fed President Jeffrey Lacker said at the conference that the Dodd-Frank Act points to unassisted bankruptcy as the “first and most preferable option.”

Even with a “resolution regime in place, we must recognize that there still will be disruption to the financial system when a large firm fails,” Dudley said. While a wind-down plan “is a very useful tool that we should continue to develop, we should view it as more preferable to prevent the failure” of the systemically important financial institution.

‘Adverse Effects’

When a financial company’s collapse presents “serious adverse effects on financial stability,” the Dodd-Frank Act provides for so-called orderly liquidation authority, where the Federal Deposit Insurance Corp. could take over a failing institution and liquidate it over time. Management would be fired and losses forced on shareholders as well as creditors.

Regulators have more work to do to reduce the likelihood of such failures, Dudley said.

“We need to do more to create incentives to force banks to act sooner to steer away from impending icebergs — cut capital distributions earlier, raise new capital faster, restructure businesses sooner, and restructure senior management and boards of directors more radically when the firm is not performing well,” Dudley said.

“For example, one approach might be to implement a long- term debt requirement in a way that enhances market discipline,” he said.

There’s also work to be done to strengthen plans for resolving firms, particularly for those with operations in multiple countries, Dudley said.

“Implementing the resolution regime on a cross-border basis remains one of the most significant challenges,” he said. “We need to continue to work with foreign regulators to iron out any issues ahead of time so that the resolution regime will work well for global, systemically important firms.”

–Editors: James L Tyson, Gail DeGeorge

Topics New York