It’s premature to bust up too big banks: Fed official

NEW YORK

Federal Reserve Bank of New York President William C. Dudley said regulators should press on with current efforts to curb the risk from too-big-to-fail financial institutions rather than try to immediately dismantle them.

“Critics of our approach believe it would be better to just break up firms deemed TBTF now,” Dudley said today in a speech in New York. “My own view is that while this could yet prove necessary, it is premature to give up on the current approach: changing the incentives facing large and complex firms, forcing them to become more resilient and making the financial system more robust to their failure.”

More than four years after the collapse of Lehman Brothers Holdings Inc., U.S. regulators are still grappling with how to reduce the risk taxpayers will need to bail out too-big-to-fail financial firms in a crisis. Dudley said regulators must lower the likelihood that such institutions fail and the “cost to society” in the event they do.

Dudley, who didn’t comment on the outlook for the economy or monetary policy, said that while “advocacy for the break- up path has been strong,” it has so far lacked “the detail to assess whether this is indeed superior to the course we are currently following.”

“It would be helpful in this regard if advocates of break-up solutions would put a bit more flesh on the bones and develop detailed proposals that address essential questions of how such downsizing or functional separation would be accomplished, and what benefits and costs could be expected,” Dudley said.

Regulators have bolstered capital and liquidity buffers at financial firms and forced them to draw up so-called “living wills” for their unwinding, Dudley said.

The Fed today told the 30 largest banks to test whether they could withstand a severe recession in the U.S. and other major economies with weakening housing markets. The Fed drew up a stress test in 2009 to restore confidence in the financial system after the worst financial turmoil since the Great Depression brought down Bear Stearns Cos. and Lehman.

Regulators have also been working to make the financial system “more robust,” such as through the wholesale funding markets, he said.

“We have a considerable ways to go to finish the job and reduce to tolerable levels the social costs associated with such failures,” Dudley said. “We should continue to press forward on the first path” of minimizing the costs from the collapse of a too-big-to-fail firm, he said. “But, if we fail to reach our destination by this route, then a blunter approach may yet prove necessary.”

Dudley said in response to an audience question that regulators “have a lot to do” in writing the rules required by the Dodd- Frank financial overhaul legislation, and that it may take a while for them to complete their task.