Bernanke looks for new regulatory approach

By Mark Felsenthal

JACKSON HOLE, Wyoming (Reuters) - U.S. Federal Reserve Chairman Ben Bernanke's suggestion that financial supervision be revamped to take into account the health of the entire system is a logical response to recent market turmoil, but may be a difficult concept to execute.

A year into a financial tsunami unleashed by the spread of bad mortgage debts to credit instruments held around the world, Bernanke last week suggested supervisors broaden their usual firm-by-firm regulatory approach.

"Supervisors often focus on institutions in isolation," he said on Friday at the Kansas City Federal Reserve Bank's annual monetary policy conference here.

"An alternative approach, which has been called systemwide or macroprudential oversight, would broaden the mandate of regulators and supervisors to encompass consideration of potential systemic risks and weaknesses as well," he said.

U.S. Congressional Budget Office Director Peter Orszag said revamping regulation in the direction Bernanke suggested could bring benefits, but also carried some potential pitfalls.

"Clearly, conceptually it has to be the right answer, to have a comprehensive regulatory structure and a comprehensive perspective," Orszag told Reuters. "The only counterarguments are practical ones -- would the Fed have enough staff, would this broader approach imperil its political independence."

Any overhaul of the U.S. regulatory system is unlikely to take place until after a new president takes office in January and even then may not be among the first priorities of a new administration and Congress.

The Fed has already broadened its role in ensuring financial system stability with its organization of the sale of Bear Stearns and its decision to open up lending facilities for other investment banks. Usually, the Fed only lends to commercial banks.

A move to give supervisors formal responsibility for broad financial stability would make sense as a way to prevent problems from escalating to the point where they require government intervention, participants at the conference said.

"There's a huge complementarity between (the Fed's) lender-of-last-resort function and the intimate knowledge of financial institutions," said one central banker who spoke on condition of anonymity.

LARGER CENTRAL BANK ROLE SEEN

The idea that supervision should be independent of the central bank has severely been put to the test in the past year, as evidenced by the stumbles that preceded the near-collapse of British bank Northern Rock, the official said. Britain gave its central bank more responsibility for keeping the financial system on even keel after that crisis.

Bernanke said a comprehensive approach could allow supervisors to raise concerns about industry-wide concentrations of certain types of assets or certain types of practices, such as underwriting unusual types of mortgages.

Similarly, system-wide supervision could take into account how rules affect institutions differently at flush economic times as well as at stressful times.

"The macroprudential supervisor would recognize that, for the system as a whole, excessively conservative lending policies could prove counterproductive if they contribute to a weaker economic and credit environment," Bernanke said.

And while risk concentrations might be acceptable at one institution in a growth period, they might be dangerous if they were widespread among many firms, he said.

The Fed chairman said regulators should be careful to examine ways in which rules such as capital requirements tend to reinforce the phenomenon of credit shrinking when the economy slows, reinforcing any weakness, and expanding when the economy is robust, possibly encouraging excess.

The broadest view of system-wide supervision would also take into account non-bank financial institutions, he said.

"In principle, such an approach would appear well justified, as our financial system has become less bank-centered and because activities or risk-taking not permitted to regulated institutions have a way of migrating to other financial firms or markets," Bernanke said.

But he also acknowledged that such an approach would be "technically demanding."

(Editing by Maureen Bavdek)