Addressing the Economic Club of New York, Bair said the FDIC had a successful history of closing failed banks quickly and smoothly, but with the growth of the non-bank financial sector it risked falling behind. In particular, many FDIC-protected banks are now part of a larger group, which fall outside the FDIC's ambit.
"This makes a co-ordinated resolution of entire financial organisations – which may or may not include an FDIC-insured bank – almost impossible," Bair said. Because such a bank often cannot operate outside its holding company, it is difficult for the FDIC to take it over, run it and ultimately sell it off.
The FDIC also needs the power to intervene in non-bank financial companies on the brink of failure, she said. At present, "these firms – like bank holding companies – must be resolved through bankruptcy. This can be a messy business in the case of systemically important non-bank financial firms. For financial firms, bankruptcy can trigger a rush to the door, as counterparties to derivatives contracts exercise their rights to immediately terminate the contracts, net out their exposures and sell any supporting collateral", she remarked.
"However, during periods of economic instability, this rush-to-the-door can overwhelm the market's ability to complete settlements, depress prices for the underlying assets, and further destabilise the markets. This can have a domino effect across financial markets, as other firms are forced to adjust their balance sheets."
FDIC resolution, in contrast, would emphasise continuity of operation, which it sees as vital for systemically important institutions. Bair asserted it was unfair and "unacceptable" for banks to receive massive bail-outs simply because they were judged too big to fail. Resolution would instead put the costs on the institution's creditors and shareholders, where they belong, she argued.
The resolution authority would be funded by an additional levy on large financial firms, based on size, systemic importance and risky behaviour such as "certain derivatives, market-making or proprietary trading, and rapid growth", in the same way as the risk-based element in FDIC's bank deposit insurance levies.
"We can't let ourselves be prisoners of outdated authorities, trapped in a resolution regime that pre-dates the evolution of the shadow banking sector," she concluded.
Regulators around the world have called for targeted high capital requirements as a solution to the problem of failures at systemically important banks. Bair's comments broadly echo those made recently by UK Financial Services Authority chairman Adair Turner and Swiss banking supervisor Daniel Sigrist, who both announced support for reforms to capital adequacy rules designed to discourage large banks from excessively risky trading.