FDIC's Bair calls for the creation of a Systemic Risk Council

Bair takes a swipe on regulators past reliance on risk management and diversification benefits to ensure safety of large financial institutions

WASHINGTON - The US financial system should rely on smaller and less complex firms over the interconnected behemoths that helped cause the current economic strife, according to a testimony made by Sheila Bair, chair of the Federal Deposit Insurance Corporation (FDIC) before a US Senate committee hearing. She said that a financial system made up of a "handful of giant institutions with global reach" and a single regulator is a recipe for mistakes.

"A strong case can be made for creating incentives that reduce the size and complexity of financial institutions as being bigger is not necessarily better," said Bair.

Bair questioned the need for firms considered to be too big to fail and called for such larger firms to face additional capital charges, restrictions on leverage and new risk-based premiums as a way to discourage aggressive growth and complexity. She suggested the US Treasury Department, the FDIC, the Federal Reserve Board and the Securities and Exchange Commission (SEC) could be members of a new "systemic risk council" set up to monitor large institutions. Such a "council" of regulators, she said, would be better equipped than a single agency to exercise that oversight, writing rules, setting capital requirements and collecting data on large institutions that pose a potential threat to the system.

A long standing cynic of the Basel II capital regime, Bair also took the opportunity to take a further swipe at the capital framework. "In hindsight, it is now clear that the international regulatory community overestimated the risk mitigation benefits of diversification and risk management when they set minimum regulatory capital requirements for large, complex financial institutions," she said.