[S]peaking of Congress: Its choices on financial reform will have long-lasting effects on economic outcomes. As a country, we don’t want to be regretting these choices in a decade or two. Stripping the Federal Reserve of its supervisory authority over either small or large financial institutions would be a potential source of exactly that kind of regret.

 I’m also concerned about those proposals under consideration that would move the regulatory and supervisory functions now held by the Federal Reserve to other agencies, new or existing... In my view, further disaggregation or fragmentation of regulatory oversight responsibility is not the appropriate response to our increasingly interconnected, interdependent financial system. Funneling information streams into diverse institutional silos leads to communication breakdowns and too often to failure to "connect the dots."

Some observers argue that the financial reform agenda should include changes in the role and governance of the Federal Reserve...   I know it might sound self serving for a Fed insider to object to such changes, but I believe such moves would present very serious risks to the effectiveness of monetary policy and ultimately to economic growth and stability...  The governance of the Federal Reserve System balances accountability, with ultimate authority resting in Washington, and independence, with the participation of non-political leaders from throughout the country.  While the performance of our economy in the last two years has clearly been unsatisfactory, and policy mistakes may have contributed to our problems, the Fed's balanced, hybrid governance structure has, I believe, given us a good record over the better part of three decades. Disrupting that balance would pose another long term challenge for our economy.

Having experienced the damage that asset price bubbles can cause, we must be especially vigilant in ensuring that the recent experiences are not repeated.  All efforts should be made to strengthen our regulatory system to prevent a recurrence of the crisis, and to cushion the effects if another crisis occurs.  However, if adequate reforms are not made, or if they are made but prove insufficient to prevent dangerous buildups of financial risks, we must remain open to using monetary policy as a supplementary tool for addressing those risks--proceeding cautiously and always keeping in mind the inherent difficulties of that approach.

I think in hindsight there's some things we would have done differently. The supervision we did, on the banks that we did supervise, I think we did very well, and I think it showed that those abuses, those subprime mortgage problems, didn't show up in the entities we were supervising and examining.

Where the problems arose were outside the banking system, in entities that we didn't have a right to go in and examine on a regular basis.

So I think - I'd give us pretty good marks for implementation. I think in hindsight there's things we would have done differently in rule making.

[T]he consolidated supervision of an individual firm, whether or not it is systemically important, is best vested with a single agency. However, the broader task of monitoring and addressing systemic risks that might arise from the interaction of different types of financial institutions and markets--both regulated and unregulated--may exceed the capacity of any individual supervisor.

A graphic illustration of what can happen when the central bank is not involved in supervision was observed a couple of years ago in the United Kingdom.  The Bank of England, the central bank, was not involved in supervision at all, and when a significant financial institution, Northern Rock, failed, the Bank of England was not in a position to be able to make judgments about a: the failure of Northern Rock and b: the ripple effects within the system.

As reported by Reuters.

[A]ddressing the pervasive problem of pro-cyclicality in the financial system will require efforts across financial sectors. To help address these issues, the Administration has proposed the establishment of a Financial Services Oversight Council composed of the Treasury and all of the federal financial supervisory and regulatory agencies, including the Federal Reserve.

See further comments on an oversight council:
Sheila Bair's Testimony ; Mary Schapiro's Testimony

The Federal Reserve's participation in this decisionmaking process {resolution process for nonbank financial firms} would be an extension of our long-standing role in protecting financial stability, involvement in the current process for invoking the systemic risk exception under the FDI Act, and status as consolidated supervisor for large banking organizations. The Federal Reserve, however, is not well suited, nor do we seek, to serve as the resolution agency for systemically important institutions under the new framework.

I believe a hybrid approach consisting of a single systemic risk regulator and a powerful council is most appropriate...there needs to be a government entity responsible for monitoring our entire financial system for system-wide risks, with the tools to forestall emergencies. I believe this role could be performed by the Federal Reserve or a new entity specifically designed for this task.
...
I agree with the Administration and FDIC Chairman Bair that this SRR {systemic risk regulator, i.e. Federal Reserve} must be combined with a newly-created Council. I believe, however, that any Council must be strengthened beyond the framework set forth in the Administration's "White Paper."

See further comments on an oversight council:
Sheila Bair's Testimony ; Daniel Turullo's Testimony

The Administration's proposal addresses the need for broader-based identification of systemic risks across the economy and improved interagency cooperation through the establishment of a new Financial Services Oversight Council. The Oversight Council described in the Administration's proposal currently lacks sufficient authority to effectively address systemic risks.

In designing the role of the Council, it will be important to preserve the longstanding principle that bank regulation and supervision are best conducted by independent agencies. Careful attention should be given to the establishment of appropriate safeguards to preserve the independence of financial regulation from political influence.

See further comments on an oversight council:
Mary Schapiro's Testimony ; Daniel Turullo's Testimony

[T]he Federal Reserve Board believes there is a compelling case for leaving consumer protection rule writing functions within the Federal Reserve and supervision with the agencies responsible for prudential supervision. While arguments for consolidating functions can themselves be compelling, it is important to also consider the substantial opportunities presented by existing arrangements.
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[T]he Federal Reserve has the resources, the structure, and the experience to execute an ongoing comprehensive program for effective consumer protection in financial services...[W]e believe that replicating in another agency the deep expertise and full array of functions embedded within the Federal Reserve and used to support our consumer protection program would be enormously challenging. We also view consumer protection as complementary to, rather than in conflict with, other responsibilities at the Federal Reserve, such as prudential supervision and fostering financial stability.

Is monetary policy independence threatened by giving a central bank other responsibilities, such as supervisory and regulatory authority for some parts of the financial system? Are there potential conflicts between a high degree of independence for monetary policy and accountability in supervisory and regulatory policy? I believe that U.S. and foreign experience shows that monetary policy independence and supervisory and regulatory authority are mutually compatible and even have beneficial synergies.

My personal view is that the Federal Reserve is well placed to do a good job in the public interest on consumer regulation. I think the fact that we have various disciplines within the (Fed) system: we have a view of the macroeconomy, the markets, our supervision system -- these are congruent with good consumer regulation. (They) give us a way of balancing issues having to do with consumer regulation…I would hope that the Congress might think about whether there are ways of strengthening the Federal Reserve's commitment to consumer regulation as an alternative to creating a new regulator.

As reported by Reuters.

Periods when earnings are strong and nonperforming loans are low are likely the times that a macroprudential supervisor would need to be particularly vigilant...[U]nlike the focus on incurred losses and accounting reserves of traditional safety and soundness supervision – a systemic regulator would need to be focused on forward-looking estimates of potential losses that could cause contagious failures of financial institutions.

I should acknowledge that even in traditional supervision, examiners can also focus on future or unexpected losses – and in theory, capital is expected to provide protection for losses occurring outside the accounting reserve model. But in practice, this is not always the case.