A second question I think we ought to be discussing is whether or not we can simplify the structure of many of our institutions... There have been questions about whether institutions should have what amount to “living wills” – meaning they’ve come up with a plan so that if they get into financial problems, the plan for resolution is relatively clear. That would probably require simplifying institutions’ structures.  So, we should explore the extent to which regulatory and supervisory procedures should make sure institutions are easy to resolve – in other words, that they have simple enough structures so that if they do get into trouble you can sell parts of them without necessarily having to take them over.

This crisis has shown us that when all firms or market participants simultaneously take an action that appears to be in their immediate, narrow interest, the collective impact on the system as a whole can be disastrous. We need to find ways to weaken or eliminate these reinforcing mechanisms and we need to introduce new dampening mechanisms into the financial system.

I want to make a few more general comments on changes, actual or potential, in credit markets. These remarks are prompted in part by the conversations I often have with bankers, business people, and consumers. During these discussions I have realized that just about everyone understands we will never return to the credit markets of the middle part of this decade, but very few people believe they understand what the "new normal" will look like once the crisis has fully passed and the economy is on a sustained recovery path. I suspect that this uncertainty is itself an impediment to stronger growth, since it makes financial planning more difficult.

I would prefer to see more emphasis on giving people the information they need in a clear and understandable format – especially targeted information that will help them to avoid making serious errors – rather than restricting their access to financial products.

Legislative change is needed to ensure that systemically important financial firms are subject to effective consolidated supervision, whether or not the firm owns a bank.

The financial crisis has underscored the importance of the original motivation for creating what is now the FSB. The connections among financial market sectors, and between macroeconomic policy and financial markets, mean that efforts to ensure international financial stability must incorporate a breadth of perspectives and include communication among the various international groups in which regulatory cooperation takes place.

The scale and scope of the financial safety net should be matched by the scale and scope of the regulatory and supervisory regime surrounding financial institutions. The central role of prudential regulation is to constrain and prevent the excessive risk-taking that would otherwise be induced by the incentive effects of safety net support.

The leading proposals before Congress concentrate almost exclusively on expanding government protection and regulation, but I believe we would be better off placing greater reliance on market-based incentives for prudent risk management.

The Supervisory Capital Assessment Program (popularly known as the stress test) provides a window into the likely future of bank supervision as well as the accounting issues encountered by regulators in evaluating capital adequacy. The stress test was a simultaneous, horizontal review of the 19 largest financial institutions in the United States. The review was led by the Federal Reserve, but conducted jointly with other federal banking regulators. In essence, we focused on three key pieces of information--pre-provision net revenue, potential losses, and final equity capital.

[W]e are prioritizing and expanding our program of horizontal examinations to assess key operations, risks, and risk-management activities of large institutions. For the largest and most complex firms, we are creating an enhanced quantitative surveillance program that will use supervisory information, firm-specific data analysis, and market-based indicators to identify developing strains and imbalances that may affect multiple institutions, as well as emerging risks to specific firms.

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.

While effective consolidated supervision of potentially systemic firms is not, by itself, sufficient to foster financial stability, it certainly is a necessary condition. The Administration's recent proposal for strengthening the financial system would subject all systemically important financial institutions to the same framework for prudential supervision on the same consolidated or group-wide basis that currently applies to bank holding companies. In doing so, it would also prevent systemically important firms that have become bank holding companies during the crisis from reversing this change and escaping prudential supervision in calmer financial times.

[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