The Fed should remain involved with community bank regulation so that it has a view of the entire financial landscape. It is important that the Fed does not become biased toward the very large, mostly New York-based institutions.

In the United States we have as a first line of defense we have a risk weighted capital ratio which is not a straight leverage ratio, it's an amount of capital we have to hold against assets where we have to hold more capital against riskier assets, which makes sense. The risk of the asset, the more capital you want to hold and we are, we the Federal Reserve and the other bank regulators are working very actively with other regulators around the world to strengthen the capital requirements. We've already made proposals to do that. We are going to get assessments from the banks about how big an impact that would have. And it's our intention to move forward with more conservative higher capital requirements. So that's the first thing.

The leverage ratio is kind of a back stop, a fail safe if you will, because it's a very simple ratio, it's just a ratio of capital against total assets without making much or any distinction between Treasury's versus loans to small businesses for example. And the United States has long had a leverage ratio as a backstop to our capital rules.

One of the interesting things that appears to be coming out of the international negotiations is that the U.S. leverage ratio, which never was used abroad now looks like it will be adopted by other countries as well, which is good for us because it'll create a more even playing field and create greater safety in the global banking system as well as here.

So the leverage ratio is part of these negotiations and discussions we're having internationally and there are proposals on the table. We haven't yet gone through the whole process of doing the quantitative analysis to figure out exactly what the right number is, so I can't tell you off hand you know what the final number will be, but we're certainly looking to make the leverage ratio part of the more conservative approach to making sure that banks have enough capital that they can absorb even in a severe crisis like one we've had they can absorb their losses.
So yes, that will be part of our proposal.

[T]he Federal Reserve has placed particular emphasis on ensuring that its supervision and examination policies do not inadvertently impede sound lending to businesses, both large and small, and we will continue to do so. Actions taken to stabilize the largest banks during the crisis have received a lot of attention. However, I think it is equally important to note the degree to which banks of all sizes were offered access to the same loan, guarantee, and capital facilities. We should never forget that the objective was to save the system as a whole, not just a handful of large institutions.

[S]ecuritization is a powerful vehicle that should play an important role in the intermediation of credit in the economy. Securitization can be quite effective at transforming illiquid assets into negotiable securities and transferring risk to a more diversified set of holders. To be sure, the expansion of securitized credit was much too extensive, and its subsequent collapse was terribly disruptive, contributing significantly to the damage to the economy. However, those developments do not mean that securitized credit, if structured properly, should not return in size. Reform efforts, to be effective, should foster development of a securitization market that properly aligns incentives and provides adequate transparency about risk transfer.

I believe that the most useful steps toward creating a practical, macroprudential supervisory perspective will be those that connect the firm-specific information and insight gained from traditional microprudential supervision to analysis of systemwide developments and emerging stresses. Here, precisely, is where our SCAP experience has helped lead the way.

While calling for action myself, I have been uneasy with what I have seen so far... We must reinvigorate fair competition within our system in a culture of business ethics that operates under the rule of law.  When we do this, we will not eliminate the small businesses' need for capital, but we will make access to capital once again earned, as it should be.

We deceived ourselves to think that we could somehow avoid the way people are.

I think it is underappreciated how important harmonization is to ensure success of the global regulatory reform effort. Without harmonized standards, financial intermediation would inevitably move toward geographies and activities where the standards are more lax.  This, in turn, would provoke complaints from those who cannot make such adjustments as easily. The political process, in turn, would be sensitive to such complaints, creating pressure for liberalization, which would cause the tougher standards to unravel over time...

...There is understandable and genuine concern that the impact of moving to global standards will fall disproportionately on some types of firms. In my view, the way to mitigate these issues is to have a long phase-in period in the transition to the new standards rather than to soften or alter the standards to shelter those firms that happen—perhaps by historical accident—to be starting in a less advantageous position. The focus should be more on the side of all ending up in a similar place, rather than on the relative degree of difficulty in getting there.

The process is also fragile because some countries seem intent on strengthening their own set of standards before the international process has had a chance to reach consensus. Although it is understandable that countries would want to move quickly to strengthen their regulatory regimes, such actions should not be undertaken in a way that is immutable and unresponsive to the emerging international consensus.¹

I see a number of benefits to making similar macroprudential stress tests routine. Such horizontal cross-bank reviews of balance sheets and risk exposures can identify potential systemic risks that might escape an institution-by-institution analysis. Furthermore, they provide a ready way for supervisory reviews and actions to respond to the latest information on macroeconomic developments. In addition, going forward, we might consider dynamic capital standards that would require banks to build their capital base during periods of strong economic growth and high bank profitability, and let banks draw down their capital cushions during downturns when profits and capital tend to be more scarce.

[R]egulatory improvements alone, as essential as they are, won't be enough. This cycle of crisis, rescue and by-pass is destined to recur, and with ever more force, unless we alter what market participants believe will happen when a financial firm becomes distressed. Recognizing that market discipline requires that creditors expect to bear losses on insolvent counterparties, many financial reform proposals create a new failure resolution process that gives policymakers additional "tools," besides the existing bankruptcy code, for handling failing firms.

Even as we improve and reorient regulation, we must not lose sight of the ultimate goal. Today we are all mindful of the economic devastation that can ensue when a financial system goes badly awry. But financial stability alone is not the aim of financial regulation. It is instead a stable financial system within which capital is efficiently directed to creditworthy consumers and businesses who need it, as well as a system that offers good savings and investment vehicles for individuals and organizations.

[T]he Federal Reserve, representing the United States, has been working with other countries, in the Basel committee and other contexts, to try to develop new standards. We have implemented a few of them, for example, for market trading, but at this point we have not completed the whole process of developing higher, more stringent capital standards for large firms.

A proposal has been put forward, which is now being tested. Banks are being asked to evaluate how much capital they would have to hold under these more stringent standards, so we can get a sense of what the implications would be for the leverage ratio. But I don't know that number yet. We're trying to figure out what will be safe. It would depend on the composition of the assets the bank has -- the riskier the assets, the higher, more capital you should have.

So we are working to try to, by the end of 2010, to try to have a very concrete proposal to -- that each country would then have to decide whether to adopt or not.

From the Q&A session

The Federal Reserve, I think, was one of the more vocal commenters on Fannie and Freddie for many years, and we were very concerned about their stability and whether they had enough capital to support those large portfolios that they had, and it turned out they didn't, and we're paying the cost of that right now.

We would not support -- let me be careful. I think we would be very cautious about supporting a return to the existing structure, where you have this potential conflict between private shareholders and the public objectives.

I think there are alternatives, and I provided some of them in a speech I gave a year and a half ago -- I'd be happy to provide you -- which would be a more stable long-term solution, including either a privatization approach with government guarantees or a public utility approach. Those are two options that you could consider.

From the House Q&A session on Wednesday

I think there that returning to a more market-oriented financial sector is a top priority, and we are, in fact, doing that. For example, all the big banks have now paid back their TARP money, and we are trying as quickly as we can to get those banks financed by private capital, which they have raised a great deal of private capital. It's very important.   AIG, of course, is very problematic, but they are selling off assets in order to pay us back, and they're making progress on that.  And our objective there, of course, is to put them back in the private sector.

We talked earlier about Fannie and Freddie, and I do think that we have to get away from this neither fish nor fowl situation where they're part-public, part-private. I think, you know, one solution would be to privatize those firms, and I think that's an interesting direction to go.

From the Q&A session in the Senate on Thursday

Smaller banks did not cause the crisis and do not need to be re-regulated. Current regulation works well for the thousands of smaller banks in the U.S. The system features deposit insurance plus prudential regulation. It allows failure, but prevents bank runs and the panic associated with them.

[W]e need Congress to enact a resolution mechanism that allows large, complex financial firms to be wound down smoothly, without the need for extraordinary interventions. In addition, we need to take steps to make the financial system as a whole more resilient and robust. This requires many steps—some already in train—including higher capital requirements for large banks, bigger liquidity buffers, and changes to ensure that compensation practices are consistent with safety and soundness and financial stability. It's a long list—there is no single silver bullet—and it will take time, but the regulatory community and the political leadership will fail to meet our shared responsibility as stewards if we do not implement the necessary reforms in a timely and effective manner.