Bernanke to tell Congress: Don’t scale back Fed banking supervision

Fed boss to make case to keep all banking duties

WASHINGTON — Federal Reserve Chairman Ben Bernanke will make the case to Congress on Wednesday that the Fed should retain supervision of smaller banks.

In testimony prepared for a House hearing, Bernanke plans to wage a fresh battle against Senate efforts to scale back the Fed’s role in overseeing the nation’s banks.

The Fed boss will argue that policymakers factor information they get from the Fed’s role as bank regulator into their decisions on interest rates. And, Bernanke said its banking duties give the Fed insights into the health of the entire banking system.

“The insights provided by our role in supervising a range of banks, including community banks, significantly increases our effectiveness in making monetary policy and fostering financial stability,” Bernanke said in his prepared remarks to the House Financial Services Committee.

Bernanke’s testimony comes as the Fed faces a significant shift in its supervisory duties.

In an effort to overhaul the nation’s financial regulatory structure, Senate Banking Committee Chairman Christopher Dodd, D-Conn., has offered legislation that would strip the Fed of its power to supervise state-chartered banks and bank holding companies with assets of less than $50 billion.

That would leave the Fed with 35 of the biggest bank holding companies under its supervision.

It currently oversees about 5,000 bank holding companies, about 850 smaller banks that are both state-chartered and are members of the Federal Reserve system and some foreign banks operating in the United States.

“Notably, the Federal Reserve’s role as a supervisor of state member banks of all sizes, including community banks, offers insights about conditions and prospects across the full range of financial institutions, not just the very largest, and provides useful information about the economy and financial conditions throughout the nation,” Bernanke said in his prepared remarks. “Such information greatly assists in the making of monetary policy,” he said, referring to the Fed’s role in setting interest rates to influence economic growth, employment and inflation.

Dodd’s bill, however, would also give the Fed new powers to oversee nonbank financial firms that are so large and interconnected that their failure could pose a risk to the economy.

Such firms could include insurance giant American International Group Inc., or General Electric Co.’s GE Capital business.

But with its narrower authority, the Fed’s system of 12 regional banks could face profound changes. The Kansas City Federal Reserve Bank and the St. Louis Federal Reserve Bank, for instance, would have no banks under their supervision.

The Obama administration has supported a broader supervisory role for the Fed. Legislation passed by the House overhauling the regulatory landscape doesn’t trim the Fed’s banking duties.

Former Fed Chairman Paul Volcker, who currently serves as economic adviser to Obama, also argued for the Fed to retain supervision over all the banks it now oversees and cited similar reasons as Bernanke.

“It would be a really grievous mistake,” Volcker said of curtailing some of the Fed’s banking oversight.

“Something important, if less obvious would also be lost if the present limited responsibilities for smaller member banks were to be ended. The Fed’s regional roots would be weaker and a useful source of information lost,” Volcker said in prepared remarks.

Small banks also made the case to continue to be regulated by the Fed.

Jeffrey Gerhart, president of Bank of Newman Grove, said the Fed would “lose valuable information about local economies,” which informs interest rate decision, if the Fed no longer supervised small banks.

Dodd’s bill would also place an independent consumer watchdog inside the Fed. The Consumer Financial Protection Bureau, however, would have its own director appointed by the president and would not fall under the authority of Bernanke.

The administration has called for a freestanding consumer agency, an approach that would strip the Fed of its consumer-protection responsibilities. The House version of a financial revamp resembles the administration’s approach. Bernanke has argued that despite past weaknesses, the Fed should retain its consumer-protection duties. He didn’t address the matter in his testimony prepared for Wednesday.

Anil Kashyap, professor of economics and finance at the University of Chicago Booth School of Business, said in prepared remarks to the House committee that consumer-protection oversight should be handled by some other agency, not the Fed.

But he backed Bernanke’s pitch for the Fed to keep its banking oversight. “Stripping the Fed of its role in bank supervision would be a step in the wrong direction,” Kashyap said.

Separately, the Fed and other regulators on Wednesday urged banks to make sure that they have sufficient cash on hand and have a cushion of liquid assets to better handle any new bouts of financial turmoil. The financial crisis revealed “extensive weaknesses” with many banks’ so-called liquidity risk management practices, said Fed member Daniel Tarullo. The stronger practices recommended by regulators is geared to bringing about a more stable financial system, he said.