As prepared for delivery
WASHINGTON - Thank you very
much for the invitation to join you today.
like this are important opportunities for global leaders in the public and
private sectors to collaborate and learn from each other. I am joined
today by my colleagues from the Financial Stability Oversight Council and the
Office of Financial Research. As we work to get the rules of regulatory
reform right and to address threats to financial stability, we need broad
engagement. Every rule I work on benefits from public input.
I want to build on your constructive dialogue by talking about our progress
implementing regulatory reform and the challenges that remain, particularly in
connection with identifying and addressing risks to financial stability. Then I look forward to answering your
the last two years, Treasury and financial regulators have been hard at work
creating a more resilient financial system.
We were given a big assignment, and we have made tremendous progress. Nine out of 10 rules with deadlines before
mid-July have been proposed or finalized.
New institutions are up and running and already hard at work, including
the Consumer Financial Protection Bureau, the Financial Stability Oversight
Council, and the Office of Financial Research, or better known to you as the
CFPB, the FSOC, and the OFR. The
framework of our new system is in place.
reform has significantly improved our ability to monitor and contain risks to
financial stability. Financial
institutions are much stronger, making them better able to withstand
shocks. Increased trading on exchanges
and new trade repositories and reporting are bringing transparency to
markets. The FSOC and OFR are actively
monitoring threats to financial stability and strengthening coordination among
regulators. Every day I see more
evidence of this progress.
even with the benefit of these new rules and institutions, we approach the task
of identifying and addressing risks to financial stability with humility. In my experience, you are never handed the
same script for a financial crisis or shock.
The next financial crisis is unlikely to look like the last. Problems can surface in unexpected ways that
will challenge even the most sophisticated tools and the smartest
reforms we have put in place have made our financial system less vulnerable,
but we all have more to do.
a result of this Administration’s efforts, we’ve made considerable progress in
repairing the economic damage from the crisis and putting our financial system
on sounder footing.
The government has closed most of the emergency
programs put in place during the crisis and recovered most of its
financial sector investments. For
example, the Troubled Asset Relief Program is expected to cost taxpayers a
small fraction of original forecasts.
Most of the expected cost will be a result of the support provided
to the housing market, which is showing signs of stabilizing.
challenges remain. Although the U.S.
economy is still expanding, the pace of economic growth has slowed during the
last two quarters. Headwinds from Europe are partly to blame. In addition, the rise in oil prices earlier
this year, the ongoing government spending reduction, and slow rates of growth
in income have all adversely affected U.S. growth.
slowdown in U.S. growth could be exacerbated by uncertainty about fiscal
matters. The United States faces
unsustainable fiscal deficits. To
restore fiscal responsibility, policy makers must take action but there is
significant uncertainty about the shape of the reforms to tax policy and
spending to come.
global economic growth has slowed in recent months and forecasts for future
growth have been reduced. The continuing crisis in Europe is the key
factor behind the slowdown. Growth in China, India, Brazil and other
large emerging economies has also slowed as a result of weaker external demand
combined with the effects of past policy tightening and an increase in risk
summary, U.S. economic activity has moderated in recent months, with growth
held back by a number of temporary factors.
Looking ahead, the fundamentals for the private sector are generally
supportive, and the housing market appears to be stabilizing. We continue to expect growth to strengthen
gradually going forward.
Financial Regulatory Reform: Stronger Financial Institutions and Financial
these challenges, we have remained focused on the need to complete financial
regulatory reform, which we believe is a necessary foundation for sustained
economic growth and financial stability.
More resilient financial institutions and markets are less vulnerable to
financial shocks and less likely to propagate risk.
want to highlight a few specific areas where we believe reform is building
stronger institutions and markets.
We have forced banks to substantially increase the amount of
capital they hold, so that they are able to provide credit to the economy
and absorb losses in the future.
Banks have added over $400 billion of high-quality capital, up 70
percent from three years ago.
More stable funding models: Banks are funding themselves more
conservatively, relying less on riskier short-term funding. As we learned during the financial
crisis, reliance on short-term funding can quickly threaten a troubled
firm. In addition, the use of the
“shadow banking system”—a key source of financial stress during the
crisis—has decreased substantially.
Regulators are limiting risk-taking at the largest financial
institutions, recognizing the outsized threats they can pose in times of
market stress. Federal regulators have imposed tougher standards on
the largest banks, and we can now subject the largest non-banks to
enhanced supervision and prudential standards. Eight large financial market utilities,
such as clearinghouses, will now be subject to heightened risk management
standards. High-risk trading strategies and investments at
depository institutions will be more constrained by the Volcker Rule.
Limiting contagion: Regulators are putting in
place the framework for the “orderly liquidation authority,” a mechanism
to unwind large, complex financial companies. Through this
authority, which was sorely lacking during the crisis, we are protecting
taxpayers and preserving financial stability in the event of a failure of
a large financial firm. In addition, nine of the largest bank
holding companies recently submitted their “living wills,” providing
contingency plans for an orderly bankruptcy.
transparent derivatives markets:
The SEC and CFTC are putting in place a new framework for
derivatives oversight, providing new safeguards for market
participants. Following the adoption of swaps definitions this
month, more than 20 key rulemakings can now move forward. This marks a major milestone in the
implementation of derivatives reforms.
As swaps move onto transparent trading venues and are centrally
cleared, regulators and market participants will have much more insight
into these exposures and potential risks in the derivatives markets.
Financial Regulatory Reform: Identifying and Addressing Risks to Financial
are also building new institutions. The Financial
Stability Oversight Council and the Office of Financial Research, both created
by the Dodd-Frank Act, are actively monitoring and mitigating threats to the
stability of the financial system.
its first meeting in October 2010, the FSOC has met regularly to discuss market
developments and potential threats to stability. Most recently, the FSOC has focused on the
situation in Europe, our housing market, and the lessons to be drawn from
recent errors in risk management at several major financial institutions,
including the failure of MF Global and the trading losses at JPMorgan
of the duties of the FSOC is to facilitate information-sharing and coordination
among its member agencies. In the run-up to the crisis, fragmentation in
our regulatory system allowed many risks to slip through the cracks. As Chair of the FSOC, Secretary Geithner
continues to make it a priority that the work of the regulators is
week, the FSOC released its second annual report, which includes a review of
significant financial market and regulatory developments, potential emerging
threats to financial stability, and recommendations to strengthen the financial
system. As Under Secretary, I spend time
working with the FSOC staff and agencies, and I can tell you that generating
the report is an extraordinarily useful and demanding process.
Dodd-Frank Act also established the OFR to collect and standardize financial
data, perform essential research, and develop new tools for measuring and
monitoring risk. In its first annual
report, also released last week, the OFR noted that gaps in financial data and
in our understanding of the financial system still represent risks.
the OFR is working on a number of projects with the FSOC, including developing
metrics for and indicators of financial stability. The OFR is also providing analysis related to
the FSOC’s evaluation of nonbank financial companies for potential designation
for Federal Reserve supervision and enhanced prudential standards.
ongoing priority is establishing a legal entity identifier (LEI), or unique,
global standard for identifying parties to financial transactions. The LEI can improve the quality of financial
data, especially in identifying the largest and most complex firms’ exposures,
and thus help to detect a buildup of risk in the system.
Current Threats to Financial Stability
where do we see threats to financial stability today? I would like to highlight just a couple of
areas raised in the FSOC’s report.
Risks in Wholesale Funding Markets
FSOC recommended a set of reforms to address structural vulnerabilities,
particularly in wholesale short-term funding markets such as money market funds
and the tri-party repurchase agreement market. As we saw during the
financial crisis, these sources of funding were particularly vulnerable to
disruption, which quickly spread through the markets.
should closely monitor their reliance on wholesale short-term funding. Maturity transformation, which entails
funding longer-term assets with short-term debt, is a core function of the
financial system, but overreliance can create additional vulnerabilities in
SEC adopted a number of reforms to the regulation of money market funds in 2010
that provided additional safeguards. However, money market funds continue
to lack a mechanism to absorb a sudden loss in value of a portfolio security,
and investors have an incentive to redeem at the first indication of any perceived
threat to the value or liquidity of the fund, potentially disadvantaging
remaining shareholders. The FSOC recommends that the SEC publish
structural reform options for public comment and ultimately adopt additional
the tri-party repo markets, the FSOC supports additional steps toward reducing
intraday credit exposure between clearing banks and market participants. In addition, the FSOC recommends that
regulators and industry participants work together to better define standards
for collateral management in the tri-party repo market, particularly for
lenders (such as money market funds) that have certain restrictions on the
instruments that they can hold.
Risk Management and Supervisory
FSOC also recommends that financial institutions establish strong risk
management and reporting structures to help ensure that risks are evaluated
independently and at appropriately senior levels. This means prudent risk management practices
for complex trading strategies.
Financial institutions also need to maintain disciplined credit
underwriting standards and vet emerging financial products.
report notes, for example, that high-speed trading is an area where increased
speed and automation of trade execution may require a parallel increase in
trading risk management and controls.
The Flash Crash in May 2010 highlighted system-wide vulnerabilities in
the equities and futures markets. Since
then, the regulators have taken a number of steps to address potential risks.
example, the SEC put in place a dynamic single-stock circuit breaker called the
limit up/limit down rule. In addition,
they recently approved a plan to create a consolidated audit trail that would
allow regulators to monitor and respond to events in the equity markets in a
more robust and timely manner. However,
more work needs to be done as financial markets evolve and high speed trading
becomes more prevalent. We must continue
to track developments and analyze risks with real-time policy responses.
FORWARD: PARTNERING IN FINANCIAL
you can see, reform is improving the way we identify threats to financial
stability. We have made tremendous
strides. Our financial system is stronger and safer. A number of
important reforms are in place. The FSOC
and the OFR are on the job.
the government will continue to work diligently to strengthen the financial
system against potential threats, we cannot do this alone. The financial services industry must become a
stronger partner in both regulatory reform and initiatives aimed at financial
the financial crisis, some in the private sector acted irresponsibly.
Risk built up where we did not have visibility or the tools to contain
it. Taking risk is an important engine of financial returns, but it must
would like to share a few suggestions on how the private sector can do its
of all, reward people for both realizing profit and constraining risk. A culture that primarily rewards short-term
profits should be set aside in favor of one that strives for long-term gains
Implement best-in-class risk management practices.
Run rigorous stress tests and scenario
analyses. Consider how investments
and activities can have unintended consequences for financial
Increase transparency in financial reporting
beyond existing requirements.
Empower, recognize, and reward effective risk
managers. Signal to the
organization that risk management is valued.
Participate in industry forums to share lessons
learned and develop best practices.
initiatives are not only good for the financial system but also benefit
financial firms by promoting client, customer, bondholder, and stockholder
also add that the relentless efforts of some in the financial industry to
undermine, work around, or stall reform are short-sighted. I strongly believe that such efforts will
further undermine trust in financial firms – trust that is essential for the
functioning of the industry.
Regulatory reform benefits, not
disadvantages, financial firms.
look forward to continued engagement to make our financial system more vibrant
and safe. To achieve that, the financial
services industry and the government each have a lot of work to do. We share responsibility for protecting
Americans from the extraordinary damage – lost jobs, lost homes, lost
businesses, and lost wealth – that a financial crisis can cause. Americans deserve a financial system that is
the foundation for sustained growth and economic security.