Substantial Financial Reforms Needed: NY Fed

By Reuters -  |  Posted 2008-07-24

WASHINGTON (Reuters) - It is critical for policy-makers to help the financial system adjust during a difficult time, but substantial regulatory reforms are needed to make institutions and markets more resilient, a top Federal Reserve official said on Thursday.

Federal Reserve Bank of New York President Timothy Geithner said in prepared testimony to the House of Representatives Financial Services Committee that the financial crisis of the past year has underscored the need to change an outdated patchwork of financial regulators.

"The critical imperative today is to help facilitate that adjustment and to cushion its impact on the broader economy," Geithner said. "The forces that made the system vulnerable to this crisis took a long time to build up and the system will need some time to work through their aftermath."

"I believe the most important imperative is to build a financial system that is more robust to very bad outcomes and more resilient to shocks," Geithner said.

Major institutions would have to become less vulnerable to shocks, and the system would need to be less vulnerable to pull-backs in liquidity and be able to withstand the failures of a major financial firm.

The financial system needs better "shock absorbers," such as stronger capital reserves and risk management among institutions, and simplifying and consolidating the regulatory architecture to reduce opportunities for regulatory "arbitrage," he said.

The use of government backstops such as central bank liquidity tools and other emergency powers requires stronger oversight to limit the "moral hazard" that they create by encouraging riskier behavior among institutions.

"To mitigate this effect on risk-taking, strong supervisory authority is required over the consolidated financial entities that are critical to a well-functioning financial system," he said.

(Reporting by Patrick Rucker; Writing by David Lawder; Editing by Andrea Ricci)