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Risk Mitigation Hot Topic at Chicago Fed Conference

As the Dodd-Frank Act moves slowly to implementation, banking officials speaking at the recent ""Chicago Federal Reserve Bank's"":http://www.chicagofed.org/webpages/index.cfm annual conference pointed to the need for continued monitoring of financial services markets to mitigate the risk of future economic crisis.

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""Federal Reserve Chairman Ben Bernanke"":http://www.federalreserve.gov/aboutthefed/bios/board/bernanke.htm called for regulators to focus on two key types of risk: gaps in regulatory coverage and risks that vary with the economy, such as the buildup of lending leverage.

Future regulation must look beyond individual firms or markets and target systematic or cross-cutting risks, according to Bernanke. Elaborating on risk management, Bernanke said, ""A traditional examination might find that an individual firm is relying heavily on short-term wholesale funding which may or may not induce a supervisory response. The implications of that finding for the stability of the broader system, however, cannot be determined without knowing what is happening outside of that particular firm. Are other similar financial terms relying on short-term funding?""

Bernanke stressed the need for regulators to consider the potential macroeconomic effect of concentrated funding sources, which is the catalyst behind the Dodd-Frank Act's new Financial Oversight Council. The council's inaugural report on financial stability is expected to be released this summer.

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""Of course, any threats to financial stability must be followed by appropriate remedies,"" Bernanke said, yet he also added that regulators shouldn't be overly cautious, which could result in impeding ""reasonable risks and innovation.""

To promote monitoring and financial stability, the Federal Reserve created the Office of Financial Stability Policy and Research, which examines global financial risk and its possible impact on economic stability. The office's focus will be on the largest financial institutions.

""FDIC Chairman Sheila Bair"":http://www.fdic.gov/about/learn/board/board.html discussed ending the concept of ""too big to fail"" during her address at the conference, and she also called for regulators to closely watch the potential financial difficulties of banks that fall just under the Dodd-Frank Act's $50 billion threshold for additional scrutiny.

""If there was ever a constructive ambiguity about the scope of the federal safety net and the existence of ├â┬ó├óÔÇÜ┬¼├ï┼ôtoo big to fail,' it was surely made obsolete by the events of late 2008 and early 2009,"" Bair said, ""In the wake of that experience, all of us have a vital interest and a collective responsibility to do what it takes to restore the safety net that assures stability and public confidence and the need to place clear and credible limits on that safety net.""

Bair stated that, in her opinion, responsible risk mitigation means adopting a willingness to close even the largest financial institutions in any future crisis. ""When a large, complex financial institution gets into trouble, time is the enemy,"" she added.

Bair also commented on the cross-organizational structure of large financial entities, pointing out that the corporate landscape of the institutions makes it difficult to resolve problems in one part of the bank without causing the entire organization to fail. She elaborated on potential solutions, saying that allowing failing businesses to continue for fear of systemic risk doesn't promote economic health. Bair suggested that allowing regulators to instigate organizational changes to better align business and legal efforts before a crisis can occur could help stem future risk.

About Author: Phil_Britt

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