Federal Reserve Chairman Ben Bernanke said this morning that the financial crisis has uncovered weakness in private-sector risk management and the public sector's oversight of the financial system. He called for a strengthened regulatory system and a broadened approach to supervision that looks not only at individual firms but risks to the entire financial system.

Bernanke, in May 7 remarks prepared for the Federal Reserve Bank of Chicago Conference on Bank Structure & Competition, said the stress tests of the nation's largest banks, the results of which are to be made public today, have "been comprehensive, rigorous, and forward-looking," adding: "Undoubtedly, we can use many aspects of the exercise to improve supervisory processes in the future."

"Macroprudential" Authority

Bernanke's speech continually hammered on the interlocking role of financial institutions and the unintended consequences of financial innovation, and how the actions of one firm will affect the overall financial system. "I believe a macroprudential approach to supervision—one that supplements the supervision of individual institutions to address risks to the financial system as a whole—could help to enhance overall financial stability."

He said that the means of establishing such oversight is still open to debate. "Some of these critical functions could be incorporated into the practices of existing regulators, or a subset of them might be assigned to a macroprudential supervisory authority. However we proceed, a principal lesson of the crisis is that an approach to supervision that focuses narrowly on individual institutions can miss broader problems that are building up in the system."

Bernanke also reiterated calls for revamping compensation practices. Bonuses and other compensation should provide incentives for employees at all levels to behave in ways that promote the long-term health of the institution," he said.

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