Fed’s Pianalto Says Living Wills Help Curb Bank System Risks

Federal Reserve Bank of Cleveland President Sandra Pianalto said so-called living wills to outline how failing financial institutions will be shut down will help increase regulatory transparency for investors.

“Successfully addressing the ‘Too Big To Fail’ problem requires the establishment of a credible resolution process, one that appears capable of safely managing the failure of systemically important financial institutions in times of distress,” Pianalto said today in a speech in Washington.

Fed officials and U.S. lawmakers are considering new ways to limit the risk that the failure of a large bank will lead to a taxpayer-funded rescue. The central bank is discussing how to limit the safety net and curtail balance-sheet expansion at the largest banks, while senators from both parties are discussing legislation that would tighten capital standards.

Increasing credibility requires transparency of information about individual firms and the broader banking system, and also regulatory actions, which will in turn “lead to greater credibility,” said Pianalto, who does not vote this year on the policy-setting Federal Open Market Committee. She didn’t discuss monetary policy or the economic outlook.

Pianalto also said stress tests would improve transparency if they were broadened to show the potential impact of troubled banks on their biggest counterparties.

“This would be especially useful if many banks each rely on the same small set of counterparties for certain kinds of transactions,” she said at a joint conference on financial stability sponsored by the Fed Board’s Office of Financial Research and the Cleveland reserve bank.

Risk Disclosure

The public should have access to more information about bank assets, specifically having regulators require lenders to disclose how much risk they may face and where their loans are made by region, Pianalto said. Regulators could also require firms to disclose the distribution of credit scores in consumer loan portfolios, she said.

Investors and regulators may view a bank with “90 percent of its construction loans concentrated in either depressed or overheated real estate markets differently from the risk profile of an institution with its construction loans distributed across the country,” the Cleveland Fed chief said.

Before it's here, it's on the Bloomberg Terminal.