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Federal Reserve Chairman Ben Bernanke said Friday that policy makers must now take action to implement programs that would limit the severity of future economic crises.
Speaking at the Federal Reserve Bank of Boston's annual economic conference, Bernanke said that the "financial turmoil" of the crisis is abating and has given financial regulators to make adjustments in their policies to improve the stability of the economy.
"All financial regulators, including of course the Federal Reserve, must take a hard look at the experience of the past two years, correct identified shortcomings, and improve future performance," he said.
Highlighting policy developments at the Federal Reserve, Bernanke said that the central bank was undertaking a series of joint efforts to ensure that systemically important firms hold more capital, improve risk management practices and liquidity management and implement responsible compensation structures.
The chairman also said that the Fed would be taking a wide approach to financial oversight that will help them to take better anticipate future financial problems.
Bernanke said that the central bank was highly supportive of international efforts to develop counter cyclical standards which would require firms to build large capital buffers in good economic times, which could be then drawn down in times of financial stress.
"For additional protection," he added, "systemically important institutions could be required to issue contingent capital, such as debt-like securities that convert to common equity in times of macroeconomic stress or when losses erode the institution's capital base."
Bernanke also touched on compensation regulation, pointing to the Fed's Thursday announcement that it would implement a new measure that would require compensation policies at 28 large banking firms - and those at smaller regional banks - to be subject to review.
"Compensation, not only at the top but throughout a banking organization, should appropriately link pay to performance and provide sound incentives. In particular, compensation plans that encourage, even inadvertently, excessive risk-taking can pose a threat to safety and soundness," he said.
The Fed chairman also stressed that financial oversight must be improved, and that the central bank has to evaluate Fed oversight to determine what can be improved.
Bernanke added that the studies affirmed the importance of effective consolidated supervision at large firms, and that a system-wide perspective must be combined with firm-specific risk analysis, which will help regulators better anticipate problems arising from firm interactions.
"To support these approaches, we are strengthening our supervisory processes to include analyses that draw on multiple disciplines, updated surveillance tools, and more timely information so that supervisors can identify emerging risks sooner and respond more effectively," he said.
Bernanke also stressed the importance that lawmakers take action in strengthening regulatory gaps and "provide supervisors with additional tools for anticipating and managing systemic risks."
"Congress should ensure that all systemically important financial institutions are subject to a robust regime for consolidated prudential supervision," he said. "Consolidated supervision of systemically important institutions, together with tougher capital, liquidity, and risk-management requirements for those firms, is needed not only to protect the firms' stability and the stability of the financial system as a whole, but also to reduce firms' incentive to grow very large in order to be perceived as too big to fail."
Among the actions Bernanke recommend Congress to take were creating new authorities to facilitate the resolution of failing firms and creating a systemic oversight council to identify threats to the stability of the financial system.
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