When banks take on too much risk, whole countries can suffer. The spate
of banking crises over the last decade, most recently in Asia, as well
as the increasing complexity and size of modern banks, have led observers
to search for new methods for managing bank risk taking. The answer, according
to some analysts, is to make additional use of market forces to encourage
more socially optimal levels of risk taking by banks. Advocates for greater
use of markets see benefit in the discipline that creditors could exert
directly on banks. They also argue that bank supervisors should take advantage
of the assessment of risk that market activity generates.
But not everyone agrees with this analysis. Some observers, including
a number of bank supervisors, have expressed skepticism that market
signals actually contain information on the risk taking of banks.
And even if some information exists, they question whether these
signals would enhance the ability of already informed bank supervisors
to do their jobs.
To help analyze these legitimate concerns, the Federal
Reserve Banks of Minneapolis and San Francisco held two conferences
for bank supervisory staff on the use of market data. The first
conference sponsored by the Federal Reserve Bank of San Francisco
in the summer of 2000 primarily examined the question of information
in market signals. Based on existing research, presenters at the
conference concluded that market data provide information on the
risk taking of banks.
This leaves the second, more specific, concern about the utility
of market data for supervisors. The Minneapolis and San Francisco
Federal Reserve banks sponsored a follow-up conference in May
2001 on the practical use of market data in the supervisory process,
which is described in the following three articles.
First, in his conference address,
Federal Reserve Chairman Alan Greenspan unequivocally called for
increased review of market data with the expectation that such
data would play a larger future role in the supervisory process.
He described the conference as:
... part of an ongoing and crucial conversation that, I
am confident, will move our banking and supervisory systems
toward increased reliance on market discipline and use of
market data in supervision. The alternative, I fear, would
be the expansion of invasive and burdensomeand less
effectivesupervision and regulation.
Federal Reserve Bank of Minneapolis President Gary Stern seconded
Greenspan's expectations, arguing that blanket rejections
of market signals were suspect because such signals represent
the collective views of millions of investors with money at risk,
can reduce the uncertainty of assessing bank risk taking and are
available for analysis at a relatively low cost.
The final article more directly responds to
concerns about the utility of market data in the supervisory process.
Supervisors face real challenges in using market data because, in part,
obtaining real-time, easy-to-interpret risk assessments from market data
is not always easy. That said, the authors, Ron Feldman and Mark Levonian,
argue that a number of practical uses of market data in the supervisory
process appear reasonable to pursue in the short term on cost/benefit
grounds (even if net benefits are not overwhelming). They conclude that
additional applied research and increased use of market data offer the
best way to determine its full potential.