FDIC Vice Chair Discusses Principles of Effective Supervision (with Lofchie Comment)

Vice Chair of the Federal Deposit Insurance Corporation ("FDIC") Thomas M. Hoenig spoke at the Institute of International Bankers' Annual Washington Conference about the principles of effective financial supervision.

Mr. Hoenig explained that the best ways to judge a firm's risk profile are through a strong supervisory program and an equally strong examination process, which include assessing a firm's "liquidity, operations, balance-sheet strength, asset quality, and management." He noted that although large insured banks are considered too complex for full-scope examinations, sampling methodologies for auditing a firm's assets still can provide reliable and affordable estimates. He cited the Shared National Credit and the Comprehensive Capital Analysis and Review as two examples of programs that can provide meaningful insights and perspectives on a firm's risk profile.

Mr. Hoenig went on to say that the Volcker Rule should be implemented, since it addresses certain shortcomings and conflicts of interests in the banking industry. He stressed that subsidizing certain derivatives activities conducted at large insured banks with "unbridled leverage" should end. At a minimum, Mr. Hoenig said, derivatives contracts should be reported on a bank's balance sheet at "fair value and capital held against this risk."

Mr. Hoenig also discussed capital adequacy, noting that while many large banking firms claim to be well capitalized, "evidence shows otherwise." According to Mr. Hoenig, the largest firms are the least well capitalized of any group of banks. He advocated the tangible leverage ratio, rather than a risk-weighted capital measure, as the best measure of capital. He explained that the risk-weighted capital measure can provide an impression of "greater owner funding, greater loss absorbing capacity, and less public exposure to loss than actually exists."

Lofchie Comment: While the FDIC is properly concerned with risk, a question may be raised as to whether it is concerned appropriately with economic growth and the opportunity for growth. Everyone can reduce their chances of being hit by a car by staying in bed. (That solution may have its own risks.) But it is not difficult to make the argument that extending credit in the form of home mortgages is a lot riskier than almost any type of derivative. The philosophical question remains: to what extent should final decisions about bank capital be left in the hands of the entity that ensures bank capital?

See: Mr. Hoenig's Remarks.