Are the Largest Banks Too Complex for Their Own Good? Audience Q&A, Part II

September 30, 2012

A panel of experts continues to answer questions from the audience.

Presentation (.pdf)


Julie Stackhouse: All right, let's see here. Let's go back, white shirt back there.

Q: My question is about the too big to fail. As a regulator, is it easier for your job to regulate seven megabanks or hundreds or thousands of $30 billion banks?

William Emmons: Steve, that's yours.

Julie Stackhouse: I think you have the megabanks, I have the little banks.

Steven Manzari: Okay. So I think the megabanks are more complicated, obviously. And I'll give you a couple of reasons why I think that. And then I think the whole point of Bill's talk was that there is right now an active debate about the question of what's sort of the social good of a large bank. A few things in my mind that make it more difficult to regulate. First, the range of different regulators that are involved in the supervision of the institution. So a firm, every jurisdiction has some sort of prudential supervisory agency. So a firm that does business in the United States does business in the U.K., Europe, Asia, there's going to be a range of different entities in the supervision of that firm. That puts a big premium on collaboration and communication with those different agencies. Second, there's not a uniform set of rules across all those entities.

So one thing that has happened in the United States is that a nationally chartered bank faces a uniform set of rules in the United States, and you don't have state-to-state differences. You still have that on a global scale because there is no unified regulatory framework for all firms. The BIS in terms of the capital regime, Bill mentioned Basel III, there is obviously a large effort to harmonize capital standards, liquidity standards, but still you get very different rules in different regimes. So things like that make supervising a large institution difficult. And then obviously to the extent that these large institutions are complex, and it's hard to say they're not since that's actually the very title of the function I run—complex, financial institutions function—their complexity alone creates relationships inside the firm that sometimes only are apparent after a problem manifests itself.

Julie Stackhouse: So, Steve, just to give our audience a sense of scale, how many employees do you have sitting in an organization like JPMorgan Chase?

Steve Manzari: All right, so let me take a step back for that for a second. I think I could actually answer this a couple ways. In the Second District of the Federal Reserve System, if I ask my team these questions, how many people in total work for the institutions that we supervise? So, you know, 200,000, 300,000, 400,000, you just add them up, and it's got to be close to a million and a half employees. The supervisory function in New York that supervises the institutions has about 750 people in total, and that resolves down to a number of professionals aligned in the supervision of these firms, probably about 450. So anyone who wants to know what an unfair fight looks like, that's an unfair fight. And I didn't include the range of investment bankers, lawyers and external accounting firms that help these folks out.

Now, you may ask yourself why does this work, why can it work? Well, first it was frankly policy development. If we promote sound standards and practices at these firms, then what happens is these firms take them into their internal control platforms—their internal audit, their compliance, their risk management platforms—and they implement those. So that's a little bit of how we do this. A typical firm like JPMorgan Chase or Citigroup, the team of folks that I have at one of those institutions would be anywhere from 30 to 40 people.

Julie Stackhouse: So I'll just really quickly hit the small bank side. The small bank regulatory regime has been in place for a long, long time. And we also have a really well-honed mechanism for these banks to fail. Since the financial crisis, over 400 small banking organizations have failed. So in that way, while the supervisory process is easier, they're less complex, there's also a very clear resolution mechanism. For those of you that remember, our last failure two or three weeks ago was Truman Bank, and it hit the papers for exactly one day. And I think it's pretty much forgotten about because that's how well it worked. The depositors became customers of Simmons Bank the next day and life went on. We're not there yet with the large institutions. But presumably Dodd Frank sets up a mechanism to help move us there if it works. Okay, more questions. Let's see here. I've got one. I see him point there. Okay, yeah, in back.

Q: Thank you. A couple years ago I read a book called, "The Creature from Jekyll Island." Is the board familiar with this book?

William Emmons: That's about the founding of the Federal Reserve?

Q: Yes.

William Emmons: Apparently, yeah.

Q: I'm going to simplify this. But it's my understanding that the Federal Reserve is not a government agency, it's not part of the government. It was set up by the banks in 1910 to take care of themselves profit wise. Now the Federal Reserve looks over the banks and the banks that set up the Federal Reserve. Am I wrong in assuming that the fox is watching the hen house?

Mary Karr: Well, I work for the Fed, but my answer is yes, you are wrong. The Federal Reserve is a complicated entity, and it is a creature of compromise, sort of like our federal government is. And the federal in Federal Reserve is really like we talk about the United States as being a federal government in which there is a federal entity in Washington and states. In the Fed, the equivalent of that is the Board of Governors which is an independent agency which is headquartered in Washington, DC, and is an agency like the Securities and Exchange Commission and other independent agencies. And then there are 12 Reserve Banks around the country who were set up in 1913. And, yes, the banks did play a key role. One of the reasons the banks played a key role in the creation of the Fed is that there was a banking panic, and you're probably better equipped to speak on that than I am.

William Emmons: 1907.

Mary Karr: In 1907 that really expressed a need for a way to provide liquidity in crises. And it wasn't just the banks who were being hurt. It was the banks' customers. So I think what happened is a grand compromise, a grand bargain. There was tremendous suspicion. And it's interesting to me as a student of history how much of this is still true. There was tremendous suspicion of Wall Street, of government in Washington, and the Main Street part of the world. And so the compromise in 1913 was, let's create a central banking structure for this country that has an independent agency in Washington, has a big bank on Wall Street, has the New York Fed, but has 11 other banks around the country. And those banks do have input from bankers, but we are not controlled by bankers. Our governance here—I'm secretary to the board of directors—we have nine directors who serve on our board, three of them are chosen by the Board of Governors in Washington—that's the independent agency part—based on recommendations, six of them are elected by bankers, but of those six, three of them may not be bankers, may not be employed by a bank, may not be a director of a bank. So they are local community people who are elected. All of them look at themselves as serving an important function which is governance of this bank, which is a corporation, and providing economic input about the banking and business conditions and consumer conditions in the district. So, you know, I look at it and I think it was a grand compromise. And when I look at what's happening now with suspicion of Wall Street, suspicion of Washington, concern on Main Street, that all still is there. So in a lot of ways I think it kind of works in our political system.

Julie Stackhouse: So just curious. Just a quick hand poll. Please be honest. Don't raise your hand because I asked you to. But we certainly could do a session on, What is the Federal Reserve? It's an odd creature. If we did a session like this on the Federal Reserve, how many would be interested? Okay. Marcela, wherever you are? I think you'll find it fascinating, and it's a question we get often. And just to let you know, I'm sure Steve would say the same thing, I don't have any reporting responsibility to the bankers on our board of directors. And, in fact, I'd say there's more than a few bankers who would say they would like the regulators to be a little bit kinder. Any bankers out here that want to...? Oh, no bankers? Oh, one, okay. Would you like your regulator to be kinder and gentler? You're not sure how to answer that. That's okay, I won't do it.

Q: I'm not allowed to answer it.

Julie Stackhouse: Yeah, you're not allowed to answer it.

Q: one of the better regulators that we have. It would be a lot nicer if the FDIC and the Office of the Comptroller of the Currency dealt with banks the way the Fed does.

Julie Stackhouse: Well, gosh, and I didn't even put that out there. So thank you, I appreciate that.

Mary Karr: But just to clarify. You don't mean by that that we're lax...

Q: No.

Mary Karr: mean by that that we're clear in what our expectations are?

Q: ...reasonable and professional as opposed to being more driven by politics and the press. The OCC and the FDIC are highly political animals.

Julie Stackhouse: So we'll pick up on that. That's a great point. One of the things that's clear, if a regulator wants to be over zealous, we can really cut down credit in the economy because you just have to go in there and be very hard-nosed. So we walk this line of wanting to ensure good provisioning of credit to the economy but realizing that we have a responsibility to you, the taxpayer. So hopefully we walk that line well. I know you wanted to ask a question. I'm going to take that as the last question and invite everyone else that still had questions to come up and visit with our panelists after we close the session officially.

Q: This is actually going to be short and easy. On governance, one of the factors in running a company that controls what they do is its major investors, the institutional and the major stockholders. Do you see a role—and I've been reading more and more in the papers about how these guys are starting to wake up and become more active—do you see any role here in effecting especially the size, disposition and perhaps the dissolution of these large financial institutions?

William Emmons: Well, the two points that I tried to make were that the small shareholder—institutional or retail—absolutely is exerting discipline through selling their stock if they're not satisfied. But there are restrictions for large shareholders. So if you obtain control of a bank, you must become a bank holding company. And maybe I didn't make that clear. So I'm saying that the...

Q: A pension fund can't put somebody on a board of directors of...

William Emmons: A pension fund cannot have a large share in a bank or they will become a bank holding company.

Q: But couldn't they have enough stock and influence to put a director on there that would be more inclined to go along with their desire to have to do governance?

William Emmons: Yes, they could, right. And private equity, for example, has been able to put a small number of directors, but I don't think it's enough...

Q: So nothing big happening in there? That's what I was really asking.

Mary Karr: It's hard. It's hard because of the regulatory structure. We have this thing called the Bank Holding Company Act and we have this concept of control. And control can start with as little as a 5 to 10 percent ownership, we start getting in determinations of who's in control. So unlike, I don't know—And if you act with a group of investors, then we'll look at all of you as being a controlled group. So on the one hand we want to know who's running the banks and we want to make sure that they're regulated as bank holding companies. That puts more of an onus I think on supervision than on investment discipline. I'm sorry, I don't mean to be pointing at you.

Julie Stackhouse: Economist points to the regulator.

Steven Manzari: My view is it's my belief that actually controlling interest in most large, publicly traded firms is very rare, that, in fact, with relatively small accumulation of holdings in an institution you become an influential shareholder, a voice that the board wants to listen to. With respect to where the financial system is going, I think one thing that's absolutely—is this the last question?

Julie Stackhouse: This is the last—well, unless they come afterwards and ask you a question.

Steven Manzari: My view would be, I think it's really important to realize this is early days in terms of the reform efforts for the financial system that, you know, many firms still have to navigate a pretty complex set of changes to the regulatory landscape to how the world is unfolding, how they're going to generate profits. So it's not clear to me that we should even expect at this point in time firms to say, here's my roadmap going forward, or we should believe that the type of governance influence that shareholders can have on firms has yet to play out. I think this is all to come.

Julie Stackhouse: So that's a great way to end. And I will just maybe remark a few things. The Dodd Frank Act which we've referenced here tonight is incredibly complex. You might have heard there are about 400 regulations, rules that are required as a result of the act with about 2/3 of those just issued for what we call public comment, but only about 1/3 of those are actually in place at this point. So the financial community, large banks in particular, those over 50 billion in assets, have a lot ahead of them. They have to understand what the regulators are going to require precisely in terms of the capital framework that's under proposal right now. They are being stress tested, if they're very large, twice a year where we look at what could happen and how they would fair if their capital was hit by an adverse event. Smaller firms 10 billion and over will be stress tested once a year. They have these enhanced prudential standards that Bill mentioned that get into looking at things such as limitations on inner-corporate transactions, require resolution and recovery plans or living wills, to essentially say, if we had to break you up, how would we break you up, and much, much more. And then on top of that, the large firms are going to have to pay a fee for the quality supervision that they get, these very large $50 billion and over firms; although, that rule is not yet written.

So it is too early, I think, to tell how all this will fair out. What we've probably concluded tonight though, is, yes, these are very complex firms. They're very difficult to manage. And even though we have big mistakes in small banks, there's a way to deal with it. The bank fails. In large banks, the Dodd Frank Act is right now the mechanism on the table to deal with these very large firms. The jury is still out on how that rulemaking will take place and how effective it will be. But certainly we have that opportunity in the years ahead to come back and update you on this issue and see how well it's evolving. And hopefully just even the information you received tonight has been helpful in forming some of your opinions. So thank you to our panelists. And if you do have a question, feel free to stop down afterwards. Thank you all for coming tonight.

William Emmons: Thanks so much for coming in, Steve.

This popular lecture series addresses key issues and provides the opportunity to ask questions of Fed experts. Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System.

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