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Questions Arise Concerning Bank Risk Oversight

In a May 17 letter to Ben Bernanke, Melanie Fein, a former senior counsel to the Board of Governors of the Federal Reserve System, questioned the ability of bank managers and regulators to supervise risks in large bank institutions in the wake of the losses recently experienced by J.P. Morgan.  She stated,

The bank in question was subject to prudential supervision by dozens of on-site bank examiners.  Neither they nor the bank's risk managers appear to have been aware of the activity that resulted in the $2.0 billion loss until it was too late.  The occurrence will be reflected in banking history as a seminal failure of supervision and risk management.

Ms. Fein raises concerns that increases in the availability of deposit insurance has resulted in a flight of money market funds as investors have sought out the safety of, in many cases, unlimited deposit insurance.  She states that these additional deposits particularly at large "systemically significant" financial institutions without a corresponding increase in loan demand have left banks with large portfolios to hedge.  According to Ms. Fein,

Had this money stayed in MMFs, MMFs would have invested all of it in corporate debt, municipal securities, and U.S. government securities for the benefit of the economy.  MMFs would not have engaged in risky trading or hedging activity.  Unlike banks, MMFs are subject to a regulatory framework that does not allow such activity.

Therefore, Ms. Fein questions the desire of the Federal Reserve Board members and bank presidents to impose changes on money market funds that would essentially do away with these products as doing so would only further concentrate assets in the banking system, increasing systemic risk.  She also acknowledges the SEC's expertise in the regulation of money market funds, saying:

It is particularly unclear what "more stringent" prudential standards the Board could impose on MMFs that are not already imposed under regulations of the Securities and Exchange Commission, which is the independent agency to which Congress has assigned supervisory and enforcement responsibility for MMFs.  The SEC has decades of regulatory experience with MMFs and dozens of staff who are expert in the operations of these useful entities, which have operated successfully for over 40 years with a safety record far superior to that of banks.

The full text of the letter is available at http://www.sec.gov/comments/4-619/4619-181.pdf.