William C Dudley: Regulatory reform of the global financial system Remarks by Mr William C Dudley, President and Chief Executive Officer of the Federal Reserve Bank of New York, at a meeting hosted by the Institute of Regulation & Risk, North Asia, Tokyo, 11 April 2011. *  *  *  I am pleased to be here today to speak about the issue of regulatory reform and the global financial system. But before I begin, I would like to express my deepest sympathies and those of my colleagues at the Federal Reserve to the people of Japan following the tragic events of the past month. We mourn your loss even as we admire the heroism of those who risked their lives to help others and the quiet fortitude with which so many of your citizens have borne their suffering and grief. We know that the character of the Japanese people will enable you to overcome the challenges before you, working together in common national purpose to rebuild and restore. On the subject of my talk today, a stable and resilient financial system that allocates credit in an efficient manner underpins and supports economic growth and rising standards of living around the world. As we saw recently, however, a financial system that is prone to booms and crashes can not only lead to an inefficient allocation of real resources during the booms but can also have devastating consequences for global economic activity and employment during the crashes.
First, a significant number of large, internationally active financial firms reached the brink of failure. Second, the financial system was not very resilient when these firms got into difficulty. Instead, the threat of failure propagated further shocks that reverberated throughout the global financial system. These two shortcomings reflect many factors including inadequate capital and liquidity buffers, poor incentives to correctly measure, price and manage risks ex ante, the opacity of firm balance sheet and counterparty exposures, and the manner in which large financial firms were interconnected within the financial system. In the end, there was too much leverage in which large amounts of highly illiquid, long-term assets were financed by short-term liabilities. The fact that a large amount of the wholesale funding used to finance these assets was provided by leveraged financial intermediaries to other financial intermediaries increased the  BIS central bankers’ speeches  1  system’s vulnerability to adverse shocks. As it turned out, the amount and quality of capital was grossly inadequate relative to the quality of the assets and off-balance-sheet exposures of many of the major global banking institutions. Moreover, many institutions had inadequate liquidity buffers. The lack of liquidity forced the fire sale of assets, which depressed prices and increased the pressure on capital. When troubled institutions did fail, this exacerbated the pressure on the remaining institutions. Aggravated by the lack of transparency about their counterparty exposures and the contingent liabilities they faced, the problems of a single institution quickly became the problems of many.