Second, it can also provide perverse incentives for financial firms to grow bigger, more complex and more interconnected simply to secure public support and finally take on more risks. To answer these concerns, the policy response has focused on the issue of ‘too- big- to- fail’ institutions. The Financial Stability Board (FSB) has proposed that global systemic financial institutions should be better capitalized and be submitted to higher capital surcharges, proportional to their contribution to systemic risk. It has also recommended a tighter supervision of these institutions, notably by setting up Crisis management groups in charge of monitoring that these institutions develop appropriate resolution and recovery plans. BIS central bankers’ speeches  1  It may be useful at this point to step back a little. The TBTF problem was not born with the crisis. The official recognition of a TBTF policy and the coinage of the term itself date back to 1984 during the testimony before Congress of the then US comptroller of the Currency on the government rescue of the bank Continental Illinois. Afterwards, a further 11 banks were identified as TBTF in an article in the Wall Street Journal. The fact that continental Illinois rescue led to a subsequent decrease in market discipline for these banks has been confirmed by several academic studies. The last crisis however gave rise to two important developments in the TBTF problem.
This topic might be less familiar to some—the terms are newer and the assessment frameworks are less developed—but I believe it is critically important. Both the official sector and many of your firms have put considerable emphasis on improving corporate cultures and reducing misconduct risk, but we continue to see striking cases of misconduct both in the U.S. and abroad. Clearly, more needs to be done. Many of the insights I will share today are drawn from interactions with industry participants and members of the official sector through outreach and industry conferences and workshops on the topic, including events hosted by the Federal Reserve Bank of New York. 2 I am confident that continued commitment and collaboration will contribute to better outcomes in this vital area. Before proceeding, I’ll emphasize that I am speaking for myself and not the Federal Reserve Bank of New York or the Federal Reserve System. Influencing Culture from Multiple Perspectives Prudent risk management is a fundamental aspect of the business of banking, which means it is a critical factor in the effective oversight of banks. Supervisors focus on financial resilience by requiring firms to maintain sufficient capital and liquidity and emphasize operational resilience by promoting effective corporate governance, risk management, and recovery planning.3 In my view, misconduct risk—defined as the potential for behaviors or business practices that are illegal, unethical, or contrary to a firm’s stated beliefs, values, policies, and procedures—is an integral part of an effective risk management framework.