Second, it is difficult because the evaluation must extend to entities and activities that operate outside of the more tightly regulated core – including, of course, the so-called “shadow banking system.” In the U.S., some of this responsibility undoubtedly falls to the Financial Stability Oversight Council,  BIS central bankers’ speeches  7  which was created by the Dodd-Frank Act. But this is a relatively new institutional arrangement and how well it will be able to perform its mission in practice remains to be determined. Similarly, on an international basis, the Financial Stability Board has undertaken an initiative to evaluate risks within the shadow banking system, but this effort is also still in a fledging stage. Finally, turning to the last issue about how to deal with institutions that run into difficulty, there has been progress. In the United States, the Dodd-Frank Act (DFA) gave the FDIC the authority to resolve certain large systemically important financial firms, on the recommendation of the Federal Reserve and the FDIC, and after the Treasury Secretary makes certain determinations in consultation with the President. Among other things, DFA enables the FDIC to establish a bridge institution in which critical activities could be moved so that the failure of a major institution will not unduly disrupt the provision of key financial services. DFA also authorizes the Federal Reserve to require that such institutions develop recovery and resolution plans – plans that must be acceptable to the Federal Reserve and the FDIC.
The extraordinarily poor economic outcomes we see today underscore the importance of building a financial system that is resilient in its ability to provide credit to households and business throughout the business cycle. It also underscores the importance of limiting the types of financial and real imbalances that develop during times of prosperity. When such balances unwind, they can cause significant damage to the financial system and the economy. A range of reforms are in train as the Dodd-Frank Act and other initiatives are implemented in the United States and abroad. Within the Federal Reserve System, we are building a more robust framework for financial stability. And, through the Financial Stability Oversight Council (FSOC), interagency coordination in identifying and mitigating risks to financial stability is being strengthened. As we move to implement financial reform, we should not be dissuaded by those who argue that the costs of reform are too high or that the job is simply too difficult. I grant that not everyone is, or will be, happy with all the reform measures. Reasonable people can disagree about the best way to achieve certain public policy objectives or the appropriate speed of the transition. But I think that the fundamental point that the financial system needs to be changed in profound ways should be broadly accepted at this point.   Policymakers and market participants must acknowledge that the financial system is inherently unstable – that it is prone to booms and busts, and that these episodes can destabilize the real economy.