2.1: Financial Stability, Risk, and Problem Identification

Promote overall financial stability, manage and contain systemic risk, and identify emerging financial problems early so that crises can be averted.

Other Information:

This objective will be pursued in part through the following actions: • Continue to develop a regulatory framework that promotes a comprehensive and systematic approach to risk taking in banking. • Conduct and encourage effective contingency planning by financial institutions to respond to crises and shocks that could occur in the banking industry. • Maximize the cooperation, coordination, and flow of information with domestic and foreign supervisory authorities and among different functions within the Federal Reserve (macroeconomic, bank supervision, payment systems, and discount window functions) to address systemic risk posed by supervised organizations. Discussion: Within its regulatory framework, the Federal Reserve must heighten the positive effect of market discipline on the stability and soundness of the banking system and financial markets by promoting sound domestic and international risk-management, accounting, disclosure, and auditing standards and overall market transparency. The supervision function has taken a leadership role in the proposed revision of the Basel Capital Accord. Basel II aims to improve risk management in banking, extending and building upon the efforts that most large banks have already begun and the market increasingly demands. Sound risk management requires that banking organizations measure risk accurately; communicate those measurements to management, to supervisors, and to the public; and relate risk both to capital requirements and to other supervisory standards. As the consolidated supervisor, the Federal Reserve works closely with other bank supervisors and the functional regulators of supervised bank and nonbank subsidiaries. The supervision function’s direct, hands-on involvement in examinations and enforcement has provided the Federal Reserve with important knowledge, expertise, relationships, and authority that complement other core central bank responsibilities. At the same time, other Federal Reserve functions work in support of the mission of the supervision function. Maximizing the benefits of these important synergies will be crucial as the financial landscape evolves and becomes more challenging to manage and evaluate. Moreover, events such as the terrorist attacks on September 11, 2001, have heightened the need for accurate information about the status of key industry participants during times of crisis. Supervision staff coordinate with other bank supervisors and financial regulators on homeland security issues that pertain to the financial sector. Further, given the increasingly global nature of financial services and the heightened complexity of business, greater coordination with overseas supervisors is required. The most sophisticated international operations take place in numerous locations, resulting in the need for multilateral coordination in relation to many large international organizations.

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