Bernanke: Banks must get better at foreseeing risk

Commercial banks and other financial institutions need to beef up their ability to detect and protect themselves against risks like the credit and mortgage debacles, Federal Reserve Chairman Ben Bernanke said Thursday.

The trio of crises - housing, credit and financial - have exposed weaknesses in financial firms' so-called risk-management practices. That is their ability to sufficiently detect and hedge against risks. Banks and other financial players have racked up multibillion-dollar losses when investments in complex mortgage-backed securities soured with the collapse of the housing market. Credit problems in housing quickly spread to other areas, intensifying the turmoil.

"Improvements in banks' risk management will provide a more-stable financial system by making firms more resilient to shocks," Bernanke said in a speech to a Federal Reserve banking conference in Chicago.

Banks need to improve upon efforts to identify and measure risk, value their assets and liabilities, and prepare for "liquidity" disruptions, when access to cash or the ability to smoothly buy and sell can be impaired, the Fed chief said.

Regulators also need to bolster their oversight, Bernanke said.

"It is clear that supervisors must redouble their efforts to help organizations improve their risk-management practices," Bernanke said. "We have focused on the institutions in most need of improvement, but we will continue to remind the stronger institutions of the need to remain vigilant, particularly in light of the ongoing fragility of market conditions," he added.

Bernanke also called upon banks and other financial institutions to step up efforts to raise capital.

"Importantly, capital raising and balance sheet repair allow for the extension of new credit, which supports economic expansion," he said. "I strongly urge financial institutions to remain proactive in their capital-raising efforts. Doing so not only helps the broader economy but positions firms to take advantage of new profit opportunities as conditions in the financial markets and the economy improve."

In his speech and fielding questions afterward, Bernanke did not give clues about the Fed's next move on interest rates or discuss the state of the U.S. economy.

To brace the wobbly economy, the Fed last month cut a key interest rate by one-quarter percentage point to 2 percent. At the same time, policymakers indicated that their rate-cutting campaign, which started in September, could be drawing to a close. They are hopeful that the Fed's powerful dose of rate cuts along with the government's $168 billion stimulus package of tax rebates for people and tax breaks for businesses will lift the country out of its slump later this year.

If the Fed does leave rates alone for a while, economists believe the central bank will focus more on its other efforts to help banks and big investment firms overcome credit stresses.

After a run on Bear Stearns pushed the nation's fifth-largest investment bank to the brink of bankruptcy in March, fears grew that others might be in jeopardy, given major stresses in credit and financial markets at that time.

Scrambling to avert a market meltdown, the Fed - in the broadest use of the central bank's lending authority since the 1930s - agreed in March to temporarily let investment firms obtain emergency financing from the Fed, a privilege previously granted only to commercial banks. That's one of the Fed's most significant actions.

The Fed also has moved to make cash loans to commercial banks and to make super-safe Treasury securities available to investment firms. All these efforts are aimed at bolstering confidence and getting firms to behave in a more normal fashion so they'll be more inclined to lend to each other, consumers and businesses.

Over the years, the explosion of financial players and products has raised questions in academic and other circles about banks' role in credit markets and the financial system. Bernanke said the recent episodes of financial turmoil show that banks still play a "central role" in the credit system.

"In that respect, the problems, the losses that have been experienced by financial institutions, which have impacted their credit positions, do have some consequences for the broader economy," Bernanke said.

"What we're seeing right now is that firms are hunkering down. They have taken a lot of losses. They've at least partially replaced those losses with new capital raising but not entirely," he added. "They're also being very protective of their liquidity ... and, therefore, they're being rather conservative in making new loans, which has implications for the broader economy."

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AP Business Writer Dave Carpenter contributed to this report from Chicago.