Chairman Reed, Ranking Member Allard and members of the Subcommittee, it is my pleasure to appear today to discuss several issues related to the oversight of financial institutions. First, I will discuss the circumstances leading to the establishment of our temporary facility for lending to primary securities dealers and our arrangements for monitoring their financial condition. Then, I will describe Federal Reserve activities related to the banking institutions we supervise, including concrete steps to address identified issues and to help these institutions improve risk management practices. Finally, I will briefly summarize planned enhancements to our consolidated supervision of bank and financial holding companies.

Federal Reserve Monitoring Activities Related to the Primary Dealer Credit Facility

Three months ago, the Board approved the establishment of the Primary Dealer Credit Facility (PDCF). This action was taken pursuant to Section 13(3) of the Federal Reserve Act, which empowers the Board of Governors to authorize a Federal Reserve Bank to lend to a corporation, including a securities firm, in "unusual and exigent" circumstances when the corporation cannot "secure adequate credit accommodations from other banking institutions." In doing so, the Board of Governors made the necessary statutory finding that market circumstances were indeed unusual and exigent. We judged that without increased access to Federal Reserve liquidity by major securities firms, overall financial market conditions would have deteriorated further and would have had a substantially adverse effect on the economy.

We fully recognized that the use of this legal authority was an extraordinary step, but considered it necessary given the circumstances. To quickly design and implement a facility to provide this liquidity, we made use of existing business relationships with a group of 20 securities firms, known as primary dealers. The Open Market Desk of the Federal Reserve Bank of New York trades U.S. government securities with primary dealers to implement monetary policy on behalf of the Federal Reserve System. The PDCF makes available overnight funding to sound primary dealers in the form of loans secured by collateral eligible to be pledged in open market operations, plus investment-grade corporate, municipal, and mortgage-backed and asset-backed securities. The PDCF was authorized for a minimum period of six months.

Most of the primary dealers are owned by either U.S. or foreign banking organizations that have been approved as U.S. financial holding companies. The U.S. financial holding companies owning primary dealers are subject to consolidated supervision by the Federal Reserve, but for the primary dealers within financial holding companies we rely extensively on the Securities and Exchange Commission (SEC) as functional regulator. The SEC, rather than the Federal Reserve, serves as consolidated supervisor for the major U.S. investment banks with primary dealers. In connection with the establishment of the PDCF, we created a program to monitor the financial and funding positions of primary dealers, focusing on those primary dealers not owned by financial holding companies. From the beginning, we have coordinated closely with the SEC, and we are currently working on an agreement with that agency to enhance information sharing both for primary dealers that are part of financial holding companies and for those that are not.

The objectives of our PDCF monitoring program are: (1) to establish the basis for an informed judgment by the Federal Reserve of the liquidity and capital positions of the primary dealers accessing the PDCF; and (2) to minimize the risk that the availability of financing under the PDCF undermines the incentives for the consolidated entity to manage capital and liquidity to levels appropriate for a sustained period of market disruption.

The Federal Reserve's monitoring program for primary dealers includes a limited on-site presence at the four largest investment banks and has a narrower focus than our broader supervision and examination of state member banks, bank holding companies, and the U.S. operations of foreign banking organizations. Specifically, the Federal Reserve is not supervising investment firms comprehensively to assess risk management. Rather, our purpose is specifically to assess the adequacy of liquidity and capital.