Fed Governor Suggests Congress Weigh Laws to Limit Bank Size

A Federal Reserve Board governor on Wednesday suggested that Congress could take steps to limit the size of banks in order to ensure financial stability.

In a wide-ranging speech at the University of Pennsylvania Law School, Daniel K. Tarullo, one of the Fed's board of governors, said that limiting the size would help ensure that institutions aren't “too big to fail” and thus require future bailouts in order to protect the financial system. Although new rules like the Dodd-Frank Act have addressed risks in the banking industry, such rules have not set standards on how big is too big.

If Congress “chooses to do so, there would be merit in its adopting a simpler policy instrument, rather than relying on indirect, incomplete policy measures such as administrative calculation of potentially complex financial stability footprints,” Mr. Tarullo said, according to prepared remarks.

He suggested one appropriate measure could involve limiting “the non-d eposit liabilities of financial firms to a specified percentage of U.S. gross domestic product.”

It is unclear whether Congress will ever take up such a measure. In his speech, however, he did address some overhauls that are before various agencies, including the Securities and Exchange Commission.

Mr. Tarullo blamed the world of so-called shadow banking, or other activities outside of traditional bank business such as lending and deposits, for some of the potential problems among financial institutions. He also threw his weight behind efforts to regulate money-market funds â€" efforts that have been stymied at the Securities and Exchange Commission but which Treasury Secretary Timothy Geithner has recently backed.

“As many of us in the government have pointed out, money market funds remain a major part of the shadow banking system and a key potential systemic risk even in the post-crisis financial environment,” Mr. Tarullo said.

Mr. Tarullo des cribed the difficulty that the Federal Reserve faces when evaluating whether to approve large bank mergers. “There is no statutory basis for identifying a certain systemic footprint above which the risks to financial stability are not worth bearing compared to whatever possible benefits may be associated with the operation of the largest, most interconnected firms,” he said.