The U.S. financial sector should rely on smaller, less complex financial firms, rather than a few large firms that can bring down the whole system, said Federal Deposit Insurance Corp. (FDIC) Chair Sheila Bair during testimony to a U.S. Senate committee on Wednesday.
Bair said the large firms considered "too big to fail" had a significant part in causing the current economic downturn. Because many financial organizations have grown in size and complexity, she pointed out that if one fails, it poses a risk to the entire financial system.
"A strong case can be made for creating incentives that reduce the size and complexity of financial institutions, as being bigger is not necessarily better," said Bair.
Bair said that systemically important firms should face capital charges based on their size and complexity, such as higher capital buffers and higher Prompt Corrective Action (PCA) limits.
Bair also said that a supervisory framework should be created for regulating systemic risk, and a comprehensive resolution authority.
"A realistic resolution regime would send a message that no institution is really too big to ultimately fail," Bair said.
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