Staff Studies.

The staff members of the Board of Governors of the Federal Reserve System and of the Federal Reserve Banks undertake studies that cover a wide range of economic and financial subjects. From time to time the studies that are of general interest are published in the Staff Studies series and summarized in the Federal Reserve Bulletin. The analyses and conclusions set forth are those of the authors and do not necessarily indicate concurrence by the Board of Governors, by the Federal Reserve Banks, or by members of their staffs.

Single copies of the full text of each study are available without charge. The titles available are shown under "Staff Studies" in the list of Federal Reserve Board publications at the back of each Bulletin.

STUDY SUMMARY

IMPROVING PUBLIC DISCLOSURE IN BANKING

Federal Reserve System Study Group on Disclosure

The use of market discipline as a complement to bank supervision and regulation has gained greater acceptance in the United States and abroad. It is also widely recognized that effective market discipline depends on market participants' having information about the risks and financial condition of banking organizations. Therefore, attention is being focused increasingly on ways to improve transparency in banking.

Staff of the Federal Reserve System undertook a study to consider initiatives that promote better disclosure in banking. The purpose of the study is to present a set of initiatives that would reinforce the current process shaping disclosure while avoiding additional regulatory requirements. The study lays the foundation for the initiatives by considering how market discipline could supplement supervision in principle and by reviewing the empirical evidence on market oversight and discipline in banking. Key sections of the study discuss the factors shaping public disclosure in banking and identify the strengths and weaknesses of the process. The study includes appendixes that (1) provide a summary of the study group's interviews with market analysts, institutional investors, rating agencies, and banking organizations; (2) present quantitative information on potential sources of market oversight in banking; (3) examine empirical evidence on the contributions of supervisory information to bank transparency; (4) review international initiatives as well as private-sector initiatives on disclosure in the United States; and (5) assess current practices relating to disclosure of trading activities.

Regarding the potential for market discipline, the study suggests that greater reliance on private-sector oversight in banking can be consistent with the supervisory goals of limiting moral hazard and systemic risk. Moreover, the oversight can be effective; the evidence suggests that the market is able to assess the condition of banking organizations and that their relative riskiness tends to be reflected in the interest rates on their debt, though the sensitivity to risk may have been damped in more recent years. In the disclosure process, banking firms have a large measure of flexibility in how they meet various disclosure requirements of standard setters such as the Securities and Exchange Commission. Although this flexibility helps banking firms respond to change in making disclosures, the study identifies several areas for improvement. These areas include four related to credit risk--risk retained in securitization, risk-rating categories, contributions to loan-loss reserves, and credit concentrations--and others related to market risk and disclosures by lines of business.

The study discusses several initiatives intended to promote better disclosure in banking. Steps already have been taken to increase the value of regulatory reports by accelerating the release to the public of information collected for the reports. In addition, the Federal Reserve is reviewing the confidential treatment of certain information in its regulatory reports, with an eye to making some of the data public. The study discusses the creation of a private-sector task force that would develop guidelines for disclosure by large banking organizations for the purpose of increasing the scope of public disclosure while trying to avoid new regulations. The task force could also provide comments on ways in which bank supervisory initiatives could promote better disclosure. An example of how the supervisory process might be used for this purpose is outlined in the study's discussion of an initiative that would have Federal Reserve examiners review the public disclosures of large banking organizations as part of the evaluation of their management. Finally, to make better use of market-related information, the Federal Reserve is establishing a system for tracking market data on individual banking organizations and is assessing how to use those data as part of supervisory surveillance.