Donald Kohn, vice chairman of the Federal Reserve, discussed the lending industry and downside risks to the economy in remarks this morning. Where he sees the most risk however, is not clear. According to CNBC:
Banks have become so wary about lending that credit costs are being pushed up despite sharp cuts in official interest rates and that is adding to the risks of an economic downturn, the vice chairman of the Federal Reserve said Thursday.
"It is this tightening that is accentuating the downside risks for the economy as a whole," he added.
Kohn however, also spoke of another downside risk- undercapitalization:
All banks — large and small — need to consider whether they need greater capital cushions," Kohn told a credit market symposium sponsored by the Richmond Federal Reserve Bank.
"Not only would more capital provide a cushion against the sorts of unexpected declines in creditworthiness and asset values that have marked recent months, it would also position banks well for expansion," he added.
Kohn said regulators will need to ensure that minimum capital requirements and liquidity management plans are adequate to prevent shocks to the banking system from turning into broader threats to the economy.
He said he had no "ready answers" but suggested that in the future banks will likely operate with much less leverage than they were before the current credit crisis hit, and that will help create a much more stable financial system.
Banks are tightening in large part to reduce leverage and increase capital. Clearly the tightening poses a risk, but so does a failure to maintain adequate capital- it is difficult to do both. So where is Kohn putting his priorities?
Apparently I’m not the only one wondering where the Fed sees the greatest downside risk. In a Google news search for "Kohn federal reserve" this morning, the wide variety of headlines indicate that the media has a number of different takes on this morning’s speech: [CNBC's headline was the noncommital, "Bank Jitters About Lending Hurt Economy: Fed's Kohn"]
