Bernanke defends Fed's small bank supervision role

WASHINGTON (Reuters) - Federal Reserve Chairman Ben Bernanke on Wednesday fought back against a plan to strip the Fed of its oversight of smaller banks, saying the knowledge it gains from that role is vital to monetary policy.

Bernanke, in testimony prepared for delivery to the House of Representatives Financial Services Committee, argued against a piece of a Senate regulatory overhaul bill that would shift supervision of thousands of banks to other regulators.

"The insights provided by our role in supervising a range of banks, including community banks, significantly increase our effectiveness in making monetary policy and fostering financial stability," he said.

The Fed's job is to keep inflation low and ensure maximum sustainable employment. It also regulates bank holding companies and some state-chartered banks. Lawmakers have heaped criticism on the institution for oversight lapses that contributed to the worst financial crisis in generations.

Senate Banking Committee Chairman Christopher Dodd, who has called the Fed's regulatory performance in the run up to the crisis an "abysmal failure," proposed in November stripping the central bank of its bank oversight powers.

However, revised legislation he unveiled on Monday would allow the Fed to oversee banks and important financial firms with assets greater than $50 billion.

Still, the measure would pull the Fed out of supervision of more than 5,000 smaller bank holding companies and state-chartered banks, handing those responsibilities to the Federal Deposit Insurance Corp and the Office of the Comptroller of the Currency.

Among Dodd's objectives was streamlining bank supervision in the United States. The ability of banks to shop among at least four major regulators for the most lenient treatment is also seen as setting the stage for the financial crisis.

Bernanke argued that small banks provide the Fed with an important window into financial conditions throughout the nation's economy.

"The Federal Reserve's ability to identify and address diverse and hard-to-predict threats to financial stability depends critically on the information, expertise, and powers that it has as both a bank supervisor and a central bank," he said.

Former Fed Chairman Paul Volcker, who will appear along with Bernanke at Wednesday's hearing at 2 p.m. (1800 GMT), will also take up the Fed's case to oversee smaller banks. Volcker is now an economic advisor to the Obama White House.

"The Fed's regional roots would be weaker and a useful source of information lost," he said.

Public resentment at the government's bailout of large financial institutions and anger over a deep recession have helped make regulatory reform a top priority for the Obama administration and lawmakers in a mid-term election year.

Passage of financial reform legislation is uncertain in the Senate, where many Republicans remain opposed to the measure Dodd has unveiled.

However, the House has passed a bill that would leave the Fed in charge of supervising smaller banks.

"The legislation passed by the House last December would preserve the supervisory authority that the Federal Reserve needs to carry out its central banking functions effectively," Bernanke said.

However, the House measure contains a provision which the Fed objects strongly to that would allow Congress to review the Fed's monetary policy decisions -- a provision that Dodd's proposed bill does not have.

(Reporting by Mark Felsenthal; Editing by Chizu Nomiyama )

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