The Federal Reserve has important responsibilities for maintaining financial stability. That involves ensuring ex ante, that banks, for example, are managing their portfolios safely, that the clearing and settlement systems are well-designed and secure, that there are good arrangements in place for dealing with some kind of financial crisis, no matter what its source might be, and that, ex post, should there be a problem, that there be plenty of liquidity provided to the banking system and that the Fed would make sure that whatever problems arise be brought to some venue where they can be unwound and discussed and assistance be given.

This change in market perception of future risk has occurred in the context, however, of a substantial increase in leverage in the balance sheets of the United States, the federal government and the U.S. household sector. These developments are a potential source of greater macroeconomic uncertainty.

Despite the dramatic changes in the markets for financial services products and in their regulatory framework, the banking system continues to operate well--indeed, it is thriving...Robust growth in loans and deposits has contributed to banks' strong profits, as has strong fee income, including mortgage origination and servicing revenues.

It appears our nation’s pattern of payments is finally evolving — some might say it is experiencing a radical change — from one based on paper checks to one based on electronics.

Changes in the payments structure have had, and will continue to have, profound effects on our physical infrastructure. It is expected that the Fed’s paper processing role will diminish as checks recede in both absolute volume and relative importance in the retail payments system. In the interim, however, the changes taking place in payments patterns are causing us to adapt and adjust to the market’s evolution.

I will highlight the Board’s three highest priority proposals. These three proposals would allow the Federal Reserve to pay interest on balances held by depository institutions at Reserve Banks, provide the Board greater flexibility in setting reserve requirements, and permit depository institutions to pay interest on demand deposits. These amendments would improve efficiency in the financial sector, assist small banks and small businesses, and enhance the Federal Reserve’s toolkit for efficiently conducting monetary policy.

We need to keep in mind that most measures designed to protect consumers from bad credit market outcomes also raise lending costs and can prevent them from obtaining credit in the first place...Having said that, policymakers should be alert for opportunities to reduce adverse outcomes without harming credit availability – in other words, to improve the terms of the trade-off between credit availability and borrower protection.

While some policies that carefully target truly abusive practices are warranted, the broader risk is of a regulatory overreaction that stifles much of the benefit of the technology-driven expansion in consumer credit.

Dramatic improvements in credit availability are accompanied by predictable increases in the incidence of delinquencies and abuse, as new products proliferate and new borrowers are drawn into the market. The spread of adverse outcomes inevitably triggers calls for new regulatory constraints on lenders. But while truly abusive practices certainly deserve regulatory attention, policy measures that impede the functioning of credit markets need to be approached cautiously to avoid an overreaction that stymies much of the benefit of the innovations in retail credit practices.

Broad efforts to improve financial literacy may not add to a lender's near-term bottom line, but financial institutions, both individually and as a whole, depend critically on their customers' trust. And trust is built on understanding.

[Federal banking agencies] have observed some easing of underwriting standards...Lenders are sometimes offering interest-only loans and are sometimes requiring very small down payments and limited documentation of a borrower's assets and income. They are also relying more on automated-valuation models and entering into more transactions with loan brokers and other third parties. Given this easing of standards, there is concern that portions of banks' home equity loan portfolios may be vulnerable to a rise in interest rates and a decline in home values...There is concern that not all banks fully recognize the embedded risks in some of their portfolios.

During previous downturns in the credit cycle, banks with high commercial real estate concentrations suffered significant losses.

Federal Reserve staff is currently considering supervisory guidance on sound risk-management practices for commercial real estate exposures, with the goal of issuing the guidance on an interagency basis.

We have recently seen signs that [underwriting] standards may be under some downward pressure as a result of strong competition and tight spreads.

I want to assure you that the approach taken by the Fed and the other federal banking agencies is not one of zero tolerance and that supervisors do not issue enforcement actions against banking organizations because they have failed to file a single suspicious activity report. On the contrary, we continue to expect examiners to use their best judgment and to look for systematic weaknesses in programs, policies, procedures, and internal controls.