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FDIC Chair Sheila Bair: Divide Banks Into High-Risk, Low-Risk Sections

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With her time winding down as head of the Federal Deposit Insurance Corporation, Sheila Bair has suggested the U.S. follow a British proposal that could help solve the problem of "too big to fail" banks.

Last week, Britain's Independent Commission on Banking, chaired by John Vickers, a former chief economist at the Bank of England, proposed changing the structure of British banks so that the consumer side of banks can be saved if the rest fails, The Economist reported.

Bair wants the United States do much the same thing, making it easier to unwind systemically important banks during a crisis, the Financial Times reports. Under new rules passed by the Dodd-Frank financial reform act, government regulators, led by the FDIC, have the power to do just that: protect customers by dividing banks into autonomous divisions with their own capital.

Specifically, Bair, who is quickly approaching the end of her tenure as FDIC chairman, wants to section off the high-risk investment banking sector of major banks from banks other role as a retail lender. In an interview with the Financial Times, Bair said the new-found power of the FDIC could be used to implement these changes.

"I'd like to get some public comment on the idea that if [banks] have an investment banking affiliate," then that investment banking section should "standalone [in both] liquidity and capital," Bair told the FT.

The proposition would significantly affect banks that have closely tied their investment structures into overall operations, creating a complicated web that is difficult to unwind in the event of a crisis. Banks like Citigroup and Bank of America, both of which recently reported declining profits, as well as the currently-surging JPMorgan Chase, would be forced to overhaul their corporate structure.

In the coming months, banks will be asked to present "living wills" to government regulators, describing how the firms could be safely collapsed without putting the economy at risk. In a report to be released Monday, the FDIC will use Lehman Brothers as an example of how these new rules would have helped make bank failings more safe during the financial crisis.

Bair's recommendation to divide, not detach investment and retail banks stops short of the rules put in place by the 1933 Glass-Steagall Act, which completely barred depository banks, where customers kept savings, from operating within the investment banking sector.

Following the repeal of the Glass-Steagall Act in 1999, depository banks quickly increased their investment banking operations, a decision that critics allege directly contributed to the financial crisis by creating corporations that required large-scale bailouts.

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