For the public to trust the U.S. financial system, regulators and managers must meet responsibilities in five areas, a Central Bank leader said Friday.
But the public must play its part, too, and be financially literate, Dennis Lockhart, president of the Federal Reserve Bank in Atlanta, said during a meeting Friday in Atlanta.
"Inadequate individual financial capability, particularly in the dimension of financial literacy, was a root cause of the market turmoil and financial crisis of 2008," Lockhart said. "As individuals, we must see a financial system that is well governed and well managed. … We must see a system we can trust."
Statistics indicated one in four Americans doesn't trust the financial system, he said. To build and ensure trust, Lockhart said, regulators and managers must embrace responsibility in five areas: oversight; ensured liquidity; controlled leverage at the system and firm level through adequate capitalization; sound lending and business practices coupled with healthy incentives for managers; and transparent markets and institutions.
Regulatory oversight is key to avoid a crisis, he said.
"Collectively, the community of regulators must judiciously supervise individual institutions and vigilantly monitor the health of the overall system, to guard the public trust and, above all, avoid a systemic crisis," he said.
Regulators can't and shouldn't guarantee that individual firms won't collapse but good oversight can prevent some failures, he said.
"Firms will fail. That reality can't be regulated or legislated away," Lockhart said.
Liquidity must be ensured, he said. The Fed has performed this task "very effectively during the financial crisis" by being the lender of last resort.
Controlled leverage through adequate capitalization is necessary because it buffers against losses that can lead to failure, Lockhart said.
"Maintaining this buffer is especially important for the larger, systemically important institutions for which government intervention in a crisis might otherwise be the only response to a threat to the entire system," Lockhart said.
Sound lending and business practices with healthy incentives for managers are also important to help gain and keep public trust, he said.
Finally, transparent markets and institutions are essential, Lockhart said. Decisions shouldn't be based on "blind guesses or herd-following impulses" but on sufficient information.
"We learned over the last decade that the lack of financial literacy in our citizenry imperils the system, and failings of high-level supervisors and managers can result in considerable harm to the economy and the general public," Lockhart said.