Fed 'remains watchful' on fixing banking system risk: Yellen

[WASHINGTON] Federal Reserve Chair Janet Yellen said policy makers still must be on guard against emerging risks to the financial system even after banks became more robust and less reliant on short-term borrowing to fund investments.

"We and other supervisory agencies have made significant progress in addressing incentive problems within the financial sector, especially within the banking sector," Yellen said in a speech prepared for delivery on Wednesday in Washington. Policy makers "remain watchful for areas in need of further action or in which the steps taken to date need to be adjusted."

Yellen didn't mention her outlook for the economy or monetary policy.

Steps are under way to address the "perception that any financial institution is too big to fail by ensuring that even very large banking organizations can be resolved without harming financial stability," Yellen said.

Regulators are weighing whether banks have sufficient total loss-absorbing capacity, including long-term debt, to enable them to be unwound without support from the government, Yellen said. The actions also include requiring banks prepare "living wills" for orderly resolution if they're insolvent.

Yellen spoke alongside International Monetary Fund Managing Director Christine Lagarde at the "Finance and Society" conference sponsored by the Institute for New Economic Thinking.

"A well-functioning financial sector promotes job creation, innovation, and inclusive economic growth," Yellen said. "But when the incentives facing financial firms are distorted, these firms may act in ways that can harm society. Appropriate regulation, coupled with vigilant supervision, is essential to address these issues."

Yellen spoke a week after Fed policy makers said they expect the economy to bounce back from a disappointing first quarter. The Federal Open Market Committee repeated it won't raise interest rates until it sees continued improvement in the labour market and its "reasonably confident" that inflation will return toward the central bank's 2 per cent target.

The US economy grew just 0.2 per cent in the three months through March, held back by severe weather, a strong dollar and weak corporate investment. The dollar and a drop in energy prices have also subdued inflation, which rose just 0.3 per cent in the year through March, according to the Fed's preferred measure of prices.

BLOOMBERG