Federal Reserve Chairman Ben Bernanke waged a fresh battle against Senate efforts to strip the Fed from banking supervision.
Bernanke, in a paper to Congress released Thursday, argued that stripping the Fed of such power would deprive the central bank of information that factors into the setting of interest rates to influence overall economic activity.
"Elimination of the Federal Reserve's role in supervision would severely undermine the Federal Reserve's ability to obtain in a timely way and to evaluate the information it needs to conduct its central banking functions effectively," according to the paper.
During the most recent financial crisis, information from banking supervisors helped Fed officials better understand the depths of credit problems, leading them to lower interest rates more quickly and aggressively than they otherwise would, the paper said.
Information on the health of banks will factor into Fed decisions about when to start boosting interest rates and reeling in other stimulus to prevent inflation from taking off, the paper noted.
Senate Banking Committee Chairman Christopher Dodd, D-Conn., wants to rein in the Fed's power and remove it from overseeing banks as part of a broader legislative revamp of the nation's financial structure. That conflicts with the Obama administration's stance as well as the approach taken by House lawmakers in their financial overhaul bill.
Dodd wants to curtail the Fed's banking powers because he blames the central bank for lax regulation and failing to spot problems_ mistakes that contributed to the worst financial crisis since the 1930s.
Although the Fed paper acknowledged "significant shortcomings" by regulators in the period leading up to the financial crisis, it pointed out that the central bank is now taking steps to tighten oversight.
Former Fed Chairman Paul Volcker backed Bernanke's efforts to keep banking regulation at the central bank.
"The central bank should maintain a robust presence with real authority," Volcker said in remarks to the Economic Club of New York.
Bernanke also argued that the Fed would lose insights into the health of not only individual banks but also of the entire banking system. That would heighten risks around the Fed's role as "lender of last resort."
The Fed lends money to banks when they can't get it in private markets, a key ingredient to keeping the financial system running during times of stress.
So far, the Fed hasn't lost any money from emergency low-cost loans made to banks via its "discount window." The Fed said that's because it has both the power and the tools to closely monitor borrowers and evaluate the collateral they put up to back the emergency loans. If the Fed lost its bank oversight duties, the central bank would be forced to depend on other banking regulators for such information.