As regulators and market participants alike underestimated the interconnectedness of the financial system contributing to the current recession, tougher risk management is now needed at those firms in the form of strengthened capital requirements in order to prevent a repeat of events, according to William Dudley, the president and CEO of the Federal Reserve Bank of New York. Dudley made the announcement while speaking to the Institute of International Bankers on the need to improve the capital standards for interconnected financial institutions. Dudley called for a complete risk capture to insure capital adequacy rules that cover a broader set of risk exposures than before the financial crisis. He also wanted to draw rules to encourage the conservation of capital in tough financial circumstances and tougher regulatory requirements that implement the use of a contingent capital instrument, automatically injecting equity capital in times of stress. “This interconnectedness implies that regulation and risk management practices that focus only on individual parts of the system will inevitably fail to address important vulnerabilities elsewhere,” Dudley said. The new policies, Dudley said, need to require vulnerable firms to cut dividends in order to conserve capital. Dudly said that the new capital framework needs to improve the risk capture not appropriately watched in recent years, and new rules need to be introduced, requiring higher capital for systemically important institutions. Dudley also called for the development of efficient forms of capital, particularly contingent capital debt instruments that would convert into equity if the bank’s share price fell steeply. “In thinking about the best way to introduce these practices into our system, we should not kid ourselves about how difficult this will be to execute,” Dudley said. Write to Jon Prior.