ISTANBUL (Reuters) - The head of the U.S. Federal Deposit Insurance Corp. said on Sunday that she wanted to end the “too big to fail” doctrine and shrink the shadow banking system that operates outside the reach of regulators.

Federal Deposit Insurance Corporation Chairwoman Sheila Bair speaks during her testimony at the Senate Banking Committee on Capitol Hill in Washington in this July 23, 2009 file photo. REUTERS/Larry Downing/Files

FDIC Chairman Sheila Bair, speaking to the Institute of International Finance meeting here, said a U.S. proposal to create the authority to shut down failing systemically important financial firms may need to be extended to insurers and hedge funds.

“We need to end ‘too big to fail’ and this needs to be an overarching policy that applies to everyone,” Bair said.

Bair said she believed that bank holding companies with subsidiaries that are shut down by regulators also should be made to pay the price of failure by being subject to the same wind-down process.

“I believe that the new regime should apply to all bank holding companies that are more than just shells and their affiliates regardless or not whether they are considered to be systemic risks,” she said, adding that including only systemically important firms in the shut-down regime could reinforce the ‘too big to fail’ doctrine.

Financial firms subject to systemic risk shutdown authority should likely also be required to publish “living wills” -- details on how an orderly wind-down would play out -- on their websites to provide more clarity to shareholders and customers.

And by applying the resolution authority more broadly outside of normal regulated bank holding companies, it would help shrink the shadow banking system by discouraging regulatory arbitrage under which financial firms shop for the most lenient supervisors.

“If you tighten regulation of the banks even more without dealing with the shadow sector you could make the problem even worse,” she said.

Bair added that reducing the shadow banking system and regulatory arbitrage is her top priority for the U.S. Congress as it works on legislation to revamp U.S. financial oversight this fall.

She said there were some problems in extending resolution authority beyond banks to insurers and hedge funds, which she called a “sea change” in their oversight. But these could be overcome and it was appropriate to consider including them in the systemic risk resolution authority regulation.

“If the entity is systemic, that means if the entity gets in trouble it could create problems for the rest of us,” she said.

Bair added that the FDIC is talking with the American Securitization Forum, a financial trade group, and others regarding the agency securitizing some of the assets that it has taken over from failed banks in order to help jumpstart U.S. securitization markets.

(Additional reporting by Steven Slater in Istanbul, Editing by Ruth Pitchford)