Tarullo: Important to Identify Gaps in Regulatory System Post-Crisis--2nd Update
21 October 2016 - 5:02PM
Dow Jones News
By Katy Burne
Federal Reserve governor Daniel Tarullo used a speech in New
York on Friday to call on academics to appraise post-financial
crisis regulations and consider areas for improvement and
alternatives, in particular addressing short-term funding
dependencies and asset correlations.
He said there were numerous shortcomings in the way rules
targeted primarily the banking system before the 2008 meltdown.
Such areas should be "central to the further development and
refinement of a regulatory system that takes account of the
financial system as a whole," said Mr. Tarullo in remarks prepared
for an event on financial regulation at Columbia University's Law
School.
They "should be fertile ground for legal and economic
scholarship." For example, he said from a purely microprudential
perspective, the Basel II changes to capital requirements for large
banks were "ill-conceived."
Mr. Tarullo called special attention to two things that concern
him: the vulnerability of firms to runs in short-term wholesale
funding, on which banks heavily rely, and the potential for rapid
redemptions from investment funds. These can lead to firms being
forced to hastily mark down the value of their assets and dump them
in what became known in the crisis as asset "fire" sales.
"My own sense is that the greatest risks to financial stability
lie in activities with vulnerability to funding runs and asset fire
sales," he said. Short-term wholesale funding sources "may dry up
quickly under stressed conditions," he said, and efforts to fight
them will be all the more difficult where there is substantial
leverage.
Another important area for scholars to research are channels of
non-bank capital that have arisen since the financial crisis. The
hallmarks of the Fed's postcrisis response are tailored stress
testing, resolution planning, redesigned capital requirements on
banks and the addition of liquidity rules, but the "sometimes
nonexistent" rule set for intermediaries operating outside the
traditional banking system, now called shadow banks, was
worrisome.
"While the extent of shadow banking has significantly diminished
since the crisis, there is good reason to believe that it will grow
in the future," said Mr. Tarullo. "Indeed, the very rigor of new
regulations applicable to firms within the prudential perimeter may
well incentivize more innovation outside that perimeter."
He said some of those firms may shake up traditional banking
activities such as payments and suggested that some of their
efforts may have far reaching effects, including the potential for
a '"shadow payments system" at the retail level.
Defining shadow banking is challenging, and he said efforts to
date risk substantial over-inclusion, or under-inclusion. The 2008
crisis was not a bank solvency crisis, but a financial crisis on
account of the spectacular crises at American International Group
and Lehman Brothers Holdings Inc., both non-traditional banks, he
said.
"The whole concept of runnable liabilities -- whether uninsured
deposits, repo, commercial paper or other forms -- was left largely
untouched, even for commercial banks, much less for broker-dealers
like Lehman Brothers or insurance holding companies like AIG," said
Mr. Tarullo.
As regulators primarily target firms considered to have large
enough footprints that they could destabilize the banking system,
Mr. Tarullo said there was a "good argument for a less-demanding
regime for smaller institutions whose contribution to systemic
contagion would almost surely be somewhere between modest and
inconsequential."
In September, the Fed proposed easing "stress-test" requirements
for banks with less than $250 billion in assets, providing
potential relief for U.S. regional banks.
In a question-and-answer session following the speech, Mr.
Tarullo said bank capital levels were being rethought because they
are a "lagging indicator" of a firm's financial health; that's why
firms also need other identifiable instruments that "won't have
been eroded in the run-up to a stressed period." He said the data
show that "what looks like a nice capital position" at a bank can
often "accelerate dramatically" before it fails.
Mr. Tarullo's call on teachers and scholars to do more work in
these policy areas is fitting: Before joining the Fed's board of
governors in 2009, he was a law professor at Georgetown University.
He said if he were to teach on financial regulation again, the
course he taught in the fall 2008 semester would have to "differ
markedly." An emphasis in studying the liability side of the
balance sheet, he said, was crucial.
Earlier this year, The Wall Street Journal called Mr. Tarullo
the most "powerful man in banking."
Write to Katy Burne at katy.burne@wsj.com
(END) Dow Jones Newswires
October 21, 2016 11:47 ET (15:47 GMT)
Copyright (c) 2016 Dow Jones & Company, Inc.