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Fed’s Yellen: Work remains in bank regulation, SIFIs, shadow banking

Janet Yellen

Janet Yellen

Federal Reserve Vice Chairman Janet Yellen said during a recent speech that much work remains in addressing the bank regulatory system and the problems posed by SIFIs, as well as limiting risks in shadow banking.

Yellen said the U.S. must support efforts by the Basel Committee on Banking Supervision to strengthen bank regulation. The committee will finalize the Basel III leverage ratio and net stable funding ratio, finish the review of trading book capital requirements, adopt a large-exposure plan and increase the comparability of capital requirements across countries.

“The stability of the global financial system depends critically on the capital adequacy of global banks, the capital adequacy of global banks depends critically on the Basel III reforms, and much of the good progress in the BaseI III reforms rests on the integrity and strength of the risk weights,” Yellen said before the International Monetary Conference in Shanghai.

Yellen said that while she does not support the idea of a return to Glass-Steagall-style separation of commercial and investment banking, she is “not convinced” the existing framework to address SIFIs is adequate to reduce risk.

“Fully offsetting any remaining too-big-to-fail subsidies and forcing full internalization of the social costs of a SIFI failure may require either a steeper capital surcharge curve or some other mechanism for requiring that additional capital be held by firms that potentially pose the greatest risks to financial stability,” Yellen said.

In order to achieve an orderly resolution of a global financial firm, Yellen said each major jurisdiction should adopt a resolution regime for firms consistent with attributes from the Financial Stability Board, adding lawmakers should ensure that SIFIs hold a sufficient amount of pre- and post-failure absorption capacity and find “concrete and credible” solutions to cross-border resolution.

Additionally, Yellen said the problems related to shadow banking are still up for debate among international and domestic regulators. She said transparency is necessary so regulators “can monitor for signs of excessive leverage and unstable maturity transformation outside regulated banks.”

“We also need to take further steps to reduce the risk of runs on money market mutual funds,” Yellen said. “In addition, we need to further ameliorate risks in the settlement process for triparty repo agreements, including through continued reductions in the amount of intraday credit provided by the clearing banks.”

Yellen said even after shadow banking reforms are accomplished, regulators will have to address systemic risk in the funding markets shadow banking relies on—short-term securities financing transactions, in particular. SFTs include repos, reverse repos, securities borrowing and lending transactions and margin loans.

“Regulatory reform mostly passed over these transactions, I suspect, because SFTs appear safe from a microprudential perspective,” Yellen said. “But SFTs, particularly large matched books of SFTs, create sizable macroprudential risks, including large negative externalities from dealer defaults and from asset fire sales. The existing bank and broker-dealer regulatory regimes have not been designed to materially mitigate these systemic risks. The global regulatory community should focus significant amounts of energy, now, to attack this problem.”

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