Fed Governor Tarullo: More comprehensive reform agenda necessary to ensure stability

126px-US-FederalReserveSystem-Seal.svg_3Federal Reserve Governor Daniel K. Tarullo said late last month that while regulators have made progress in implementing reforms to the financial system to curb risky activity, U.S. markets are still vulnerable, and a more comprehensive reform agenda is necessary.

Tarullo discussed the shadow banking sector, in particular, saying the run on the system that occurred during the last financial crisis is similar to the run on deposits at banks in the early 20th century.

“Just as it was necessary, though not sufficient, to alter the environment that led to those successive deposit runs by introducing deposit insurance in order to create a stable financial system in the early-twentieth century, today it is necessary, though not sufficient, to alter the environment that can lead to short-term wholesale funding runs in order to create a stable financial system for the early twenty-first century,” Tarullo said.

Tarullo pointed to calls from some participants for regulators to provide discount window access for broker-dealers or to guarantee certain types of wholesale funding.

He said, however, that he is “wary” of such an approach and that he would prefer an approach that requires market participants using or extending short-term wholesale funding to “internalize the social costs.”

He also pointed to the SEC’s rules on money market funds as a response to the crisis, saying that while the initiatives are important, “the risk of contagious runs would persist even in the absence of individually systemic institutions.”

“And with less vulnerable money market funds, other cash-rich entities could emerge as a source of inexpensive funding for the shadow banking system,” Tarullo said. “[T]he systemic risks associated with short-term wholesale funding in prudentially regulated institutions have not fully been countered by the important capital and liquidity standards adopted since the crisis…[A] sounder, more stable financial system requires a more comprehensive reform agenda.”

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