The regulatory framework for banks that was established after the last financial crisis – the “global financial crisis” of 2008-10 – withstood the financial impact of the coronavirus crisis, the Federal Reserve’s top supervisor said Thursday, calling that result a “broad lesson” learned.
In comments to the Institute of International Finance in Washington, D.C. (via webcast), Federal Reserve Board Vice Chair for Supervision Randal Quarles said the coronavirus crisis did not cause the same sort of problems faced by the banking sector during the financial crisis of more than a decade ago, “and the financial system and the economy would have been much worse off if we had seen it.”
“Instead, banks have been a source of strength,” Quarles said. “The system worked.”
He told the group his conclusion is consistent with the emergency measures undertaken by the Fed in response to the pandemic’s impact on the economy. He said nearly all of the measures adopted by the Fed were targeted toward financial markets, nonbank financial institutions, and the real economy.
“Moreover, the unprecedented and in many ways unimaginable nature of the shock posed by the COVID event made it appropriate to take these steps when we did, to backstop the functioning of markets essential to the financial system,” he said. “Their creation was an unmistakable signal to market participants of the capability and willingness of the Fed to restore market functioning, and the fact that this functioning was restored so quickly, with relatively little borrowing, shows this message was received, and believed. The system worked.”
However, Quarles outlined two other “lessons learned” from the most recent crisis:
- Short-term funding markets proved fragile and needed support, with the the commercial paper market and prime and tax-exempt money market funds being key examples.
- The Treasury market is not immune to the problems of short-term and dollar funding markets.
Quarles reiterated his call made earlier in the week for addressing vulnerabilities associated with short-term funding, noting he has set up at the international Financial Stability Board (FSB, which he chairs) a steering group of central bankers, market regulators, and international organizations to oversee the FSB’s work on nonbank finance. The group, he said, would also help coordinate work across the range of global standard setting bodies that oversee the financial sector.
The group, he said, is currently completing a “holistic review” of the coronavirus crisis to better understand the role that vulnerabilities stemming from nonbank financial institutions played in those events and to define a work program to address such vulnerabilities during 2021.
“One might look to the emergence of strains in short-term funding markets in March of this year as an indication that previous reform efforts fell short. Perhaps, and we will be looking at this at the FSB,” he said.
“The COVID event precipitated the most abrupt decline in U.S. and global economic activity in recorded history,” Quarles said in closing remarks. “It is far from shocking that funding strains emerged, and it is heartening that the banking system remained resilient and that policy efforts were able to calm financial markets relatively quickly. The lessons we draw from this year’s events as we seek to strengthen our regulatory framework will leave us better positioned for the next shock and thereby support financial stability and sustained economic growth.”