Supervisory framework was successful in 2020 – but other concerns emerged, Fed’s top supervisor to report

While the supervisory framework of the Federal Reserve was tested – and found to work – in the face of the financial impact of the coronavirus crisis, there are other areas that were found to be wanting, the agency’s top supervisor will tell a House committee Wednesday.

In prepared testimony for a Wednesday hearing before the House Financial Services Committee, Fed Vice Chairman for Supervision Randal Quarles indicates that the public can have ”particular confidence” in the framework when gauged by a real-time stress testing regime. “In the future, having learned the lessons of this test, we will be able to rely on the automatic restrictions of our carefully developed framework when the stress test tells us the system will be resilient, rather than impose ad hoc and roughly improvised limitations,” Quarles will testify.

However, he noted that other areas are “ripe for closer examination.” Those include, he said strains in short-term funding markets, and the second destabilizing run on prime money market mutual funds in roughly a decade, which, he added, required significant public intervention to address.

“Despite some efforts after the 2008 crisis to enhance the resiliency of these investment vehicles, the basic model of a seemingly stable-value fund, backed by assets the value and liquidity of which varies, remained vulnerable,” he said. “Work is ongoing both domestically and at the Financial Stability Board on how to better address these vulnerabilities.

Other areas in need of attention or review, he said, included:

  • Treasury markets, where selling pressures last year overwhelmed dealers’ willingness or ability to intermediate, he said. The agency is reviewing the design and calibration of the supplementary leverage ratio, he said, which was originally gauged for a financial system with far lower levels of cash reserves and a much smaller Treasury market.
  • A rapidly changing set of customer practices;
  • Changing patterns in the use of financial services, by consumers and businesses;
  • And a changing relationship between banks and their nonbank partners.

Quarles will also point to two “highest priorities” of the year for the Fed: finalizing the post-crisis Basel III reforms and completed transition away from use of the London Interbank Offered Rate (LIBOR) reference rate at year’s end.

On LIBOR, Quarles was unequivocal: banks need to stop using it or risk trouble. “The time for comment, speculation, and delay has long since passed,” Quarles will say. “Continued use of LIBOR in new contracts after 2021 would create safety and soundness risks, and we will examine bank practices accordingly.

Fed Vice Chair for Supervision Randal K. Quarles: Supervision and Regulation

 

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