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The Deal: What Too-Big-to-Fail Banks Should Expect From Yellen Fed

NEW YORK ( The Deal) -- The biggest U.S. banks would not be broken up if Federal Reserve Governor Janet Yellen takes over as the head of the central bank.

However, if Yellen were to take over the reins at the central bank, as many Fed watchers expect, she would take further steps in an effort to end the perception that large financial institutions are "too big to fail," a situation that she acknowledges still exists.

Under her oversight that effort will likely come in the form of tough capital and leverage regulations on big banks, as her recent speeches demonstrate. She is expected to back the chock-full agenda recently laid out by the Fed's chief bank regulator, Fed Governor Daniel Tarullo.

"You've seen the Fed pursue strict counterparty credit limitations, higher capital requirements for big global banks and other major financial firms [and] tough leverage limits and Yellen would continue down that road," said Michael Barr, a former assistant secretary for financial institutions at the U.S. Treasury between 2009 and 2010.

Yellen has outlined a whole host of new requirements she'd like to see imposed on big financial institutions, including new restrictions on short-term wholesale funding big banks often rely upon to make loans.

In the run-up to the 2008 financial crisis, big banks became increasingly reliant on short-term funding to make loans. The quality of collateral that banks put up to obtain the funding became steadily worse, including subprime loans, all of which helped drive a liquidity crisis in 2008. Proponents argue that new capital requirements on the activity could help limit a run on the banks and help stem a future crisis should a significant amount of the loans begin to go bad.

In a June speech, Yellen indicated her backing for new restrictions on short-term funding, noting that the "trigger for the acute phase of the [2008] financial crisis was the rapid unwinding of large amounts of short-term wholesale funding" that had been made available to "highly leveraged" big banks. Most observers expected that Yellen would back Tarullo in his efforts to require more capital for financial firms that rely on short-term wholesale funding.
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