Fed's Tarullo Eyes Tougher Rules for Short-Term Bank Funding

The central bank governor suggested that restrictions for the market could include an outright prohibition, higher capital requirements or taxation
By Ronald Orol ,

A top government official on Tuesday suggested that regulators should take additional steps to regulate the opaque $3 trillion short-term funding market employed by the largest U.S. banks, a key source of liquidity that dried up during the 2008 financial crisis.

"I continue to believe that the post-crisis work to create a solid regime to protect financial stability cannot be deemed complete without a well-considered approach to regulating runnable funding outside, as well as inside, the regulatory perimeter," said Federal Reserve Governor Daniel Tarullo at an event hosted by the Center for American Progress focusing on shadow banking. "It is important to note that the short-term funding or immediately redeemable investments that can run when a shock hits are likely to have contributed to the vulnerability of relevant asset classes to those shocks."

Tarullo focused some of his attention on the so-called repurchase agreement market, which are essentially collateralized loans, where one party sells a security to another party with an agreement to repurchase it later, usually the next day, at an agreed price.

"If you can refuse to roll over your repo tomorrow, why be too concerned about whether the underlying collateral may prove to be overvalued a few months later?" Tarullo asked. "The very short-term nature of the transaction reduces the incentives of counterparties to evaluate carefully the loan or investment they are making,"

Federal Reserve chairwoman Janet Yellen, Tarullo and other top central bank regulators have said large banks were too reliant on the repo market in the period leading up to the 2008 financial crisis and believe they still rely too heavily on them. Yellen and Tarullo and others have suggested that big banks employing short-term wholesale funding may soon be required to hold larger amounts of capital or highly liquid assets to offset risks from the market.

On Tuesday, Tarullo suggested a list of possible restrictions on short term funding, including an "outright prohibition" of the trading, minimum margin requirements, tougher capital requirements for the practice or taxation.

Tarullo noted that the biggest financial institutions that were dependent on short-term funding in the pre-crisis period have now either converted to or combined with banks, which already subjects them to tougher rules and higher capital requirements. However, Tarullo raised concerns that these big institutions could create new forms of "financial intermediation" based on short-term funding. "As liquidity standards, stress testing, and resolution planning evolve, regulators will continue to work on this issue with prudentially regulated firms," he said.

Carolyn Sissoko, fellow at the University of Southern California Center for Law and Social Science, raised concern with JPMorgan (JPM) - Get Report role in supporting the short-term repo market. "If the lessons of the 1930s had actually been learned the role of JPMorgan as a tri-party clearing bank and as an Federal Deposit Insured Corp.-insured market-maker in repo would never have been allowed to develop," she said.

Other big banks that obtain a large percentage of their funding from short-term money including Bank of America (BAC) - Get Report , State Street (STT) - Get Report , Well Fargo (WFC) - Get Report , Citigroup (C) - Get Report , Morgan Stanley (MS) - Get Report , Goldman Sachs (GS) - Get Report and Bank of New York Mellon (BNY) - Get Report .

Citigroup and Wells Fargo are holdings in Jim Cramer's Action Alerts PLUS Charitable Trust Portfolio. Want to be alerted before Cramer buys or sells C or WFC? Learn more now.

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