Bernanke outlines shadow banking reform priorities

Fed chairman outlines regulatory steps taken so far in relation to shadow banking; says careful monitoring and supervision of the whole system are required

The chairman of the Federal Reserve, Ben Bernanke, on April 9, outlined the Fed’s priorities in relation to tackling the so-called shadow banking sector.

Speaking at the Federal Reserve Bank of Atlanta’s financial markets conference in Georgia, Bernanke began by discussing the provisions of Basel 2.5 and Basel III in addressing “interconnectedness and other sources of systemic risk”.

The principal method for tackling shadow banking deployed by the Basel rules relates to raised capital requirements for exposure to unregulated financial institutions, such as hedge funds, asset managers and credit insurers.

Bernanke said Basel III also contains quantitative liquidity rules that reflect the sponsorship of off-balance-sheet vehicles by banks.

The chairman also discussed progress made by the Financial Stability Board (FSB) with regard to developing rules to govern shadow banking institutions. He said the FSB was examining the supervisory framework from five perspectives: money market funds, securitisation, securities lending and the repo market, banks’ interactions with shadow banks, and “other shadow banking entities”.

The Fed chairman described the FSB’s agenda as ambitious due to the “substantial variation in the structure of shadow banking in different countries”.

Turning his thoughts to the domestic picture, Bernanke outlined how the Financial Accounting Standards Board had introduced a rule in 2009 requiring securitisations and other structured finance vehicles, in certain situations, to be consolidated onto the sponsoring bank’s balance sheet

He said additional steps to increase the “resiliency” of money market funds were important for the overall stability of the financial system and “warranted serious consideration”.

Bernanke said that while the Securities and Exchange Commission (SEC) introduced measures to increase the liquidity buffers money market funds are required to maintain, the risk of runs on money market funds could not be discounted. He said this is due to a possible combination of fixed net asset values, extremely risk-averse investors, and the absence of explicit loss absorption capacity.

Bernanke said the SEC had outlined further measures it would like to introduce, including possibly requiring funds to maintain loss-absorbing capital buffers.

The SEC recommendations were among a number of proposals suggested in relation to money market funds, said Bernanke. He did not specify what the other proposals were, nor did he express a preference for any of the suggested methods of reducing the systemic risk posed by the funds, but emphasised that it is “important” that further measures be taken.

Having set out the reforms, which he said aimed to bring the shadow banking system “into the sunlight”, the Fed chairman warned that the financial system was constantly evolving, and that as new regulations come into force, the financial system will adapt to find ways to “push risk-taking from more regulated to less regulated areas”. He said this increased the need for careful monitoring and supervision of the system as a whole.

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