Speaking at the Clearing House 2014 Annual Conference in New York, Board of Governors of the Federal Reserve System (“FRB”) member Daniel Tarullo discussed the evolving role and impact of post-crisis bank liquidity regulation and supervision in the United States.
Governor Tarullo stressed that liquidity regulation complements and is dependent on other regulatory initiations, namely capital buffers, resolution procedures and lender-of-last-resort (“LOLR”) practice. While LOLR is needed to prevent firms from hoarding liquidity in times of stress, and “underhoarding” liquidity under normal market conditions, LOLR, when used to prop up weak or insolvent institutions, may result in moral hazard. Liquidity regulation, according to Governor Tarullo, is necessary to limit the use of LOLR and serve both as a tax and a mitigant to offset such externalities.
Examples of the significant milestones in liquidity regulation that were discussed by Governor Tarullo included the Liquidity Coverage Ratio (“LCR”) adopted by the FRB last September, as well as the Net Stable Funding Ratio (“NSFR”) adopted recently by the Basel Committee on Banking Supervision (“Basel”). Governor Tarullo indicated that the FRB would be issuing a proposed rule next year to implement the NSFR in the United States, and that this rule would differ from the Basel standards by, for example, imposing regulatory surcharges on maturity mismatches within the contemplated 30-day stress scenarios.
Governor Tarullo concluded by discussing developments in the FRB’s supervisory approach to liquidity regulation and indicated that the FRB has rejected automatic sanctions for firms who fall out of compliance with the LCR or NSFR in times of generalized stress. Out of concern that mandatory sanctions would encourage liquidity hoarding, he said, the FRB is developing a context-dependent approach that will enable such firms to come back into compliance with the LCR and NSFR without becoming exposed to greater stress.