FRB Powell on Financial Stability Reform and Credit Markets

Federal Reserve Board (“FRB”) Governor Jerome H. Powell discussed financial stability reforms and cautioned against supervisory interventions that “lean against” the credit cycle. The Governor delivered his remarks at the Stern School of Business of New York University.

According to Mr. Powell, the agenda for financial stability reform that relates to global systemically important banks (“G-SIBs”), financial market infrastructure and money markets is well developed. With regard to G-SIBs, Mr. Powell discussed higher capital requirements, liquidity regulation and stress testing, and noted that regulators have yet to work through resolution procedures and address cross-border issues regarding the failure of G-SIBs. Concerning market infrastructure, Mr. Powell explored possible reforms to the tri-party repo market, including the elimination of reliance on discretionary intraday credit to facilitate settlements, as well as central clearing for standardized derivatives and margin requirements for uncleared derivatives. Mr. Powell noted, however, that regulators have yet to adopt liquidity, margin and other regulations applicable to central counterparty clearinghouses. Finally, with regard to money markets, Mr. Powell cited the Securities and Exchange Commission’s 2014 rule on money market fund reform, and discussed the ongoing development by the Financial Stability Board of global margin rules for securities financing transactions involving nongovernmental securities.

In contrast to the reform agenda for G-SIBs, financial market infrastructure and money markets, the basic agenda for financial stability reform relating to credit markets is less advanced, the Governor stated. He argued that the standard for regulatory intervention in credit markets should be higher than in other areas. In particular, he talked about the leveraged loan market, noting that because such loans generally were not held in investment structures that utilized short-term, confidence-sensitive funding, leveraged loans were not a principal source of runs during the financial crisis.

Mr. Powell argued that supervisors should remain alert to the emergence of run-prone financing structures in credit markets that could lead to fire sales, as well as to conditions that could pose risks to the safety and soundness of G-SIBs. However, Mr. Powell cautioned strongly against using supervisory interventions to “lean against” the credit cycle and expressed his skepticism concerning the ability of supervisors to accurately identify “dangerous” conditions. False positives, he noted, would have the effect of limiting the availability of credit unnecessarily by interfering with market forces.

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