Fed’s Rosengren: Bank Regulators Need To Go Beyond Basel III

Author: Market News International | Category: News

By Denny Gulino

WASHINGTON (MNI) – Boston Federal Reserve Bank President Eric
Rosengren Thursday suggested banking regulators need to do more to
ensure financial stability under stress, particularly with money market
mutual funds and foreign bank branches.

Speaking to the Global Interdependence Center’s Conference on
Capital Markets in the Post-Crisis Environment in Stockholm, Rosengren
said, “The global banking system currently remains more vulnerable than
it should and could be.”

He continued, “Share prices have fallen dramatically for some bank
stocks and credit default swap prices for some global banks are at
elevated levels.”

When markets reach a certain stage of turbulence, he suggested, the
largest systemically important banks should no longer be able to buy
back shares or declare higher dividends, until the stress subsides.

“Using market triggers as well as capital triggers to prevent
capital from leaving the banking system — or to bolster if it is
necessary — during times of stress should be revisited,” he said.

In that case, should the assessment of the market turn out to be
faulty, “banks would only have deferred dividends or share repurchases,”
he said, and could be resumed at a higher level later.

Otherwise, “allowing dividends and share repurchases to occur when
the risk of a crisis is high allows scarce capital to leave the banking
system at a time when it is most needed.” In that case, “Taxpayers, debt
holders and the economy will suffer should bank capital be insufficient
to weather the crisis.”

“While Basel III has proposed dividend reductions as capital
becomes depleted, I suspect that is likely to be too late, given the
slow pace at which accounting losses are realized,” he said.

Rosengren also focused on money market mutual funds, suggesting
they develop “a meaningful capital-like buffer that exceeds, for
example, their single-issuer concentration exposure limits — perhaps on
the order of 2% to 3% — that if violated, automatically leads to a
fund’s conversion to a floating net asset value.”

“Given the systemic importance of the MMMF industry, it is critical
that one way or another we make the industry less susceptible to credit
shocks and liquidity runs,” he said.

He said that while many of the funds have been reducing their
exposure to troubled financial institutions, “some continue to take what
some observers might consider outsized credit risks.”

The experience of 2008, he said, showed the potential for MMMF
problems “to precipitate redemptions that are ultimately destabilizing
to short-term credit markets and contribute to economic difficulties.”

In the case of foreign bank branches in the United States, in
contrast to foreign banks’ subsidiaries, he said their reliance on
wholesale funding — jumbo certificates of deposit, commercial paper and
repurchase agreements — means that during times of stress they are all
“less stable than typical retail deposit accounts.”

While “important and useful,” the foreign branch banks are facing a
change in strategy of short-term wholesale funding of longer-term U.S.
dollar assets because of the problems in Europe. “The recent
announcement of several central banks that they would provide
longer-term dollar financing has once again highlighted that short-term
credit markets are, in my own opinion, overly dependent on structures
that are highly sensitive to credit and liquidity conditions.”

Over time, he continued, “it will be important to get to a place
where adequate funding flows do not require official intervention during
times of stress.”

Meanwhile, he said, it may be advisable “to require greater
liquidity from global parents.” Some countries, he said, require foreign
branches to hold capital or require all bank operations to be under a
separate holding company structure with capital to support the entirety
of domestic operations in the country.”

Rosengren said it is his own preference to “move towards all
foreign banking operations requiring some form of bank capital,” an
approach that could reduce liquidity crises and address the fact that
some branches are too big for their foreign parents to back up during a
crisis.

** Market News International Washington Bureau: 202-371-2121 **

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