Federal Reserve Governor Jeremy Stein said liquidity swaps between central banks and new U.S. regulations will curtail the risks from the ways foreign banks finance their operations.
“The Federal Reserve’s temporary dollar liquidity swap lines with the European Central Bank and other central banks are an effective response to stresses in dollar funding markets,” Stein said in the text of a speech today in Frankfurt.
Stein, a former Harvard University professor, drew on academic research he had written with his former Harvard colleagues Victoria Ivashina and David Scharfstein showing that Europe’s debt crisis may be reducing lending by that continent’s banks in the U.S. more than in Europe.
The research supports the Fed’s decision last week to extend its temporary dollar-swap agreements with four major central banks through Feb. 1, 2014. The arrangements include the Bank of Canada, the Bank of England, the European Central Bank and the Swiss National Bank, according to the Fed. The arrangements had been authorized through Feb. 1, 2013.
The Fed first opened swap lines in December 2007 to provide the global financial system with dollar liquidity as the subprime mortgage crisis began to create doubts about the quality of assets on bank balance sheets around the world. The swaps were closed in February 2010 and re-opened in May of that year as a squeeze in dollar funding re-emerged with the European financial crisis.
Outstanding swaps on the Fed’s balance sheet were at $12.4 billion Dec. 12, down from as high as $109 billion in February. Foreign banks hold billions in dollar assets without the broad deposit-based funding structure of U.S. banks. The Fed swaps provide a backup to market sources of dollar funding.
Stein also said the research supports the need for new Fed rules proposed last week to subject foreign banks with at least $50 billion of global assets to stricter U.S. capital rules.
The Fed proposed that most of the banks also be forced to comply with more-stringent liquidity rules and pass stress tests analyzing how they would fare in a severe economic downturn. The board voted Dec. 14 to seek public comment on the plan, which would take effect in July 2015.
“These rules should reduce the pressure on foreign banks that rely heavily on short-term dollar funding to either sell illiquid dollar assets or cut back on dollar lending in times of financial stress,” Stein said.
Stein, 52, was nominated by President Barack Obama last December to a term at the Fed lasting through January of 2018. Stein and Jerome Powell, an attorney and private equity investor, were confirmed by the U.S. Senate on May 17.