Tarullo Sees Remaining Contagion Risk in Bank Liabilities

Federal Reserve Governor Daniel Tarullo said large banks are vulnerable to runs from non-deposit liabilities, and regulators need to do more to curb such risk.

“These vulnerabilities involve both large, prudentially regulated institutions, and thus too-big-to-fail concerns, and the broader financial system,” Tarullo said today to the Cornell International Law Journal Symposium in New York. “The liability side of the balance sheets of financial firms has been barely addressed in the reform agenda.”

Fed bank supervision and monetary policy are increasingly focusing on threats to financial market stability. Tarullo, the Fed governor in charge of financial regulation and bank oversight, has worked with Chairman Ben S. Bernanke on revamping the central bank’s risk surveillance and bank monitoring.

Tarullo said financial oversight has to be a central component of monetary policy given the large costs to price stability and employment that result from banking crises. Citing a speech by Fed governor Jeremy Stein, Tarullo said the Fed also should have a “considered view” of the role monetary policy might play in addressing financial stability.

Regulators in the U.S. and U.K are jointly crafting plans for minimizing disruption from the wind-down of a failing bank with worldwide operations, with the Bank of England and the Federal Deposit Insurance Corp. having released a Dec. 10 paper identifying differences in such procedures in both countries.

Minimum Haircuts

Tarullo, 60, said regulators meeting in international forums have “tentatively discussed” requiring minimum haircuts for financing transactions in which a security is pledged for cash. In a haircut, the lender gives less than the value of the security.

“This is certainly a ripe subject for discussion, insofar as securities financing transactions facilitate leverage, enable maturity transformation and produce the kind of interconnectedness that can spawn runs and contagion,” he said.

President Barack Obama’s first appointment to the Fed, Tarullo helped create the Large Institution Supervision Coordinating Committee, a group of senior Fed bank supervisors, economists, payment experts and quantitative analysts that look for risks that may be clustering in several of the largest financial institutions at once.

The Fed on Dec. 14 said it would require foreign banking organizations with “significant U.S. presence” to create holding companies over their U.S. subsidiaries. That would allow the central bank to supervise and set capital and liquidity standards for large foreign banking organizations in the U.S.

Tarullo didn’t comment on the Fed’s monetary policy.

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