Fed’s Yellen Urges Higher Bank Capital Rather Than Size Limits

Federal Reserve Vice Chairman Janet Yellen said she favors forcing the largest U.S. banks to hold additional capital rather than limiting their size or requiring sales of businesses.

“I am not persuaded that such blunt approaches would be the most efficient ways to address the too-big-to-fail problem,” Yellen said in a speech today in Shanghai. Instead, Yellen said there may need to be “either a steeper capital surcharge curve or some other mechanism for requiring that additional capital be held by firms that potentially pose the greatest risks to financial stability.”

U.S. regulators and lawmakers are seeking ways to limit the risk that a large bank failure would result in another taxpayer-funded bailout. Fed Chairman Ben S. Bernanke said last month he opposed size restrictions on banks and said they should instead be forced to put up additional capital to ensure their safety.

While the preamble to the Dodd-Frank financial regulation act says its intent is to “end ‘too-big-to-fail,’” some of the largest banks may still benefit from the perception that they would be rescued by the government, Bernanke told lawmakers in February.

“Tougher prudential regulation and supervision have substantially reduced the probability” of a failure of a systemically important financial institution, Yellen said at the 2013 International Monetary Conference, according to the prepared text of her remarks today. “But at the same time I’m not convinced that the existing” work of regulators, “which moves in the right direction, goes far enough.”

Additional Capital

Yellen also called for additional capital for banks to reduce risk from short-term loans, which can become less available in times of trouble.

“A major source of unaddressed risk emanates from the large volume of short-term securities financing transactions -- repos, reverse repos, securities borrowing and lending transactions, and margin loans -- engaged in by broker-dealers, money-market funds, hedge funds, and other shadow banks,” she said.

“The perfect solution may not yet be clear but possible options are evident: raising bank and broker-dealer capital or liquidity requirements” or “imposing minimum margin requirements.”

Greater transparency is a “reasonably clear” step toward reducing systemic risk among money market funds, hedge funds and other financial firms known as shadow banks, Yellen said.

Increase Transparency

“We need to increase the transparency of shadow banking markets so that authorities can monitor for signs of excessive leverage and unstable maturity transformation outside regulated banks,” Yellen said. “We also need to take further steps to reduce the risk of runs on money market mutual funds.”

Yellen, a 66-year-old former professor at the University of California-Berkeley, is seen as the most likely person to take the helm of the U.S. central bank when Bernanke’s term ends in January, according to a quarterly poll of international investors by Bloomberg News in May.

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