Fed's Bernanke warns shadow banking risks persist

CHICAGO Fri May 10, 2013 11:56am EDT

U.S. Federal Reserve Chairman Ben Bernanke gestures at the International Monetary and Financial Committee (IMFC) meeting during the Spring Meeting of the IMF and World Bank in Washington, April 20, 2013. REUTERS/Yuri Gripas

U.S. Federal Reserve Chairman Ben Bernanke gestures at the International Monetary and Financial Committee (IMFC) meeting during the Spring Meeting of the IMF and World Bank in Washington, April 20, 2013.

Credit: Reuters/Yuri Gripas

CHICAGO (Reuters) - Federal Reserve Chairman Ben Bernanke said on Friday that the shadow banking system still posed a threat to financial stability, and funding markets might still not be able to cope with a major default.

In a wide-ranging speech explaining the Fed's role in monitoring the health of the banking system, Bernanke also laid out how the central bank was looking at asset markets closely for signs of excessive risk taking.

"While the shadow banking sector is smaller today than before the crisis...regulators and the private sector need to address remaining vulnerabilities," Bernanke said at a banking conference sponsored by the Chicago Federal Reserve Bank.

The 2007-09 credit meltdown, and the collapse of investment bank Lehman Brothers, brought to light a group of firms and funding vehicles known together as shadow banks that were poorly regulated but harbored large risk.

The highest grouping of U.S. financial regulators, the powerful Financial Stability Oversight Council, which is chaired by Treasury Secretary Jack Lew, last month also warned that runs on shadow banks were still possible.

Asked about the issue of too-big-to-fail banks, Bernanke said regulators should tell banks to hold more equity if they decide that current rules do not do enough, rather than impose an arbitrary limit on size.

"Because that makes them safer, but also because it reduces or eliminates their funding advantage and gives them an incentive to reduce or simplify their firms," Bernanke said.

Calls to cut the size of big banks, which are perceived to rely on taxpayer bailouts no matter how risky their business conduct, are on the rise in Washington, but Bernanke said current global capital rules needed to be put in place first.

Fed Governor Daniel Tarullo, the central bank's main spokesman for supervision, last week said that the leverage ratio, a cap on how much banks can borrow that is part of the global Basel III capital accord, might need to be tougher.

Tarullo also said that big banks could be told to raise more hybrid debt, which converts into equity in case of financial stress, and that they could get a capital bonus if they funded their business with less-risky instruments.

He has also proposed a rule that would force foreign banks operating in the United States to hold more capital here, a measure that has invoked the wrath of the European Union and led to a flurry of critical letters from banks.

The Fed chairman said more work was needed to ensure the repo market - the wholesale market banks use for their everyday funding needs - could deal with the potential consequences of a default by a large borrower or a broker-dealer.

A run on money market funds also remained a possibility, Bernanke said.

He did not address the outlook for monetary policy or the economy, but he did say that the Fed was monitoring a wide range of asset markets for signs investors were "reaching for yield" in a way that might pose risks to the financial system, given that interest rates were so low.

(Writing by Douwe Miedema Additional reporting by Jason Lange and Tim Ahmann; Editing by Andrea Ricci)

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/
Comments (4)
thelastford wrote:
What is the “leverage cap”?
It would be MORE informative with examples and/or specifics.
Who are the “shadow/repo banks, i.e. NAMES!

May 10, 2013 11:24am EDT  --  Report as abuse
Harry079 wrote:
“the Fed was monitoring a wide range of asset markets for signs investors were “reaching for yield” in a way that might pose risks to the financial system, given that interest rates were so low.”

The Fed IS the reason that interest rates are so low. It was an intentional move on the Chairman’s part to drive funds from fixed income into equities and he has said so more than a few times.

The Federal Reserve is the shadow bank. Just not the ones he talks about.

May 10, 2013 2:13pm EDT  --  Report as abuse
Harry079 wrote:
Here’s the reason Fannie and Freddie are turning such huge so called profits.

From our own Reuters:

The Fed’s holdings of Treasuries totaled $1.814 trillion as of Wednesday, up from $1.806 trillion the previous week.

The Fed’s ownership of mortgage bonds guaranteed by Fannie Mae, Freddie Mac and the Government National Mortgage Association (Ginnie Mae) totaled $1.071 trillion on Wednesday, matching previous week’s total.

The Fed’s holdings of debt issued by Fannie Mae, Freddie Mac and the Federal Home Loan Bank system was $72.05 billion, down slightly from $72.42 billion the prior week.

Now that’s what I call a Shadow Bank!

May 10, 2013 2:34pm EDT  --  Report as abuse
This discussion is now closed. We welcome comments on our articles for a limited period after their publication.

Recommended Newsletters

Reuters U.S. Top News
A quick-fix on the day's news published with Reuters videos and award-winning news photography and delivered at your choice of one of four times during the day.
Reuters Deals Today
The latest Reuters articles on M&A, IPOs, private equity, hedge funds and regulatory updates delivered to your inbox each day.
Reuters Technology Report
Your daily briefing on the latest tech developments from around the world from Reuters expert tech correspondents.