By Douwe Miedema
WASHINGTON Nov 22 Global financial watchdogs
should have more policy tools and powers over firms such as
hedge funds to counter the risk of a devastating run on
investment banks, the U.S. Federal Reserve's top regulator said
Fed Governor Daniel Tarullo unveiled new details of the
central bank's plans to require banks to hold more capital if
they rely heavily on raising short-term cash from other banks,
and he pushed regulators writing global rules to do more.
But oversight should not be limited to banks, he said,
because risks that could bring them down can often hide in the
so-called shadow banking system, a loosely defined set of
lending activities outside banks.
"There is a need to supplement prudential bank regulation
with a third set of policy options in the form of regulatory
tools that can be applied on a market-wide basis," Tarullo said
at a conference with other regulators.
Shadow banking remains largely unregulated even though it
was a key factor in the collapse of Lehman Brothers at the
height of the financial crisis in 2008, which led to a raft of
new regulations for bank capital and derivatives trading.
Tarullo detailed the Fed's planned rule -- announced earlier
this year -- to make it less attractive for banks to raise cash
in short-term wholesale funding markets, which have proven to be
fickle if a panic hits the market.
Banks that rely on short-term funding from peers should be
required to hold more capital on top of what is already mandated
by the international Basel III pact, he said.
The extra buffer would be calculated by looking at total
liabilities minus regulatory capital, deposits and obligations
with a maturity longer than a certain minimum, Tarullo said, and
could take account of the level of risk of the funding source.
International regulators should also consider a surcharge on
banks' exposure to a prominent part of shadow banking, the
repurchasing -- or repo -- markets, even if books were fully
matched, or the maturities of assets and liabilities evenly
Banks would be inclined to support the books even if a
counterparty went under so as not to hurt their reputation,
Tarullo said. That means the actual risk in those matched books
is higher than it would appear, due to accounting standards.
Tarullo said supervisors at the global Financial Stability
Board could still include plans for repo books in the so-called
net stable funding ratio, designed to encourage banks to move
away from short-term funding.
Regulators should address risk in such transactions
regardless of whether they were executed by banks or by other
market participants, such as hedge funds, and focus on
overseeing a certain type of transaction rather than a specific
set of institutions.
"There have already been reports of some hedge funds
exploring the possibility of disintermediating deals by lending
cash against securities collateral to other market
participants," Tarullo said.
Minimum safety buffers in repo markets - so-called haircuts
- should be extended to include all market participants,
regulated or not, he said.
Tarullo said that JP Morgan Chase's $6 billion
"London Whale" trading loss -- named for the huge positions the
bank took -- had been a reality check for regulators writing the
so-called Volcker rule, which bans banks from betting on
financial markets with their own money.
The rule, which regulators are hoping to finalize this year,
had been proposed at the time the loss happened, but regulators
were then still redrafting it and taking into account a ream of
comment letters from the industry.
"One of the key mandates to the staff from all the five
agencies working on the final rule has been to ensure that
London Whale in substantive and procedural terms couldn't happen
again," Tarullo said.