June 29, 2012 / 11:32 AM / 7 years ago

Fed official floats stress tests of money funds

AMSTERDAM (Reuters) - A top U.S. Federal Reserve official floated the idea on Friday of expanding bank “stress tests” to include the likely support those institutions would need to provide to sponsored money market mutual funds.

Eric Rosengren, President and Chief Executive Officer of the Federal Reserve Bank of Boston, listens at a U.S. House of Representative Financial Services Committee field hearing entitled "Seeking Solutions: Finding Credit for Small and Mid-Size Businesses in Massachusetts" in Boston, Massachusetts March 23, 2009. REUTERS/Brian Snyder

The likely capital support for such funds could be calculated and revealed to financial regulators, thereby cutting down on so-called “capital arbitrage,” Boston Fed President Eric Rosengren said in prepared remarks.

The U.S. Securities and Exchange Commission has circulated draft rules that would reform the $2.6 trillion money market fund industry, a proposal Rosengren supports. But it is unclear whether enough SEC commissioners will back the plan.

“In the absence of such reforms for all money market mutual funds, an alternative for funds with depository institution or depository institution affiliated sponsors would be to include likely money market mutual fund support in the sponsor’s stress tests,” said Rosengren, who has pushed industry reforms since last summer.

“Based on the historical experience of their money market funds, the historical experience of similar funds, and their money market funds’ exposures, sponsors could calculate the likely capital support needed from the organization in a stress scenario,” he said in a statement prepared for an event sponsored by the Dutch Central Bank.

Rosengren did not comment on Fed monetary policy nor the economy, instead focusing on protecting the financial system from a repetition of the 2007-2009 crisis.

The vulnerabilities of money market mutual funds came to light when in 2008 the big Reserve Primary Fund “broke the buck” - meaning its per-share value fell below $1 because of heavy losses on debt holdings in Lehman Brothers, which had collapsed a few days earlier.

A money market fund is a type of mutual fund that is required to invest in low-risk securities. They are not required to hold capital. Rosengren targeted his remarks at so-called prime money market mutual funds, which together have about $1.41 trillion in total assets.

Harnessing the stress tests could “illuminate the impact of various scenarios on fund sponsors, many of which are banks or financial institutions,” the Fed official said, adding it was “an admittedly partial approach, in the absence of more comprehensive reforms that I hope will occur.”

Rosengren said the approach would make banks more resilient and would inform investors about which money funds would be well capitalized in stressful times.

The Fed and other regulators globally administer stress tests to determine whether banks have enough capital to withstand an economic or financial shock.

Reporting by Gilbert Kreijger; writing by Jonathan Spicer; editing by Andre Grenon

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