Fed's Powell reinforces regulation and defends repo support in letter to Congress

Feb 12 (Reuters) - U.S. central bank officials are considering options that would make it easier for banks to treat Treasury holdings similar to reserves when meeting liquidity requirements, Federal Reserve Chair Jerome Powell said this week in a letter to a top Senate Democrat.

The Fed chair said financial firms have a preference for holding reserves when planning for stress scenarios, and that central bank officials are considering changes to address situations when Treasuries and reserves should be “fully substitutable,” in a letter to Senator Sherrod Brown.

But Powell emphasized that any potential change would not soften liquidity regulations, a concern Senate Democrats, including Brown and Elizabeth Warren, raised in a letter to Powell last week.

“We are considering a range of options to address this set of issues in a way that would not weaken safety and soundness or financial stability and would not put the taxpayer at risk,” Powell said in the letter.

The Fed has been injecting billions of dollars of cash into overnight lending markets since mid-September, when a liquidity shortage caused a surge in short-term borrowing costs. The central bank is conducting daily and term temporary operations in the markets for repurchase agreements, or repo. The Fed is also purchasing short-term Treasury securities in a move to boost reserves back above $1.5 trillion, the level seen in early September before the disruption.

The primary dealers participating in the Fed’s repo operations have increasingly turned to the central bank for funding, instead of borrowing from banks and money market funds as they would have before the disruption in the fall, Powell said.

But Fed officials expect those borrowers to return to the private market as the central bank reduces its repo operations, Powell said. He also pointed out that the rates on the repo operations from the Fed have been close to rates charged in the private market, addressing a concern from some market participants that the central bank has become the lender of first resort instead of a backstop.

“We expect that as our repo operations wind down, dealers will return to their usual market sources of financing,” he said. The Fed will issue an update for its repo operations and balance sheet expansion plans on Thursday.

Powell also said the central bank’s efforts to calm money markets indirectly benefited consumers by preventing the volatility from spreading to other lending markets, in response to a question about whether the Fed’s support was helping to lower borrowing costs for consumers. (Reporting by Jonnelle Marte; Editing by Andrea Ricci)