-Dealing W/S-T Fundg Mkts Most Important Remaining Fin Reform Task

By Brai Odion-Esene

WASHINGTON (MNI) – Federal Reserve Board Gov. David Tarullo Tuesday said
requiring large banks to maintain a minimum long-term debt level is appealling
as a “near-term policy priority,” because it counteracts the moral hazard tied
to government-funded rescues and could instill greater confidence.

And in prepared remarks at a Brookings Institution conference, Tarullo
described finding an effective way to deal with the shadow banking system as
“the most important task” yet to be addressed by financial regulatory reform.

Casting an eye over proposals put forward to tackle the spectre of
too-big-to-fail banks, Tarullo — who oversees the Fed’s regulatory-writing
efforts — noted that proposals to require large financial firms to hold minimum
levels of long-term debt have been put forward as one way to enable the orderly
resolution of such firms.

“A minimum long-term debt requirement could lend greater confidence that
the combination of equity owners and long-term debt holders would be sufficient
to bear all losses at the firm, thereby counteracting the moral hazard
associated with taxpayer bailouts while avoiding disorderly failures,” he said.

An examination of the proposal “did not immediately suggest any unfavorable
unintended consequences, thereby perhaps strengthening its appeal as a near-term
policy priority,” he added.

Tarullo said while there will be some costs associated with such a
requirement, they are likely to only fall on the largest banks — in keeping
with the principle of the Dodd-Frank Act.

The largest, most complex financial institutions should be subject to
stricter regulation, he said, because their failure would have greater negative
consequences for the financial system and the economy more generally.

“Thus, if there is a modest effect on industry structure, it would be an
intended –rather than unintended or undesirable — consequence of the
regulation,” Tarullo said.

Tarullo also commented on some calls for a reenactment of the
Glass-Steagall Act, which would break up large banks along commercial and
investment banking lines. He warned that it could entail “substantial costs.”

Bringing back Glass-Steagall would mean that bank clients could no longer
retain one financial firm with the capacity to offer the whole range of
financing options — from lines of credit to public equity offerings —
depending on a client’s needs and market conditions, he argued.

He also pointed out that many smaller banks provide some capital market
services to their clients — usually smaller businesses as well — “a
convenience and possible cost savings that would be lost under Glass-Steagall
prohibitions.”

Then there are the proposals to cap a bank’s non-deposit liabilities as a
fraction of U.S. GDP in order to directly address sources of systemic risk.

“For the largest U.S. financial firms, non-deposit liabilities today are
highly correlated with the systemic risk measures used at the Federal Reserve
Board to measure interconnectedness and complexity for purposes of evaluating
the financial stability effects of mergers,” Tarullo said.

While there is “considerable conceptual appeal” in these proposals, the Fed
official said there remain a number of important questions — an analysis of
which could help determine the most effective elements of the proposal, identify
costs, and possibly suggest alternative means to the same policy goals.

“In the process, it could advance what I regard as the most important
remaining task of financial regulatory reform — determining the most effective
and efficient ways to deal with short-term funding markets, often characterized
as the shadow banking system, that are inherently subject to runs,” Tarullo
said.

–MNI Washington Bureau; tel: +1 202-371-2121; email: besene@mni-news.com

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