Tags: Tarullo | risk | bank | Basel

Fed's Tarullo Talks About Zombie Banks — Part II

By    |   Thursday, 06 Nov 2014 07:51 AM

Federal Reserve Governor Daniel Tarullo, lead governor of the Fed for financial supervision, continued his discussion with Tim Adams, CEO of the powerful financial trade association Institute of International Finance, at the group's Annual Membership Meeting held at the Ronald Reagan Building in Washington.

As the conversation continued, Tarullo spoke of a five-to-10-year time horizon for absorbing the concepts of so-called "macroprudential" supervision and regulation, which calls for considering the effects of risks to the entire financial system, not just to individual firms. He noted that it had only been a couple years since the term had been coined (perhaps the person who coined it should get a Nobel prize or presidential medal).

Tarullo went on to say that while steps are being taken to apply margin requirements to securities transactions outside the regulated banking system, studies are just beginning as to where to go from there. He ended up saying that the authorities are working to get to the point where they can begin to do the necessary analysis. (This might lead readers to wonder where the regulators have been all these years, but they may also recall that the Fed neglected to use mortgage regulation authority for 14 years leading up to the crisis episode of 2008.)

Planting the notion that systemic risk is not due to the size of the institutions, Adams chose to focus on the issue of their interconnectedness. (Obviously the risk posed by "too big to fail" is due to both their size and interconnectedness; nothing says only one choice is available.)

Tarullo responded by citing funding risk, so-called "runable" funding, an issue he has raised consistently in this debate, and correlated asset holdings, issues that are obviously related with each other. The funding response would depend on the characteristics, including leverage, of each institution.

Adams referred to a speech Tarullo had given several months ago in Chicago on the subject of leverage, and he asked whether this means the authorities are moving back to Basel I and scrapping Basels II and III. (It would be comical if this were the case, but this is the world of international banking regulation.)

Tarullo insisted that Basels II and III had strengthened the quality and the ratios of capital the largest banks would hold and that it would be of a quality that would absorb loss. Regarding Basel II, Tarullo admitted that the complexity of the risk modeling it entailed might outweigh the benefits ascribed to capital requirements that were supposed to be more risk-sensitive. He sees the Basel framework as consisting of leverage ratios combined with risk weights and the practice of stress testing that has been introduced in recent years.

Tarullo has come to question the value of internal risk modeling, in part because it has yielded inconsistent risk weights among the institutions and also because modeling has never received the degree of scrutiny that he anticipated.

Adams sought to assure Tarullo that his organization is studying the variances in outcomes and trying to determine their cause.

(Archived video can be found here.)

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Robert-Feinberg
Federal Reserve Governor Daniel Tarullo continued his discussion with Tim Adams, CEO of the powerful financial trade association Institute of International Finance, at the group's Annual Membership Meeting held at the Ronald Reagan Building in Washington.
Tarullo, risk, bank, Basel
510
2014-51-06
Thursday, 06 Nov 2014 07:51 AM
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