The U.S. Federal Reserve is only in the early stages of developing a set of macroprudential tools to ensure financial stability, and faces limits because of the divided nature of U.S. financial sector oversight, Fed Governor Lael Brainard said on Wednesday.
"While the Federal Reserve has an inherent responsibility for financial stability, it has an incomplete set of authorities and a limited regulatory perimeter in a financial system that has large capital markets and a fragmented regulatory structure," Brainard said, an explicit recognition that the Fed may only be able to go so far in its creation of a so-called "macroprudential toolkit."
The tools most easily at hand, Brainard said, are those associated with its supervision of the largest and most complex financial institutions. Those could include tailoring annual stress tests to target types of lending the Fed has come to see as risky, or the imposition of higher capital buffers as a remedy against frothy markets. She said the Fed is also exploring the use of stricter margin requirements.
Her remarks at the Brookings Institution are the most detailed to date by a Fed policymaker about the evolution of macroprudential tools — measures that go beyond regulation of an individual bank in an effort to more broadly curb activities that pose a systemic risk to the economy. In some countries, for example, regulators have put strict limits on mortgage lending in response to rapid increases in property values.
The discussion has become a central one as the U.S. tries to develop a regulatory system that would lower the risk of a repeat of the financial crisis, which had its roots in risky mortgage lending. Fed officials have cited the potential for a new crisis to arise out of unexpected corners of the financial system, and are studying tools to try to identify problems early and nip them in the bud.
Brainard said that in its review of such measures it has become apparent that the Fed will face limits because of the breadth and complexity of U.S. capital markets that include shadow banks, a large mortgage lending market, and other credit channels the Fed cannot easily reach. Other agencies, therefore, may need to be involved in macroprudential oversight even though they don't necessarily have a financial stability mission.
She noted, for example, that the Consumer Financial Protection Bureau could enact mortgage lending rules that would slow down a real estate bubble, but under its mandate might only do so if consumers were felt to be directly at risk, not financial institutions.
"The Federal Reserve is seen as the agency with the broadest sight lines across the economy," she said. But "no U.S. agency yet has access to complete data regarding bank and nonbank financial activities. Recognizing these limitations, the Federal Reserve is likely to actively utilize the tools under its authority, which means placing a strong emphasis on structural resilience in the largest and most complex institutions."
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