Fed's Fischer Floats Ideas for Regulating Shadow Banks

        By Ryan Tracy
        STONE MOUNTAIN, Ga.--The Federal Reserve's No. 2 official floated a series of ideas for regulating nonbank financial companies, the latest indication that top U.S. policy makers are focusing on risks in the so-called shadow banking sector.
        "While there has been progress on the financial reform front, we should not be complacent about the stability of the financial system," said Fed Vice Chairman Stanley Fischer in remarks prepared for a conference here hosted by the Federal Reserve Bank of Atlanta. He noted existing rules create an incentive for risky activities to move into less-regulated financial firms and said "we should expect that further reforms will certainly be needed down the road."
        Mr. Fischer briefly discussed monetary policy after the speech, reiterating his expectation that it is likely the Fed will raise interest rates some time this year. He said Fed policy makers should start thinking further ahead. "We've got to start thinking about what interest rate determination will look like after we lift off" and begin raising rates, he said.
        Mr. Fischer also defended the Fed's 2% inflation target, saying it is reasonable and that he adopts former Fed Chairman Alan Greenspan's view that stable prices occur "when people don't have to take inflation into account in the great bulk of their transactions."
        He also gave some insight into the way Fed policy makers view economic data. Asked about the reliability of data on U.S. economic productivity, he noted that in the past, gross domestic product measurements have had to be revised. "I think there is a significantly positive probability that the GDP data may not be accurate," he said.
        Mr. Fischer, who sits on the Washington, D.C.-based Fed board that supervises most large U.S. financial firms, is just the latest central banker to raise concerns about nonbanks, which are providing a larger share of credit than in the past. Last week, he and Bank of England Governor Mark Carney, gave speeches in Germany in which they raised concerns about whether those firms would become unstable in periods of stress.
        Nonbank firms have had a positive impact by making financial markets function more efficiently, Mr. Fischer said in Monday's remarks, but the recent financial crisis showed "nonbank distress can harm the real economy. Mortgages, auto loans, and credit through securities issuance became harder to obtain."
        Mr. Fischer discussed how nonbank firms, such as mutual funds or broker-dealers, might be regulated, saying policy makers ought to focus their attention on whether those firms structure themselves in a way that ensures they can pay their bills and obtain funding to keep operating in periods of stress.
        "We will not go far wrong if we begin by considering how to promote solvency and liquidity, taking into account the unique structures and activities of each type of nonbank," he said.
        To promote solid funding, regulators might consider "having direct restrictions on the structure of liabilities, such as on their duration or on the use of wholesale funding," he said. Alternatively, he added, regulators might consider requiring nonbanks to hold minimum amounts of super-safe assets that could be sold for cash in a pinch.
        As for keeping nonbanks solvent and able to pay their bills, Mr. Fischer suggested another idea: requiring them to issue debt that would be available to absorb losses in hard times.
        The Fed has already required the largest U.S. banks to hold super-safe assets, and it is developing a rule requiring them to issue loss-absorbing debt. If it wanted to extend those rules across many nonbank firms, it would likely have to win the support of other regulators like the Securities and Exchange Commission, since the Fed's authority is limited mostly to bank-holding companies.
        Mr. Fischer said the SEC has already taken some positive steps, such as its new rules for money market mutual funds. "Much has been done to strengthen prudential regulation and supervision of the nonbank financial system, but more will need to be done," he said. "We must remain vigilant for changes in the system that increase systemic risk, and we should make appropriate changes to regulation and the structure of regulation as necessary."
        (END) Dow Jones Newswires

        March 30, 2015 20:57 ET (00:57 GMT)

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