Center for American Progress Event on Shadow Banking
Center for American Progress
Exploring Shadow Banking
Tuesday, July 12, 2016
Key Topics & Takeaways
- Runnable Funding: Federal Reserve Governor Daniel Tarullo expressed his belief that post-crisis reforms cannot be deemed complete without a “well-considered approach” to regulating runnable funding inside and outside of the regulatory perimeter.
- Further Bank Reforms: Asked about possible reforms to address the connections of banks and shadow banking, Sen. Sherrod Brown (D-Ohio) called on regulators to be stricter about living will submissions, and also urged the Federal Reserve to move more quickly with rules on commodity trading.
- Taub on Regulating Shadow Banks: Jennifer Taub said improved regulation of shadow banking will necessitate better data, improved liquidity and reduced use of derivatives, higher capital standards for traditional banks, and enforcement of the consequences for non-credible living wills.
Participants
- Neera Tanden, President and CEO, Center for American Progress
- Lisa Donner, Executive Director, Americans for Financial Reform
- Daniel Tarullo, Governor, Federal Reserve Board
- Sen. Sherrod Brown (D-Ohio)
- Adam Ashcraft, Senior Vice President, Federal Reserve Bank of New York
- Bill Harrington, journalist, DebtWire
- Carolyn Sissoko, Fellow, University of Southern California Center for Law and Social Science
- Daniel Schwarcz, Julius E. Davis Professor of Law, University of Minnesota Law School
- Jennifer Taub, Author, Other People’s Houses
Welcoming Remarks
Neera Tanden, President and CEO of the Center for American Progress, commented that the nation is still recovering from the financial crisis, which was caused in part by poor regulation of shadow banking. She stated that “significant risks” remain in shadow banking today that require regulator attention.
Lisa Donner, Executive Director of Americans for Financial Reform, said the crisis provided a vivid demonstration of how interconnected shadow banking was with regular banking. She lamented that we have a financial regulatory system that is “more fragmented and divided” than the financial system itself, and also warned that regulators may not be flexible enough or have the necessary authorities to ensure financial stability. She also stated that Wall Street has been aggressive in working to roll back progress in regulation since the crisis.
Tarullo Remarks
In his remarks, Governor Daniel Tarullo of the Federal Reserve Board said that when considering shadow banking, it is productive to focus on the characteristics of shadow banking-related financial activities and institutions that are most likely to pose risks to financial stability. He said the most significant of these risks lies in runnable liabilities that could force fire sales and dramatically reduce asset values. He noted that this type of funding remains at levels well below those before the crisis and that the largest broker-dealers that were once very dependent on short-term funding have either converted to or been absorbed by bank holding companies subject to capital and liquidity regulation. He also added that new regulatory requirements have placed constraints on the relationships between shadow banking and prudentially-regulated banking organizations.
However, Tarullo warned that decreased levels of runnable funding do not mean that they are at optimal or even safe levels, and that it would be reasonable to expect that new forms of financial intermediaries that depend on runnable funding could develop in the future. He expressed his belief that post-crisis reforms cannot be deemed complete without a “well-considered approach” to regulating runnable funding inside and outside of the regulatory perimeter.
Tarullo raised five questions for the remaining speakers of the day to consider in designing such a regulatory approach: 1) to what degree will it rely on uniform regulation of users of runnable funding no matter the characteristics of the market actors and business models involved in the funding relationship; 2) what agency or agencies would be the appropriate regulators; 3) what form or forms would the regulation take, such as outright prohibition, minimum margining requirements and practices, capital requirements, and taxation; 4) to what extent is the supply of short-term funding a response to a persistent demand for more safe assets; and 5) to what extent does a comprehensive regulatory approach to shadow banking need to include mechanisms for the creation of more genuinely safe assets, as well as limitations on the runnable varieties that can precipitate or exacerbate financial stress.
Conversation with Sen. Sherrod Brown (D-Ohio)
SEC
Asked about the role of market regulators in dealing with shadow banking, Sen. Sherrod Brown (D-Ohio) commented that the Securities and Exchange Commission (SEC) was not strong enough a decade ago in its enforcement nor its promulgation of rules. He argued that Congress must make it clear that it is watching the SEC and push it to move forward with rulemakings, and that he attempted to do this with a letter urging the Commission to focus more on financial stability mandates.
FSOC
In response to a question on potential improvements to the Financial Stability Oversight Council (FSOC), Brown said the de-designation of GE Capital was the right thing to do because it showed that the FSOC can be transparent and that the process can work. However, he added that he would want to “give FSOC more teeth” to regulate large players in systemic markets, such as insurance companies, and for it to look at doing more than just regulating activities.
Answering a question about threats to the FSOC process, Brown noted concerns about regulatory capture, as well as Republican threats regarding funding or imposing rigid cost-benefit analysis requirements in which the costs of financial regulation are far easier to quantify than the benefits of avoiding another crisis.
Senate Banking Committee
Brown commented that he is more optimistic about the Senate Banking Committee being productive next year, as current Chairman Richard Shelby (R-Ala.) will be termed out of the leadership position. He stated that he has a better relationship with Sen. Mike Crapo (R-Idaho) and that he believes they could work together more effectively.
Criticism of Republicans and Industry
Brown suggested that Wall Street and Republicans are “always going to say that FSOC is too aggressive,” and recalled that financial services lobbyists considered the passage of Dodd-Frank to be “halftime” as fights over implementation would continue for years. He said he and other Democrats sent letters to regulators expressing their views because the regulators always hear complaints from Republicans about overregulation.
Further Bank Reforms
Asked about possible reforms to address the connections of banks and shadow banking, Brown called on regulators to be stricter about living will submissions, and also urged the Federal Reserve to move more quickly with rules on commodity trading.
Panel Discussion
Adam Ashcraft, Senior Vice President, Federal Reserve Bank of New York
Ashcraft defined shadow banking as the funding of illiquid assets through money-like instruments that do not benefit from explicit credit and liquidity support from the official sector. He discussed the growth of shadow banking, noting increasing credit and maturity transformation and a rapid rise of financial innovation relative to gross domestic product (GDP).
In thinking about regulation, Ashcraft urged that the banking system needs to be made as resilient as possible through the regulation of asset quality and funding liquidity. He said the best way to influence the shadow banking system is to try to influence interactions between regular banks and shadow banks, and stated that the FSOC has the ability to change the boundary between shadow and traditional banks, though this also has the potential to cover more firms under the safety net. He also pointed to prudential market regulation by using tools such as risk retention.
In response to a question on the challenges involved in shadow banking markets since the financial crisis and areas of emerging risk on Wall Street, Ashcraft stated that the challenge is that new rules can quickly become outdated given the way the financial system responds to them.
Responding to a question on concerns about the flow of corporate capital into the shadow banking system, Ashcraft argued that the issues associated with the normal credit cycles are being amplified, and that while he does not believe they will create systematic runs, it does not mean that there could not be significant losses.
Carolyn Sissoko, Fellow, University of Southern California Center for Law and Social Science
Sissoko pointed to the lack of official sector oversight as a key characteristic of shadow banking. She said that runnable aspects of the shadow banking system exist because of the regulators’ approach to them and that ‘runnables’ are often funded by explicit or implicit guarantees from commercial banks. She argued that while regulators can police the boundaries between banks and shadow banks, they can also choose not to, as was the case before the financial crisis. Sissoko discussed repurchase agreements and stated that commercial banks support this market, but that if the government learned its lesson from the Great Depression, this support would have been developed.
To improve regulatory oversight of shadow banking, Sissoko caked on regulators to police the boundaries between traditional and shadow banking to ensure that commercial banks are not providing implicit guarantees. She said regulators must be willing to restrict bank activities at the product level, just as they did with leveraged loans.
Jennifer Taub, Author, Other People’s Houses
Taub defined shadow banks as entities, such as pooled investment vehicles like hedge funds, private equity funds, and money and money market funds, that gather customer savings and channel them into loans to businesses and consumers. She argued that problems can arise in this system when investors seek to redeem assets, and that while these entities are not subject to regulatory supervision and are not supposed to have access to the government safety net, in reality shadow banking contributed to the financial crisis and stopping runs required government intervention.
Taub commented that regulators have more tools to monitor and regulate shadow banking today, and noted SEC proposals on liquidity and the use of derivatives by mutual funds, registration and examinations of private funds, as well as reports on the risks funds pose to financial stability. However, she warned that lobbyists for shadow banking are “running to Washington” to push Congress to allow funds to hold back critical information.
Taub said improved regulation of shadow banking will necessitate better data, improved liquidity and reduced use of derivatives, higher capital standards for traditional banks, and enforcement of the consequences for non-credible living wills.
Daniel Schwarcz, Julius E. Davis Professor of Law, University of Minnesota Law School
Schwarcz discussed the intersection of shadow banking and the insurance industry. He said insurance companies can pose systemic risks by guaranteeing that equity markets will not decline by using complicated risk management measures to hedge risks. He further outlined the systemic risks posed by the insurance industry, pointing at potentially short-term liabilities such as insurance products with high liquidity, securities lending operations, and captive reinsurance support by short-term letters of credit, and potentially illiquid assets such as corporate bonds and real estate.
Bill Harrington, Journalist, DebtWire
Harrington opined that rating agencies have no accountability beyond publishing methodologies and ratings and that the SEC is abetting the situation. He stated that the SEC cannot comment or provide oversight on rating agencies’ methodologies or comment of ratings, and that although there was a range of legislation that would have helped, the SEC put out a no-action letter to prevent the Dodd-Frank provision that would have exposed rating agencies to expert liability. He argued that the nebulous information presented in ratings is not helpful and that he would like to see ratings agencies treat their ratings as a closed system, and that the SEC should rescind its no-action letter shielding rating agencies from expert liability.
For more information on this event, please click here.
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Center for American Progress
Exploring Shadow Banking
Tuesday, July 12, 2016
Key Topics & Takeaways
- Runnable Funding: Federal Reserve Governor Daniel Tarullo expressed his belief that post-crisis reforms cannot be deemed complete without a “well-considered approach” to regulating runnable funding inside and outside of the regulatory perimeter.
- Further Bank Reforms: Asked about possible reforms to address the connections of banks and shadow banking, Sen. Sherrod Brown (D-Ohio) called on regulators to be stricter about living will submissions, and also urged the Federal Reserve to move more quickly with rules on commodity trading.
- Taub on Regulating Shadow Banks: Jennifer Taub said improved regulation of shadow banking will necessitate better data, improved liquidity and reduced use of derivatives, higher capital standards for traditional banks, and enforcement of the consequences for non-credible living wills.
Participants
- Neera Tanden, President and CEO, Center for American Progress
- Lisa Donner, Executive Director, Americans for Financial Reform
- Daniel Tarullo, Governor, Federal Reserve Board
- Sen. Sherrod Brown (D-Ohio)
- Adam Ashcraft, Senior Vice President, Federal Reserve Bank of New York
- Bill Harrington, journalist, DebtWire
- Carolyn Sissoko, Fellow, University of Southern California Center for Law and Social Science
- Daniel Schwarcz, Julius E. Davis Professor of Law, University of Minnesota Law School
- Jennifer Taub, Author, Other People’s Houses
Welcoming Remarks
Neera Tanden, President and CEO of the Center for American Progress, commented that the nation is still recovering from the financial crisis, which was caused in part by poor regulation of shadow banking. She stated that “significant risks” remain in shadow banking today that require regulator attention.
Lisa Donner, Executive Director of Americans for Financial Reform, said the crisis provided a vivid demonstration of how interconnected shadow banking was with regular banking. She lamented that we have a financial regulatory system that is “more fragmented and divided” than the financial system itself, and also warned that regulators may not be flexible enough or have the necessary authorities to ensure financial stability. She also stated that Wall Street has been aggressive in working to roll back progress in regulation since the crisis.
Tarullo Remarks
In his remarks, Governor Daniel Tarullo of the Federal Reserve Board said that when considering shadow banking, it is productive to focus on the characteristics of shadow banking-related financial activities and institutions that are most likely to pose risks to financial stability. He said the most significant of these risks lies in runnable liabilities that could force fire sales and dramatically reduce asset values. He noted that this type of funding remains at levels well below those before the crisis and that the largest broker-dealers that were once very dependent on short-term funding have either converted to or been absorbed by bank holding companies subject to capital and liquidity regulation. He also added that new regulatory requirements have placed constraints on the relationships between shadow banking and prudentially-regulated banking organizations.
However, Tarullo warned that decreased levels of runnable funding do not mean that they are at optimal or even safe levels, and that it would be reasonable to expect that new forms of financial intermediaries that depend on runnable funding could develop in the future. He expressed his belief that post-crisis reforms cannot be deemed complete without a “well-considered approach” to regulating runnable funding inside and outside of the regulatory perimeter.
Tarullo raised five questions for the remaining speakers of the day to consider in designing such a regulatory approach: 1) to what degree will it rely on uniform regulation of users of runnable funding no matter the characteristics of the market actors and business models involved in the funding relationship; 2) what agency or agencies would be the appropriate regulators; 3) what form or forms would the regulation take, such as outright prohibition, minimum margining requirements and practices, capital requirements, and taxation; 4) to what extent is the supply of short-term funding a response to a persistent demand for more safe assets; and 5) to what extent does a comprehensive regulatory approach to shadow banking need to include mechanisms for the creation of more genuinely safe assets, as well as limitations on the runnable varieties that can precipitate or exacerbate financial stress.
Conversation with Sen. Sherrod Brown (D-Ohio)
SEC
Asked about the role of market regulators in dealing with shadow banking, Sen. Sherrod Brown (D-Ohio) commented that the Securities and Exchange Commission (SEC) was not strong enough a decade ago in its enforcement nor its promulgation of rules. He argued that Congress must make it clear that it is watching the SEC and push it to move forward with rulemakings, and that he attempted to do this with a letter urging the Commission to focus more on financial stability mandates.
FSOC
In response to a question on potential improvements to the Financial Stability Oversight Council (FSOC), Brown said the de-designation of GE Capital was the right thing to do because it showed that the FSOC can be transparent and that the process can work. However, he added that he would want to “give FSOC more teeth” to regulate large players in systemic markets, such as insurance companies, and for it to look at doing more than just regulating activities.
Answering a question about threats to the FSOC process, Brown noted concerns about regulatory capture, as well as Republican threats regarding funding or imposing rigid cost-benefit analysis requirements in which the costs of financial regulation are far easier to quantify than the benefits of avoiding another crisis.
Senate Banking Committee
Brown commented that he is more optimistic about the Senate Banking Committee being productive next year, as current Chairman Richard Shelby (R-Ala.) will be termed out of the leadership position. He stated that he has a better relationship with Sen. Mike Crapo (R-Idaho) and that he believes they could work together more effectively.
Criticism of Republicans and Industry
Brown suggested that Wall Street and Republicans are “always going to say that FSOC is too aggressive,” and recalled that financial services lobbyists considered the passage of Dodd-Frank to be “halftime” as fights over implementation would continue for years. He said he and other Democrats sent letters to regulators expressing their views because the regulators always hear complaints from Republicans about overregulation.
Further Bank Reforms
Asked about possible reforms to address the connections of banks and shadow banking, Brown called on regulators to be stricter about living will submissions, and also urged the Federal Reserve to move more quickly with rules on commodity trading.
Panel Discussion
Adam Ashcraft, Senior Vice President, Federal Reserve Bank of New York
Ashcraft defined shadow banking as the funding of illiquid assets through money-like instruments that do not benefit from explicit credit and liquidity support from the official sector. He discussed the growth of shadow banking, noting increasing credit and maturity transformation and a rapid rise of financial innovation relative to gross domestic product (GDP).
In thinking about regulation, Ashcraft urged that the banking system needs to be made as resilient as possible through the regulation of asset quality and funding liquidity. He said the best way to influence the shadow banking system is to try to influence interactions between regular banks and shadow banks, and stated that the FSOC has the ability to change the boundary between shadow and traditional banks, though this also has the potential to cover more firms under the safety net. He also pointed to prudential market regulation by using tools such as risk retention.
In response to a question on the challenges involved in shadow banking markets since the financial crisis and areas of emerging risk on Wall Street, Ashcraft stated that the challenge is that new rules can quickly become outdated given the way the financial system responds to them.
Responding to a question on concerns about the flow of corporate capital into the shadow banking system, Ashcraft argued that the issues associated with the normal credit cycles are being amplified, and that while he does not believe they will create systematic runs, it does not mean that there could not be significant losses.
Carolyn Sissoko, Fellow, University of Southern California Center for Law and Social Science
Sissoko pointed to the lack of official sector oversight as a key characteristic of shadow banking. She said that runnable aspects of the shadow banking system exist because of the regulators’ approach to them and that ‘runnables’ are often funded by explicit or implicit guarantees from commercial banks. She argued that while regulators can police the boundaries between banks and shadow banks, they can also choose not to, as was the case before the financial crisis. Sissoko discussed repurchase agreements and stated that commercial banks support this market, but that if the government learned its lesson from the Great Depression, this support would have been developed.
To improve regulatory oversight of shadow banking, Sissoko caked on regulators to police the boundaries between traditional and shadow banking to ensure that commercial banks are not providing implicit guarantees. She said regulators must be willing to restrict bank activities at the product level, just as they did with leveraged loans.
Jennifer Taub, Author, Other People’s Houses
Taub defined shadow banks as entities, such as pooled investment vehicles like hedge funds, private equity funds, and money and money market funds, that gather customer savings and channel them into loans to businesses and consumers. She argued that problems can arise in this system when investors seek to redeem assets, and that while these entities are not subject to regulatory supervision and are not supposed to have access to the government safety net, in reality shadow banking contributed to the financial crisis and stopping runs required government intervention.
Taub commented that regulators have more tools to monitor and regulate shadow banking today, and noted SEC proposals on liquidity and the use of derivatives by mutual funds, registration and examinations of private funds, as well as reports on the risks funds pose to financial stability. However, she warned that lobbyists for shadow banking are “running to Washington” to push Congress to allow funds to hold back critical information.
Taub said improved regulation of shadow banking will necessitate better data, improved liquidity and reduced use of derivatives, higher capital standards for traditional banks, and enforcement of the consequences for non-credible living wills.
Daniel Schwarcz, Julius E. Davis Professor of Law, University of Minnesota Law School
Schwarcz discussed the intersection of shadow banking and the insurance industry. He said insurance companies can pose systemic risks by guaranteeing that equity markets will not decline by using complicated risk management measures to hedge risks. He further outlined the systemic risks posed by the insurance industry, pointing at potentially short-term liabilities such as insurance products with high liquidity, securities lending operations, and captive reinsurance support by short-term letters of credit, and potentially illiquid assets such as corporate bonds and real estate.
Bill Harrington, Journalist, DebtWire
Harrington opined that rating agencies have no accountability beyond publishing methodologies and ratings and that the SEC is abetting the situation. He stated that the SEC cannot comment or provide oversight on rating agencies’ methodologies or comment of ratings, and that although there was a range of legislation that would have helped, the SEC put out a no-action letter to prevent the Dodd-Frank provision that would have exposed rating agencies to expert liability. He argued that the nebulous information presented in ratings is not helpful and that he would like to see ratings agencies treat their ratings as a closed system, and that the SEC should rescind its no-action letter shielding rating agencies from expert liability.
For more information on this event, please click here.