Financial regulators need to come up with new tools to regulate shadow banking system in order to guard against system-wide crises, a top Federal Reserve official said Friday.
Daniel Tarullo, a Federal Reserve governor and the de facto point man for the central bank on regulation, singled out the asset management industry in particular for regulation in his remarks at a meeting of federal regulatory agencies in Arlington, Virginia.
In the wake of the 2008 financial crisis, the Fed, Treasury and other agencies have addressed risk on Wall Street by raising capital ratios, running stress tests to ensure banks’ safety and instituting other new rules. But by tightening regulation on big banks, Tarullo warned, the government may “be increasing incentives” for more lending to “migrate outside the regulatory perimeter” to so-called shadow banks.
Shadow banking refers broadly to any financial activity taking place outside of the banks regulated by the Fed and other agencies, including through mutual funds, hedge funds, government-sponsored enterprises and other firms. The shadow banking system is roughly the same size of the traditional banking sector in the U.S. and growing, according to the International Monetary Fund.
Tarullo said Friday that asset managers, firms such as Fidelity or BlackRock, could pose a risk to the financial system if they were forced to sell off assets quickly. Such a fire sale could drive down asset prices and cause problems at other companies, including banks.
Increased regulation of asset management firms has been a topic of interest at the Financial Stability Oversight Council, a super-group of regulators tasked with identifying overall threats to the financial system. The Fed is represented at the Council by chairwoman Janet Yellen. Critics have said that asset managers pose no systemic threat, given that they can simply return money to investors in the case of a panic.
Tarullo’s comments indicated that he thought asset management was nevertheless a candidate for new oversight and regulations.
Tarullo also stressed the need for margin requirements for short-term borrowing by firms that rely heavily on such transactions for funding. He said that the Fed would soon propose a rule to implement an internationally-brokered framework for such margins, and that it would look for additional ways to oversee shadow banking.
