STONE MOUNTAIN, Ga. - Federal Reserve Chairman Ben Bernanke said Monday evening that the economy is still suffering from the financial crisis and talked about the ongoing efforts the Fed and its fellow financial regulators are making to prevent future crises.
Bernanke, in remarks prepared for the Atlanta Federal Reserve Bank's annual financial markets conference, said the Fed has been working with other member agencies of the Financial Stability Oversight Council (FSOC) to better supervise "systemically important" banks.
But he said more regulation is needed of "systemically important" non-bank financial firms and the so-called "shadow banking system."
Bernanke expressed concern about the risks posed by money market funds and the tri-party repo market, the source of so much intraday credit for financial institutions.
And he said the Fed is still analyzing the vulnerabilities of the U.S. economy to the European debt crisis.
Bernanke did not talk much about the economy or monetary policy in his text, but he did briefly point to the lingering economic effects of the financial crisis. And he did talk about the need for monetary policy to operate in tandem with improved financial stability policy.
"About three and a half years have passed since the darkest days of the financial crisis, but our economy is still far from having fully recovered from its effects," he observed. "The heavy human and economic costs of the crisis underscore the importance of taking all necessary steps to avoid a repeat of the events of the past few years."
In the past, Bernanke said the primary responsibility of the Fed and other central banks was seen to be the conduct of monetary policy, but in wake of the crisis a new paradigm has emerged, he said.
"In the decades prior to the financial crisis, financial stability policy tended to be overshadowed by monetary policy, which had come to be viewed as the principal function of central banks," he observed. "In the aftermath of the crisis, however, financial stability policy has taken on greater prominence and is now generally considered to stand on an equal footing with monetary policy as a critical responsibility of central banks."
Bernanke said much has been done to safeguard financial stability through the use of so-called "macroprudential" supervision, but he conceded that "our framework for conducting financial stability policy is not yet at the same level."
He said the Fed and its fellow regulators are "continuing to develop an effective set of macroprudential policy indicators and tools."
Bernanke took aim at the "shadow banking system," where the intermediation of credit takes place through a variety of institutions, instruments, and markets that lie at least partly outside of the traditional banking system.
"Although the shadow banking system taken as a whole performs traditional banking functions, including credit intermediation and maturity transformation, unlike banks, it cannot rely on the protections afforded by deposit insurance and access to the Federal Reserve's discount window to help ensure its stability," he said. "Shadow banking depends instead upon an alternative set of contractual and regulatory protections -- for example, the posting of collateral in short-term borrowing transactions."
In particular, Bernanke voiced concern about money market funds, runs on which amplified the financial crisis in wake of the Lehman Brothers collapse in 2008 and whose heavy withdrawals from European financial instruments contributed to financial strains in the Euro zone earlier this year.
Bernanke noted that the Securities and Exchange Commission amended its regulations in 2010 to require that money market funds maintain larger buffers of liquid assets, which he said "may help reassure investors and reduce the likelihood of runs."
But he suggested that and other rule changes didn't go far enough.
"Notwithstanding the new regulations, the risk of runs created by a combination of fixed net asset values, extremely risk-averse investors, and the absence of explicit loss absorption capacity remains a concern, particularly since some of the tools that policymakers employed to stem the runs during the crisis are no longer available," he said.
SEC Chairman Mary Schapiro has advocated additional measures to reduce the vulnerability of money market funds to runs, including possibly requiring funds to maintain loss-absorbing capital buffers or to redeem shares at the market value of the underlying assets rather than a fixed price of $1, he noted.
Bernanke also cited a need for reform of repo markets.
"The initial efforts have focused on the vulnerabilities created by the large amounts of intraday credit provided by clearing banks in the triparty repo market," he said. "Intraday credit, while a great convenience in normal times, may foster systemic risk by creating large mutual exposures between securities dealers and clearing banks."
Bernanke warned that "in times of market stress, a dealer default on intraday credit extended could be large enough to pose a threat to the stability of the clearing bank -- institutions tightly connected to the rest of the financial system."
"But were a clearing bank to decline to provide intraday credit to a dealer, that dealer's ability to operate normally would be substantially compromised, likely causing difficulties for its clients and counterparties, including many other financial institutions," he continued. "As a result, during a period of market stress, the actions of clearing banks can jeopardize the stability of securities dealers, and vice versa."
More generally, Bernanke suggested the Fed now sees itself not just as a monetary policy maker, but as a monitor, if not guarantor, of financial stability. He suggested this will be an ongoing challenge because of the ever-changing nature of the financial system.
"Even as we make progress on known vulnerabilities, we must be mindful that our financial system is constantly evolving, and that unanticipated risks to stability will develop over time," he said.
"Indeed, an inevitable side effect of new regulations is that the system will adapt in ways that push risk-taking from more-regulated to less-regulated areas, increasing the need for careful monitoring and supervision of the system as a whole."
Bernanke said the Fed, together with the FSOC, has "stepped up our monitoring efforts" and will continue "developing a framework and infrastructure for monitoring systemic risk."
"Our goal is to have the capacity to follow developments in all segments of the financial system, including parts of the financial sector for which data are scarce or that have developed more recently and are thus less well understood," he said. "For example, based on public data, we develop and monitor measures of systemic importance that reflect firms' interconnectedness and their provision of critical services."
Because data on the shadow banking sector can be more difficult to obtain, he said regulators will "look at broad indicators of risk to the financial system, such as measures of risk premiums, asset valuations, and market functioning."
"We try to gauge the risk of runs by looking at indicators of leverage (both on and off balance sheet) and tracking short-term wholesale funding markets, especially for evidence of maturity mismatches between assets and liabilities," he said. "We are also developing new sources of information to improve the monitoring of leverage."
Bernanke said "broader economic developments can also create risks to financial stability" and said that to assess such risks, "we regularly monitor a number of metrics, including, for example, the leverage of the nonfinancial sector" and use data from the flow of funds accounts "to assess how much nonfinancial credit is ultimately being funded with short-term debt."
He said "this assessment is important because an overleveraged nonfinancial sector could serve to amplify shocks, to the detriment of the functioning of the financial sector and broader economy."
Bernanke concluded by saying that "continuing to develop an effective set of macroprudential policy indicators and tools, while pursuing essential reforms to the financial system, is critical to preserving financial stability and supporting the U.S. economy."
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