Fed's Tarullo: Consensus Growing Around TBTF Resolution Plans

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Daniel Tarullo, governor of the U.S. Federal Reserve, chats with a guest before speaking at the Clearing House Association L.L.C.'s first annual business meeting and conference in New York, U.S., on Wednesday, Nov. 9, 2011. The Federal Reserve will address some banks' concerns that they may not be allowed under new rules to provide shareholder payouts as they wish, Tarullo said. Photographer: Scott Eells/Bloomberg *** Local Caption *** Daniel Tarullo

WASHINGTON — Federal Reserve Governor Daniel Tarullo said Friday that consensus is growing around key aspects of the resolution authorities granted to by Congress after the financial crisis five years ago.

Tarullo, who oversees regulatory efforts at the Fed, said "the emergence of a growing consensus around the key elements of a credible resolution mechanism, and the work to engraft those elements into appropriate statutory and administrative frameworks, is one of the more unheralded - if still in progress - successes of the post - crisis regulatory response."

The Dodd Frank Wall Street Reform Act, passed in 2010, gave regulators the authority to find ways to take down failing financial firms in an orderly way, so as not to upend the financial markets.

Referred to as Title II, this resolution mechanism "is gaining greater operational credibility as the FDIC builds out its single-point-of-entry approach," Tarullo said in prepared remarks at a conference on resolution planning for financial institutions.

The conference, hosted by the Federal Reserve Bank of Richmond and the Fed's Board of Governors, was kicked off by Richmond Fed Bank President Jeffrey Lacker who said "ensuring that the relevant portion of the financial sector is covered by robust and credible resolution plans can seem like a daunting task."

Tarullo said there has been progress on the task at hand, though. "With each rule, policy statement, cross-border agreement, and firm-specific resolution plan, that credibility is further increased," he said.

Still, Tarullo admitted "considerable work remains, so as to continue building and communicating a credible resolution mechanism" that will adequately inform investors, creditors, and counterparties of large financial firms and give them "reasonable expectations as to how a resolution would be conducted."

Without such a consensus, he said, "necessary but unpalatable government interventions during the crisis would only further entrench the too-big-to-fail status of systemic financial firms - increasing moral hazard, undermining market discipline, and harming competitive equality among financial institutions of different sizes."

Tarullo also stressed that while such a mechanism is important in trying to contain too-big-to-fail problems, "it would not be desirable to have to use it. The more desirable outcome would be for its very credibility to work in concert with capital, liquidity, and other applicable regulations to reduce the chances of its actual utilization."

The Federal Reserve, in consultation with the FDIC is likely to propose in the next few months, requirements for the largest, most complex banking firms "to hold minimum amounts of long-term, unsecured debt at the holding company level," Tarullo said.

"This requirement will have the effect of preventing erosion of the current long-term debt holdings of the largest, most complex U.S. firms, which, by historical standards, are currently at fairly high levels," he said.

He added that "absent a minimum requirement of this sort, one could expect declines in these levels as the quite flat yield curve of recent years steepens; indeed, we have recently seen some evidence of the beginnings of such declines."

Tarullo also said short-term wholesale funding markets still posed a risk to the financial system during a crisis, and need to be addressed in resolution planning. "The most important systemic vulnerabilities that have not been subject to sufficient regulatory reforms are those created in short-term wholesale funding markets," he said.

Tarullo pointed to three critical issues addressed by Dodd Frank's Title II resolution, which provides for a resolution mechanism for large financial firms that deals with unique characteristics of financial markets.

Particularly, he said the speed of resolution, provide a source of immediate funding and the temporary stay of close-out rights of qualified financial contract counterparties.

Even when a large systemically important financial firms can be resolved at no cost to taxpayers, Tarullo said, "there will very likely still be significant negative externalities in the financial system. That is, even if a firm is not too-big-to-fail, it may still be of sufficient systemic importance to make its failure a costly event."

Market News International is a real-time global news service for fixed-income and foreign exchange market professionals. See www.marketnews.com.

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