U S Department of Treasury : Introductory Remarks of Deputy Secretary Sarah Bloom Raskin at the Fourth Annual OFR-FSOC Conference

As prepared for delivery

WASHINGTON - Good morning, everyone.  It's my pleasure to welcome you to today's event, the fourth annual conference co-hosted by the Office of Financial Research and the Financial Stability Oversight Council.  I want to thank Dick Berner and Trish Mosser from the Office of Financial Research, Patrick Pinschmidt the Financial Stability Oversight Council's Executive Director, and their teams for arranging this year's conference.  I also want to thank Chairman Gruenberg and the FDIC staff for graciously hosting us all.

Today's conference, like the three before it, continues the consistent commitment to, and focus on, ensuring that regulators are identifying, monitoring, and addressing systemic risk in a timely and effective way.  Indeed, this conference exemplifies the dedication to the transparent and spirited discussion that we need on this complex and crucial policy topic, and I am glad the OFR and the FSOC are leading the way by facilitating this engagement.

Since the financial crisis, governments around the world have substantially strengthened financial regulation, and as we implement this work, we are beginning to see the development of significantly improved regulatory and supervisory practices; and, again positively, these practices are becoming more embedded into a comprehensive system of prudential regulation. 

Policymakers here and abroad have accomplished a great deal to confront financial stability challenges.  Working together, we have established a more rigorous capital regime for the largest banking institutions and implemented stress tests to help calibrate those new requirements in practice.  We have reached international consensus on key components of liquidity regulation, including minimum requirements for firms' holdings of liquid assets and measures to strengthen short-term, wholesale funding markets.  Regulations have also been promulgated to strengthen, and improve transparency in, derivatives markets.

But still, much work remains to be done.  As we all fully know, the U.S. regulatory system (let alone the global one) is fragmented; and, hence, it takes time to coordinate, to develop and implement policies and to calibrate them appropriately.  Such is today's imperative.  We are still in the early stages of assessing the comprehensive impact of the Basel standards and Dodd-Frank Act requirements.  Though the bulk of the Dodd-Frank reforms have been adopted, many are still being phased in, and regulators are in various stages of analyzing the effectiveness of efforts that increase the amount, and improve the quality, of required minimum capital; of continued stress testing and capital planning; and of tools to monitor and reduce risk related to short-term wholesale funding.

These reforms are essential to building resilience to absorb future shocks. They reduce the risks to financial stability that could be posed by asset bubbles and excessive credit growth, excessive leverage, inappropriate maturity transformation, non-transparent exposure to unstable funding; and thus, these reforms reduce the potential for future financial crises.

Today's conference provides an opportunity to openly assess our progress, identify and weigh unintended consequences, and refine perspectives.   In particular, we can use this forum to ask important questions:  Where are the sources of complementarity or conflict in these reforms? Are policies sufficiently broad and global, or are they too bank-centric or domestically focused?  Are there other reforms necessary in the context of promoting financial stability? Is risk being contained, or is it drifting to areas with different regulatory standards or outside the regulatory framework entirely?  If there is such a drift, what do we do about the areas where the risk may reside?

These topics deserve thoughtful debate, which is why I am glad that we have a diverse array of distinguished participants here today to engage in discussion on topics including: stress testing; liquidity regulation; margin and haircut regulation; and resolution and recovery.  Without delving too far into each these issues, I would like to set the stage for the panel discussions today.

Stress testing, the subject of the first panel, is now commonly used around the world by supervisors and banks alike. Stress testing requires management, boards, and supervisors to think carefully about the external shocks that might threaten an institution; and it further demands risk-management practices and regulatory capital levels to fortify companies against those shocks.  Likewise, by analyzing asset classes, stress testing can focus attention on particular risks of, and exposure to, potential asset bubbles.  

At the same time, and as the OFR and others here have noted in their research, stress testing would be even more valuable as a macroprudential tool if it could incorporate interactions of financial institutions under stress, and gauge the effect that pivotal decisions have on other institutions.  For example, how do we best incorporate into stress tests the possibilities of fire sales or runs that involve multiple participants?  Likewise, can stress tests be used to evaluate resilience both in terms of liquidity and solvency?

Another panel will discuss liquidity regulation. A principal danger to leveraged financial intermediaries lies in excessive reliance on unstable short-term wholesale funding; a reliance that makes them vulnerable to heightened rollover risk, sudden losses of confidence, and funding runs. Working to address this risk, liquidity regulation increases the stock of cash or easily marketable securities available in the event of a funding run or margin call.  Specifically, under the Basel III accords, bank regulators have agreed to both a liquidity coverage ratio and a net stable funding ratio.  These standards work together to require certain banking organizations to maintain a liquid asset buffer to cover potential cash outflows, and to require that their balance sheets have an aggregate funding structure appropriate to their particular asset mix.  By creating minimum liquidity requirements and weighting assets and liabilities by relative risk levels, the intent is to deter liquidity risk-taking, which in turn reduces the chance of liquidity crises.

Accordingly, it will be important to evaluate these liquidity policies in practice.  For example, are higher capital and liquidity requirements working together to promote a transparent and understandable risk profile for large firms?  Do these policies shift liquidity or risk to other, differently-regulated corners of the financial system?   How can regulators foster an environment where liquidity requirements are countercyclical?  How do we support an environment that encourages firms to use liquidity reserves in periods of stress?

Another panel will discuss haircut or margin floors in secured, short-term funding markets.  Haircuts refer to the difference between the value of collateral and the amount borrowed in a funding transaction.  If the borrower cannot repay and the lender must sell the collateral to satisfy the loan, the haircut provides some protection against any change in the value of the collateral.  Haircuts   tend to be procyclical, falling in good times, which supports credit expansion, and rising in busts, which contracts credit.  Floors on haircuts offer a promising way to mitigate this procyclical tendency.  In October, the Financial Stability Board proposed standards for haircut calculation methods used in securities financing markets that are not centrally cleared, including minimum haircuts for some assets.  But transitioning from concept to implementation raises complex issues.  How should we calibrate haircut floors?  Should they vary by collateral type or counterparty, and if so, how?  Should they be constant or should we try to vary them counter-cyclically?

Today there will also be a panel in which you will discuss the construction of a viable regime for the resolution and recovery of large, complex financial institutions.  Having a viable regime for resolving these institutions is a core component of sustaining financial stability.  Moreover, the scope and structure of the resolution regime will shape market participants and their behaviors.  Already, we see evidence that some of the largest U.S. financial institutions have begun to simplify their corporate structures, making them easier to resolve; but this is an ongoing conversation that will benefit greatly with insight from the panelists this afternoon.

Finally, as I have stated before, and which still bears repeating again and again:  if regulators become fixated on the policy tools at the expense of compliance and enforcement, the tools themselves will be meaningless.  Only when such tools-be they stress test-focused, liquidity-focused, or margin and haircut-focused-are appropriately calibrated and fully embedded into a comprehensive system of prudential regulation will they reach their full potential.

Conclusion

I have raised difficult questions to kick off today's event, but I am confident that you will candidly engage in these and other topics, and will dig into the content covered.  There is no doubt that together, we have much to learn through the protracted lessons of implementation.  There is also no doubt that the tools being discussed today are important components for further promoting the economic imperative of sound and productive financial intermediation.  After all, it is sound and productive financial intermediation-intermediation to provide sustainable, affordable credit to households and businesses-that is required for maintaining economic growth.  

Thank you.

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