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Board of Governors of the Federal Reserve System
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Federal Reserve Board of Governors

Statement by Governor Jeremy C. Stein

December 14, 2012

Let me start by adding my thanks to the many people who put so much thought, effort, and care into crafting this proposal. These are important issues for financial stability, and I view this proposal as a strong step in the right direction.

As Governor Tarullo has noted, the proposal addresses a number of vulnerabilities that were revealed during the 2007-2009 crisis, and that have resurfaced again with the ongoing financial strains in Europe. I will focus my comments on one such vulnerability: the heavy reliance by the U.S. offices and affiliates of many large foreign banks on short-term, wholesale dollar funding, such as large time deposits and commercial paper that are often placed with U.S. prime money market funds. This funding model became increasingly prevalent in the years leading up to the crisis.

Although this funding model provided a cheap source of dollar financing to foreign banking organizations, research conducted here at the Fed and elsewhere has documented that it led to two related sorts of problems when markets became stressed and the credit quality of foreign banks came into question. First, as their access to dollar funding markets dried up, foreign banks attempted to obtain dollar funding in a number of markets, including by swapping euros into dollars with the FX swap markets, but the cost of dollar funding rose in all these markets. And second, with dollar funding scarcer, some foreign banks were forced to sell U.S. dollar-denominated assets, and dollar-denominated lending by these banks, to borrowers both in the U.S. and abroad, was cut back.

These problems were mitigated to some extent by Federal Reserve policy actions. In the early stages of the crisis, U.S. branches of foreign banking firms were major borrowers from the Fed's liquidity facilities, which allowed them to replace some of their lost dollar funding. And the Fed's dollar swap lines with the ECB and other central banks also helped at various points to ease the dysfunctions in dollar funding markets. Nevertheless, it should go without saying that an important goal of our regulatory program, with respect to both domestic and foreign banking firms, is to reduce the likelihood that such emergency liquidity-provision measures will have to be undertaken in the future.

This proposal is one significant piece of that broader effort. It aims to enhance financial stability by strengthening the liquidity and capital positions of the U.S. operations of foreign banking organizations. Importantly, in so doing, the proposal would not disadvantage foreign banking organizations relative to domestic U.S. banking firms, but rather it seeks to maintain a level playing field.

>While the proposal may lead foreign banks to change the way they organize some of their U.S. operations, ultimately these changes should make the banking system more resilient. In particular, the proposal is intended to address funding fragility by encouraging banks to lengthen the maturities of their dollar liabilities. Although the proposal may reduce somewhat the gross cross-border positions of foreign banking organizations, from the evidence that I've seen, the effect on credit availability and on economic activity more broadly seems unlikely to be significant relative to the benefits. Additionally, we expect to provide a meaningful transition period, which will help minimize the effect on economic growth.

Finally, I would be especially interested in any commentary on two aspects of the liquidity buffer: First, for that portion of the buffer that branches are, according to the proposal, allowed to hold outside the United States, what are the costs and benefits of permitting that remaining buffer to be kept in a currency other than dollars? And second, should the Board provide more clarity around when the buffer should be used to meet liquidity needs during times of stress? In other words, what standards would be appropriate for governing the "usability" of the liquidity buffer?

I look forward to comments on these and other issues in the proposal. Thank you.

Last update: August 2, 2013