Michael S Barr: Supporting market resilience and financial stability
Speech by Mr Michael S Barr, Vice Chair for Supervision of the Board of Governors of
the Federal Reserve System, at the 10th Annual US Treasury Market Conference,
Federal Reserve Bank of New York, New York City, 26 September 2024.
* * *
Thank you, and thank you for the opportunity to speak to you today.1
It is great to be here again, particularly because this year marks the 10th annual
conference on the Treasury market, a milestone that is worth celebrating. I want to
acknowledge the Federal Reserve Bank of New York for its leadership in this area,
including the dedication and excellence it has brought to hosting this conference over
the past decade, in collaboration with the Inter-Agency Working Group on Treasury
Market Surveillance, led by the Treasury Department. The Treasury market is the
means by which our government meets its financing needs in service to the American
people, and it is also the bedrock of the financial system. Promoting the resilience of the
Treasury market and ensuring it can continue to fulfill these roles requires the
collaboration of agencies and individuals across the government along with the private
sector.
As others have pointed out today, we have made important progress since last year's
conference. The Securities and Exchange Commission has finalized a rule on central
clearing of Treasury transactions, the Treasury Department has instituted a program for
buying back less-liquid Treasury securities, and the Office of Financial Research is
preparing for its permanent collection of data on non-centrally-cleared bilateral
repurchase agreement (repo) transactions, which will support our understanding of this
market segment as it evolves.
I will share some thoughts with you on how I see the work of the Federal Reserve in
supporting Treasury market resilience. Our capital and liquidity regulations, our
supervision of the firms over which we have authority, and our liquidity facilities play
important roles in supporting market resilience and financial stability. Earlier this month,
I gave a speech where I reiterated the crucial role of capital in serving these objectives,
and the need to balance resilience and efficiency in designing our rules. In that speech,
I also outlined the elements of a capital re-proposal that I believe will have broad
consensus at the Federal Reserve Board. The adjustments are in response to a robust
public comment process, and some of them are designed to address interactions and
market functioning concerns raised by commentators.
In terms of rulemaking, today I will focus on some additional aspects of our regulatory
framework-namely, enhancements to our liquidity regulations. I will share some
perspective on how our liquidity regulations work together and are supportive of market
functioning and the smooth implementation of monetary policy.
The Intersection of Monetary Policy Tools and Supervision and
Regulation
We consider how all of the Fed's tools work together to support our objectives. In
previous speeches, I have talked about the role of the discount window and the
standing repo facility (SRF) in supporting both monetary policy implementation and
financial stability, noting how important it is that eligible institutions be ready to use
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these facilities. Today I want to dig into this topic a bit more, including how these tools
support monetary policy implementation through appropriate incorporation into liquidity
regulations and supervisory practices.
After the banking stress in March 2023, we saw a substantial improvement among
banks of all sizes in their level of readiness to tap the discount window both in taking
the necessary steps for set-up and in their pledging of collateral. Since that time, over
$1 trillion in additional collateral has been pledged to the discount window, and
additional banks have established access to the SRF. Both of these facilities are
potential venues for monetizing assets and raising liquidity to address volatility in
private funding market rates or gaps in the availability of private-market funding.
We had been hearing that some were confused about how banks could incorporate
ready access to the discount window and the SRF into their contingency funding plans
and internal liquidity stress tests. Supervisors have a role in assessing the viability of
large banks' plans to meet stressed outflows in their stress scenarios, and we have
been asked whether the discount window, the SRF, and also Federal Home Loan Bank
advances can play a role in those scenarios. The answer to this question is "yes."
We provided clarity to the public in August on permissible assumptions for how firms
can incorporate the discount window and the SRF into their internal liquidity stress-test
scenarios. There are a couple of principles that underlie our response in the frequently
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asked questions we posted on the Board's website. One principle is that our tools are
readily available to firms. This means that we see it as acceptable and beneficial for
firms to incorporate our facilities to meet liquidity needs in both planning and practice. If
firms plan to use our facilities, we expect them to demonstrate ex ante that they are fully
capable of doing so, including through test transactions. An additional principle
underlying our approach is that, while firms should be ready to use a range of funding
sources, firms need to hold sufficient highly liquid assets to meet their potential liquidity
needs. That is, they need to self-insure against their own liquidity risks. A third principle
is that firms should be ready and able to use private channels to turn these assets into
cash, in addition to any public channels they may plan to use.
I want to dig a bit deeper into the benefits to both individual firms and the financial
system when firms incorporate Fed facilities into their stress preparedness planning.
Again, a design feature of our liquidity regulations is that large banks must self-insure
against major liquidity risks. Our regulations also provide flexibility in terms of the
portfolio composition such banks use to do so. This flexibility allows them to adjust their
portfolios based on market conditions and firm needs. A key component of this flexibility
is that reserves and certain high-quality liquid assets (HQLA), such as Treasury
securities, are equivalent in terms of being treated as the highest quality of liquid
assets. This feature is important because, while it allows firms to manage their liquidity
buffers more flexibly, it also allows for greater flexibility in our monetary policy
implementation and it supports market functioning. We have heard over the years,
however, that the degree of substitutability among these assets has been limited by
concerns about capacity in stress for the market to turn securities into reserves
immediately; these concerns are valid. This constraint can be addressed in part by the
appropriate incorporation of Federal Reserve facilities into monetization plans in firms'
internal liquidity stress tests.
When firms understand that they will not be fully constrained by the capacity of private
markets or their individual credit lines to monetize HQLA immediately in stress, they can
reduce their demand for reserves in favor of Treasury securities, all else being equal,
for their stress planning purposes. This dynamic improves the substitutability of holding
reserves and holding Treasury securities either outright or through repo transactions.
When banks exhibit a high degree of substitutability of demand for these assets, money
market functioning improves. Let me explain with an example. If a bank sees holding
reserves and investing in Treasury repo as near substitutes in its liquidity portfolio, it
should lend into Treasury repo markets when repo rates rise above the interest rate
earned on reserves. When banks can nimbly adjust portfolios in response to price
incentives, the efficiency of reserves redistribution through the system improves, and
market functioning is enhanced.
In aggregate, this activity can prevent rates from rising further, all else being equal. The
point at which banks, in aggregate, have a relatively immutable demand for reserves,
and are unwilling to lend them out, is evident when a small decrease in the supply of
reserves results in a sharp increase in the cost to borrow them. Our monetary policy
tools are well positioned to help us avoid this outcome. But, of course, greater
willingness of banks to reallocate across close substitutes should help avoid the
emergence of sudden pressures in money markets by reducing money market frictions.
In 2021, the Federal Reserve launched the SRF, which, along with the discount
window, should help cap upward pressure in repo markets that could spill over into the
federal funds market. Use of these facilities also increases the supply of reserves in the
system. The enhanced clarity for firms that Fed facilities are a fully acceptable venue to
get same-day liquidity for their HQLA should help reassure firms about holding reserves
and their close substitutes, such as Treasury securities, in their liquidity portfolios.
Of course, as I stated earlier, for the largest banks, there is a requirement that they hold
highly liquid assets to address their own liquidity risks. They must also be ready to use
private markets to monetize these assets. It is also critical that banks recognize and
manage the interest rate and liquidity risk of their securities portfolios to ensure those
securities held for liquidity purposes can be monetized in stress without creating other
adverse effects on a firm's safety and soundness. In 2022 and 2023, certain large
banks did not effectively manage the risks of rising rates, and suffered significant fair
value losses on their securities holdings, including those in held-to-maturity (HTM)
portfolios. These losses affected their ability to respond to liquidity stress, as monetizing
the assets could result in realizing losses. When the banking stress hit in March 2023,
these securities could not be sold to meet stressed outflows because large unrealized
losses inhibited their sale without significant capital implications. This is further
complicated in the case of HTM securities, which cannot be sold without risking
revaluing a firm's entire HTM portfolio. Selling HTM securities to generate liquidity
would therefore have had a particularly large effect on these firms' capital levels, likely
increasing the stress on these firms. Further, some firms were unable to rely on private
channels such as repo markets for monetization because they were not prepared, they
were not regular participants in the market, and market participants were unwilling to
lend because of counterparty credit concerns. This combination of factors meant that
HTM securities that had been identified by banks as available to serve as a liquidity
buffer of assets in stress could not effectively serve that function.
Improvements to Our Liquidity Regulations
As I have mentioned in previous speeches, to address the lessons about liquidity
learned in the spring of 2023, we are exploring targeted adjustments to our current
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liquidity framework. Many firms have taken steps to improve their liquidity resilience,
and the regulatory adjustments we are considering would ensure that large banks
maintain better liquidity risk-management practices going forward. Improvements to our
liquidity regulations will also complement the other components of our supervisory and
regulatory regime by improving banks' ability to respond to funding shocks.
Specifically, we are exploring a requirement that larger banks maintain a minimum
amount of readily available liquidity with a pool of reserves and pre-positioned collateral
at the discount window, based on a fraction of their uninsured deposits. Community
banks would not be covered, and we would take a tiered approach to the requirements.
The collateral pre-positioned at the window could include both Treasury securities and
the full range of assets eligible for pledging at the discount window. It is vital that
uninsured depositors have confidence that their funds will be readily available for
withdrawal, if needed, and this confidence would be enhanced by a requirement that
larger banks have readily available liquidity to meet requests for withdrawal of these
deposits. This requirement would be a complement to existing liquidity regulations such
as those that require the internal liquidity stress tests (ILST) I described earlier as well
as meeting the liquidity coverage ratio (LCR).5
Incorporating the discount window into a readiness requirement would also
reemphasize that supervisors and examiners view use of the discount window as
appropriate under both normal and stressed market conditions.
In addition, as I have discussed previously, we identified significant gaps in interest rate
risk management in the March 2023 banking stress, including in portfolios of highly
liquid securities. Relatedly, we saw that banks faced constraints in monetizing HTM
assets with large unrealized losses in private markets because they were unable to
repo these securities or sell these securities without realizing significant losses. To
address these gaps, we are considering a partial limit on the extent of reliance on HTM
assets in larger banks' liquidity buffers, such as those held under the LCR and ILST
requirements. These adjustments would address the known challenges of banks being
able to use these assets in stress conditions.
Finally, we are reviewing the treatment of a handful of types of deposits in the current
liquidity framework. Observed behavior of different deposit types during times of stress
suggests the need to recalibrate deposit outflow assumptions in our rules for certain
types of depositors. We are also revisiting the scope of application of our current
liquidity framework for large banks.
These enhancements to our liquidity regulations will help bolster firms' ability to manage
liquidity shocks, and they will also be well integrated with our monetary policy tools and
framework.
Modernizing Our Tools to Meet Current and Future Needs
Turning back to the discount window, I also want to note that the discount window has
served its role well in recent years, and that we are also engaging in ongoing work to
improve its operations. Given the crucial role of the discount window in providing ready
access to liquidity in a wide variety of market conditions, we continuously work to
assess and improve its functionality while engaging with current and potential users of
the window.
Among the steps we have taken recently include that we now have an online portal,
Discount Window Direct, that allows firms to request and prepay discount window loans
in a more streamlined manner than was previously possible. We also recently published
a request for information on discount window operations and daylight credit asking
about key components of these functions. Feedback from the public will help us
prioritize areas for improvement, so I strongly encourage anyone with an interest in this
topic to weigh in during the comment period. Your feedback will help us ensure that the
discount window continues to improve in its role of providing ready access to funding
under a variety of market conditions.
Thank you.
1
The views I express here are my own and not necessarily those of my colleagues on
the Board of Governors of the Federal Reserve System or the Federal Open Market
Committee.
2
See Michael S. Barr (2023), "The 2023 U.S. Treasury Market Conference," speech
delivered at the Federal Reserve Bank of New York, New York, November 16.
3
See "Subparts D and O-Enhanced Prudential Standards" in Board of Governors of the
Federal Reserve System (2024), "Frequently Asked Questions about Regulation YY,"
webpage.
4
See Michael S. Barr (2024), "On Building a Resilient Regulatory Framework," speech
delivered at Central Banking in the Post-Pandemic Financial System, 28th Annual
Financial Markets Conference, the Federal Reserve Bank of Atlanta, Fernandina
Beach, Fla., May 20.
5
The LCR and ILST are two separate, but complementary, liquidity requirements. The
LCR is a standardized liquidity measure across banks, meaning the outflow
assumptions are the same for each bank. The ILST is a nonstandardized liquidity
measure across banks, meaning each bank determines its own outflow assumptions,
subject to supervisory input.