This underscored a critical structural weakness of money market mutual funds created by the convention that the net stable asset value could be fixed at par. When a money market mutual fund incurs losses that cause it to “break the buck,” this encourages investors to rush to withdraw their funds from other funds before they break the buck. The result can be a run on money market mutual fund assets. In the United States, the Securities Exchange Commission has already tightened the rules with respect to liquidity, quality and the average maturity of so-called 2a-7 fund assets, but there is still more to be done to address the remaining vulnerabilities. As mentioned earlier, the final major strand of regulatory reform is to strengthen the core of the financial system and make the system as a whole robust to the failure of a large bank or non-bank financial institution. In this realm, there are several notable initiatives. First, an effort is underway to create robust resolution regimes that allow large systemically important financial institutions to be wound down smoothly in a way that minimizes contagion and the risk of a broader panic or that causes damage to other parts of the financial system. For example, the Dodd-Frank Act gives enhanced resolution powers to the Federal Deposit Insurance Corporation (FDIC) to use to wind down large, complex non-bank financial institutions. If such a firm becomes troubled, the regulators, with concurrence from the U.S. Treasury, can avert a bankruptcy filing and instead put the non-bank financial company into resolution.

The move toward a tougher capital and liquidity regime undoubtedly receives the greatest attention in terms of the measures being implemented to make large banks safer. However, there also are a number of other important changes being made to supervisory practices in the United States and elsewhere. One noteworthy example is the more widespread use of horizontal stress tests to ensure that banks have adequate capital. This is a very important development, because it makes the evaluation of capital more forward-looking. The issue is not just how much regulatory capital a bank has currently but how that bank’s capital level is likely to evolve over time in adverse economic circumstances. In the United States, another important change is that we are refocusing our supervisory practices to identify structural weaknesses and to push firm managements to remedy their shortcomings relative to “best practice” standards. Horizontal reviews across the large banks are being undertaken to identify firm-specific deficiencies. At the Federal Reserve, we are placing greater emphasis on understanding banking organizations’ business models and strategies – in other words, better understanding the specific markets and activities from which the banking organizations make money over time and the nature of the risks they take in this process. Strong risk management practices within organizations are particularly important, as risk managers must be empowered to stand up to those in the front office and prevent activities and practices that create risks or incentives that are incompatible with bank safety and soundness.