Additionally, having some excess capacity, also known as headroom, in ON RRP operations over expected usage is important for the facility’s effectiveness in helping to control rates. One might want such headroom – which provides confidence to market participants that an ON RRP cap will not bind – to be somewhat higher on average if take-up in ON RRP operations becomes more volatile. Given the importance of a successful liftoff to the Federal Reserve’s credibility, the FOMC has indicated an intention to set ON RRP capacity at a temporarily elevated level when policy firming commences to support policy implementation. As always, the Federal Reserve will monitor financial markets closely and make adjustments in its execution of monetary policy, as needed, to achieve its mandated objectives. Changes in money markets The operational approach for policy normalization I described earlier refocuses the mechanism for implementing monetary policy back to money markets, after the post-crisis period in which policy has been driven by large-scale asset purchases. However, we will be operating in a complex, dynamic, and still-evolving market environment that looks much different from the money markets in which the Fed last operated actively to achieve its interest rate objectives. Still, these markets are no less important for the transmission of monetary policy or the broader U.S. financial system than they were before. 19  In order to explore how term tools might be used more broadly during normalization, the Desk also conducted a series of one-week term RRP operations in mid-February through early-March 2015.

Supervisors will have the responsibility to review firms’ compensation policies and structures with institutional and systemic risk in mind and, to apply corrective measures, such as higher capital requirements, to those firms that fail to implement sound compensation policies and practices. Supervisors would also have the ability to modify compensation structures in the case of firms that fail or require extraordinary public intervention. 33. As I already alluded to, supervisors should pay a major attention to financial firms’ governance. As it stands, prudential regulation to a large extent is build on trust in their ability to value, manage and control their risks. Supervisors should have the power to hold boards responsible for the performance of their institutions. They should ensure that boards and individual directors are sufficiently empowered and informed to understand and to respond appropriately to their risk taking policy. 34. In light of the crisis, proper liquidity risk management should also stand high in firms’ own agenda. In many respect, the recent crisis revealed wrong liquidity pricing and poor liquidity risk valuation by financial firms. There is ample evidence that in an environment of excess global liquidity prior to the recent crisis many financial institutions were led to (i) overestimate the liquidity of their assets, (ii) have overly optimistic assumptions on their ability to refinance, and (iii) ignore, or pay insufficient attention to, liquidity risks in their internal pricing processes. 35. One should never forget that liquidity has a price.