Wednesday, June 13, 2012

Fed Governor Tarullo calls for making 'shadow banking' more transparent

According to the Wall Street Journal's Real Time Economics blog, Fed Governor Daniel Tarullo called for making shadow banking less risky by increasing transparency.

It is nice to see that someone at the Fed agrees with your humble blogger that the way to lower the risk of the financial system is by increasing transparency.

Federal Reserve governor Daniel Tarullo pressed Tuesday for quick action to reduce risks in the shadow banking system, including in money-market mutual funds and in short-term financing markets. 
Murky corners of the financial system still pose vulnerabilities and regulators should work to make the “shadow banking” system more transparent and less vulnerable to risk, Mr. Tarullo said in a speech delivered via satellite to a conference at the Federal Reserve Bank of San Francisco on Tuesday. 
“We ought not to wait for the comprehensive solution,” he added. “We need to identify areas of vulnerability in clear established markets in order to act there.”...
Clear areas of vulnerability include banks, structured finance securities and repurchase agreements.
He called broadly for more transparency throughout the shadow banking system and especially in the repo market, where Wall Street goes to borrow and lend fixed-income securities. He also said that regulation was a possibility. 
“Large segments of the repo market remain opaque today,” he noted.... 
The repo market, which came under extreme stress following the failure of Lehman Brothers in September 2008, allows banks and other institutions to borrow and lend bonds and, in turn, provides a vital source of short-term financing to banks. Since that crisis, regulators have worried that settlement failure between two counterparties in that market could undermine the entire financial system. 
Naturally, the regulators don't focus on why the repo market came under extreme stress.  It came under extreme stress because a) no one could tell which banks were solvent and which were not and b) what the value of the structured finance securities used in repo agreements was.

Both of these causes of stress would be eliminated if transparency were brought to bank disclosure and structured finance.

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