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POLITICS: PennAve

New banking rules could raise cost of borrowing, critics warn

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Politics,Treasury,Finance and Banking,PennAve,Joseph Lawler,Economy,Federal Reserve,Janet Yellen,Wall Street,PoliticsToday

New regulations intended to prevent future financial panics will force banks and other companies to hold more Treasury securities, a move that some critics think could raise the cost of banking for ordinary people and create its own source of financial panic.

Bank regulators moved Wednesday to require banks to hold an additional $100 billion in liquid assets to ensure that they would be able to raise enough cash to survive a run, a major new regulation meant to prevent a repeat of the 2008 financial crisis and taxpayer-funded bailouts.

The top category of assets counted as liquid are Treasury securities, which can be exchanged for cash even in the midst of a crisis.

But some in the financial industry worry that the effect of the rule could be to lower banks' income, thereby raising costs for their customers. And they are concerned that once it and other recent reforms requiring financial companies to hold more high-quality, liquid assets are phased in, the rules could exacerbate an ongoing “safe asset shortage” — a lack of high-quality collateral crimping normal lending by banks.

“Rule after rule is increasing concentration by investors, banks and others in what are called high-quality liquid assets,” said Wayne Abernathy, vice president at the American Bankers Association.

"In a stress, everyone's going to be looking for those,” Abernathy warned. “When you have a shortage of something everyone wants, you’re creating the conditions for panic."

In addition to the new liquidity rule, post-recession rules reforming money market mutual funds push for greater Treasury holdings. A run on the Reserve Primary Fund, a money market mutual fund, in September 2008 greatly exacerbated the financial crisis.

But some experts believe that requiring such funds to hold more Treasurys, coupled with rules requiring banks to hold similar assets, might have other costs regulators haven’t anticipated.

“The whole focus on having everyone hold Treasury securities doesn’t seem like the best plan of action,” said Hester Peirce, a researcher at the libertarian Mercatus Center.

Introducing the liquidity rule, a regulatory agency official addressed such concerns, saying that “we don’t think [the requirement] will substantially impact or create a shortfall of Treasurys,” adding that companies can meet the required ratio of liquid assets by divesting illiquid assets such as long-term corporate bonds or real estate.

As for the added borrowing costs to consumers whose banks or mutual funds would be forced into lower-yielding assets, officials think it will be a small price to pay to ensure that the economy avoids another disaster similar to the one that struck in 2008.

Bill Nelson, deputy director of monetary affairs at the Federal Reserve, acknowledged at the agency’s vote on the liquidity rules that they will “make credit a bit more costly.” But that must be “weighed against” the benefit that requiring banks to have greater liquidity will make “financial crises less likely and less severe” – and financial crises entail a collapse in credit.

Furthermore, the supply of short-term Treasurys available to companies for regulatory purposes has been significantly increased by the introduction of a new tool that the Federal Reserve uses to control interest rates. The Fed sets short-term interest rates by borrowing from financial firms for very short time periods, giving them Treasury securities as collateral.

Federal Reserve Chairwoman Janet Yellen and other members of the central bank are still debating how heavily they should rely on the tool, known as the reverse repo facility, when they decide to raise rates. Recently, however, it has become large, totaling between $100 billion and $200 billion in overnight loans over the past month.

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