Treasury Secretary Yellen Highlights Regulatory Approach to Risks Posed by Nonbank Financial Institutions

Treasury Secretary Janet Yellen described U.S. banking regulators' response to recent bank failures and highlighted Treasury's regulatory approach to risks posed by nonbank financial institutions.

In remarks before the National Association for Business Economics 39th Annual Economic Policy Conference, Ms. Yellen stated that in order to mitigate systemic risk and preserve the broader U.S. banking system, banking regulators guaranteed insured and uninsured deposits "almost immediately" upon Silicon Valley Bank's ("SVB") and Signature Bank's failures. She made clear that the banks’ failures are "very different" than the events surrounding the 2008 financial crisis. In 2008, she said, banks came under stress as the result of their subprime asset holdings. In the process of evaluating the failure of SVB and Signature, Ms. Yellen said it was important to first consider whether current supervisory and regulatory regimes adequately address risks faced by banks today, and to consider steps to mitigate those risks if necessary.

Ms. Yellen underscored that one of the Financial Stability Oversight Council's ("FSOC") top priorities is "mitigating vulnerability in nonbank financial intermediation." She highlighted "guiding principles" for mitigating nonbanks risks. For policymakers, these include: (i) addressing risks regardless of their source and ensuring that activities that pose similar financial stability risks are treated with similar levels of regulatory scrutiny, and (ii) tailoring policies to account for the "unique structural features" of the institutions and markets they regulate.

She identified several nonbank financial institutions and their unique risks:

• Money Market and Open-End Funds. Ms. Yellen stated that the "structural vulnerabilities at the heart of money market and open-end funds aren’t new." She said that the incentive for a run in times of extreme stress is caused by a "first-mover advantage" for investors that exit funds first. She noted that the SEC proposed rules to reduce first-mover advantage and incentives, in addition to imposing new liquidity management tools.
• Hedge Funds. While the use of leverage among hedge funds is relatively small, Ms. Yellen said that its "appears to be concentrated among a select number of large hedge funds." She stated that to address financial stability risks due to leverage, Treasury (i) restored the FSOC Hedge Fund Working Group which has developed a risk monitoring framework to detect related-risks in the financial system and (ii) directed the Office of Financial Research to expand data collection on bilateral repo transactions without a central counterparty.
• Digital Assets. Ms. Yellen acknowledged that while new technologies can offer "faster, safe, and cheaper financial services," they can also cause significant disruption and harm. Specifically, the run incentives that Ms. Yellen had mentioned being present in the traditional financial system, are also present for stablecoin. She explained that stablecoin holders have a first-mover advantage which she warned can lead to a "contagion" of fire sales and runs as seen in 2008 and 2020. To address the risks posed by stablecoins, Ms. Yellen said that Treasury has recommended Congress create a prudential regulatory framework for stablecoin issuers. Furthermore, she said that Treasury is examining the risks unique to digital assets caused by (i) vertical integration of crypto-trading platforms and (ii) a lack of visibility into the operations of subsidiaries.

Ms. Yellen concluded that one of the most critical short-term Congressional actions to safeguard our financial stability would be to raise or suspend the debt limit before crisis strikes. She added that if the United States defaults on its obligations, there would be economic and financial catastrophe that hurts Americans and extends globally.