FRB Governor Daniel K. Tarullo on Financial Stability Regulation (Important Speech)

Federal Reserve Board Governor Daniel Tarullo gave a speech ("Financial Stability Regulation") in which he examined the sources of systemic risk, its treatment in financial regulation, and the job of creating a "financial stability regulatory system" under Dodd-Frank. Tarullo framed the decades leading up to the recent financial crisis as "essentially deregulatory," and as a period that placed light emphasis on systemic risk. As a result, he stated, legislators who were tasked with crafting a response to the financial crisis had to write Dodd-Frank "on a mostly blank slate." The product of that process, then, is a bill that that provides a framework for financial stability regulation to be developed, but which leaves most of the heavy lifting to regulators, who are often asked to coordinate their rulemakings. Complicating matters, Tarullo noted, is the fact that, so far, there has been little consensus on how exactly financial stability may be undermined.

In reviewing the legal and institutional framework established by Dodd-Frank, Tarullo focused his suggestions on a few specific areas. With respect to the Federal Reserve approval of mergers between large financial firms, Tarullo suggested a strong, but not irrebuttable, presumption of denial for any acquisition by a firm that falls into the higher end of the list of global systematically important banks developed by the Basel Committee, and a slightly less robust presumption of denial for firms at the lower end of the list. He argued that, even though our tools for assessing a firm's systemic footprint are still being developed, such presumptions would be reasonable because "everything we do know suggests that the firms on the Basel Committee list strongly implicate the kinds of systemic considerations mentioned by Congress."

Further addressing the issue of large financial firms, Tarullo suggested capping the non-deposit liabilities of financial firms to a specified percentage of U.S. gross domestic product, thus limiting the "growth of financial firms to the growth of the national economy and its capacity to absorb losses." Additionally, Tarullo singled out money market funds as an area of concern, stating that they "remain a major part of the shadow banking system" and a key potential systemic risk. Tarullo mentioned critically the SEC, which he argued has ample regulatory authority to address the systemic risk problem posed by money market funds, but which so far has declined to take significant action. He noted that, while there may be "second-best" alternatives, such as an FSOC designation of money market funds as systemically important, SEC rulemaking would be preferable.

View speech in full here (links externally to FRB website).