FRB Vice Chair Barr Highlights Current Treasury Market Risks

Bradley P. Ziff Commentary by Bradley P. Ziff

In remarks before the U.S. Treasury Market Conference, Federal Reserve Board ("FRB") Vice Chair for Supervision Michael S. Barr identified and responded to challenges facing the Treasury market.

On Interest Rate Risk: Mr. Barr described how financial institutions were complacent in their interest rate risk management following a period of low-interest rate risks. He said that such complacency became apparent following the failure of Silicon Valley Bank ("SVB"). He urged banks to improve their management of interest rate risk and liquidity, in light of the market stresses caused by rate hikes.

On Contingency Funding: Mr. Barr said that banks faced difficulties in scaling up funding in private markets, such as in the repo markets. He emphasized the importance of maintaining diverse funding sources and the readiness to use facilities like the discount window to provide "ready access" to liquidity, regardless of market conditions.

Leverage in the Treasury Market: Mr. Barr highlighted risks associated with leverage in the Treasury market, particularly the highly leveraged positions of hedge funds facilitated by low or zero haircuts on repo financing. He said that the liquidation of these positions contributed to market stress and called for better understanding and management of such activities.

Cyber Risk Management: Mr. Barr reiterated the importance of managing "constantly evolving" cyber-risk. He urged financial institutions to work to better understand system vulnerabilities, invest in remedies and develop robust business continuity plans to withstand cyber incidents.


A few considerations to keep in mind:

On Leverage in the Treasury market: the SEC's proposal to address these issues--Central Clearing of Repos and US Treasuries--has now been postponed until Q1 2024 and receiving further review within FSOC. Industry participants have also been very skeptical that the Clearing proposal will address the concerns outlined by Mr. Barr and others related to leverage in the Treasury and Repo markets and will involve discussions surrounding other potential mitigants with the banks and brokers who have extended balance sheet to their clients. In addition, regulators and the industry have acknowledged that an additional contributing factor requiring redress has been the growth in funding provided from the investor sector which has grown sharply the past several years.   

On Contingency Funding: Industry participants have said that one of the principal reasons for banks failing to achieve funding goals has been the steady increase in capital requirements and additional bank oversight and regulation which has impinged on their ability to trade and invest in the treasury and repo markets. Further, banks and investors have argued that one of the important contributing events leading to the market stress in 2020 surrounding Covid was driven by the rapid increase in margin by the exchanges which resulted in sudden unwinds which exacerbated the decrease in liquidity. 

Email me about this

Premium Content

Available only to Premium subscribers.