A prominent financial regulator on Friday advocated for new measures aimed at strengthening large Wall Street firms, a move that could add momentum to the growing number of calls to reduce the risks posed by big banks.
In a speech, Daniel K. Tarullo, a Federal Reserve governor, said that some of the debt markets that Wall Street institutions borrow in remain vulnerable, even after the overhauls instituted after the financial crisis of 2008.
To make the system safer, Mr. Tarullo floated an idea that could affect banks that make heavy use of these so-called wholesale markets. His idea is to require such banks to hold extra capital, a part of a bank’s balance sheet that can serve as a buffer against losses.
“We would do the American public a fundamental disservice were we to declare victory without tackling the structural weaknesses of short-term wholesale funding markets, both in general and as they affect the too-big-to-fail problem,†Mr. Tarullo said during a speech at the Peterson Institute for International Economics.
Mr. Tarullo’s speech, which called for other changes to toughen regulation, comes in the wake of a bill introduced last week that took aim at large banks. The legislation, from Senator Sherrod Brown, a Democrat from Ohio, and Senator David Vitter, a Republican from Louisiana, would subject the biggest banks to much higher capital requirements than smaller banks. If the bill is passed, many large banks would probably choose to shed assets to shrink to a size where they would not be required to hold higher amounts of capital.
The bill has already generated fierce objections from the financial industry. Its critics said the capital increases would force banks to cut back on their lending, and they argued that large banks provide unique benefits to the economy.
Political analysts have said that the Brown-Vitter bill has little chance of passing, but the measure has reignited a conversation about what to do about banks whose failure could weaken the broader financial system.
Mr. Tarullo’s speech indicates that senior regulators are also dissatisfied with the status quo. They are devising ways to improve on the two main overhauls that came after the crisis, which are the Dodd-Frank Act, passed by Congress in 2010, and the internationally agreed bank regulations known as Basel III.
Regulators like the Federal Reserve don’t have to wait for Congress to pass legislation to introduce new measures. The Dodd-Frank act gave regulators substantial freedom to come up with measures to strengthen the system on their own. Mr. Tarullo mentioned that leeway in this speech on Friday. Dodd-Frank “gives the Federal Reserve the authority, and the obligation, to apply regulations of increasing stringency to large banking organizations in order to mitigate risks to financial stability,†he said.
The wholesale debt markets are a concern to Mr. Tarullo because they were particularly susceptible to panic in the 2008 crisis. The Fed’s biggest bailout loans went to shoring up these markets. Firms like Goldman Sachs and JPMorgan Chase borrow heavily in these markets and use the borrowed money to purchase assets.
In times of stress, wholesale debt markets can dry up and a vicious wave of selling can ensue, causing asset prices to plunge. To mitigate that risk, banks now have to hold more liquid assets.
But Mr. Tarullo thinks more could be done. “Relatively little has been done to change the structure of wholesale funding markets so as to make them less susceptible to damaging runs,†he said in the speech.
Mr. Tarullo sees heightened risk when a very large bank uses a lot of wholesale financing. It would appear to make a too-big-to-fail bank more unstable and thus more of a threat to the system than if it used more stable sources of borrowing like long-term bonds and federally insured deposits.
The more wholesale financing a bank uses, the more capital it would have to hold, taking into account its reserves of liquid assets, according to Mr. Tarullo’s approach. If this idea becomes a fleshed-out official policy, the Fed could in theory implement it under the special powers it gained from Dodd-Frank.
If such a rule appears, it sounds as if Mr. Tarullo would want it to have teeth.
“To provide a meaningful counterweight to the risks associated with wholesale funding runs, the additional capital requirement would have to be material,†he said.
