Fed Weighing New Rules on Short-Term Borrowing, Yellen Says

A crucial part of Wall Street still keeps federal regulators up at night.

But Janet Yellen, the chairwoman of the Federal Reserve, said on Tuesday that her agency is actively considering measures to strengthen that potential weak spot in the nation’s securities markets.

Ms. Yellen said that despite an onslaught of new bank regulations, risks remained in the markets where Wall Street firms and other entities lend and borrow hundreds of billions of dollars for short periods. The 2008 financial crisis showed that these gigantic short-term debt markets were particularly susceptible to panic. With that in mind, Ms. Yellen suggested some measures on Tuesday that could restrain the use of short-term borrowing at the largest banks â€" including requiring them to hold more capital.

“There might be room for stronger capital and liquidity standards for large banks than have been adopted so far,” Ms. Yellen said, citing a 2010 study on the potential relationship between economic growth and further regulation. Capital is the financial cornerstone of a bank. A bank with more capital can, in theory, absorb more losses and may be less vulnerable to a bank run.

Daniel Tarullo, a Fed governor who oversees regulation, said nearly a year ago that the Fed was thinking of linking capital to short-term borrowing. The fact that the Fed has continued to press on this front could send a chill through Wall Street firms, like Goldman Sachs and JPMorgan Chase, that borrow billions of dollars a day in the short-term debt markets.

Banks may oppose the measures out of self-interest. Holding more capital can make it harder for banks to post the sort of returns that their shareholders expect. And these days, many bank executives receive much of their compensation in stock.

Bankers may also argue that the Fed is practicing overkill. Ms. Yellen’s speech follows the approval last week of a new rule â€" called the supplementary leverage ratio â€" that could prompt the largest banks to find as much as $68 billion in extra capital over the next few years.

If the Fed moves ahead with the new short-term debt market regulations, it will have to publish a proposed draft of the rules. This would give the banks a chance to criticize and lobby against what they do not like in the proposals.

The industry is likely to push back against the argument that the economy will be fine even if the banks have to hold more capital. Donald N. Lamson, a partner at the law firm Shearman & Sterling, said that when considering the new measures, regulators would have to consider whether reducing risks within the largest banks can undermine the creation of credit in the economy. “Those impulses are at odds,” Mr. Lamson said. “They need to achieve the correct balance.”

Bank lobbyists might also note that since the crisis, Wall Street firms make much less use of so-called repo lending market. In this market, banks lend and borrow money for short periods against financial collateral.

Although the market has shrunk, banks and brokers still tap the repo market for around $1.6 trillion in borrowings, according to the Fed. And in her speech, Ms. Yellen said that the existing overhaul might not address potential weaknesses in places like the repo market.

For instance, Wall Street firms say that they try to closely match the money they borrow in repo markets with the repo loans they make to their clients. On the surface, that matching practice looks safe and balanced.

But in panics, even the most carefully managed repo books can fall apart. That can happen when a Wall Street firm cannot raise money quickly enough to pay off its fleeing repo creditors.

When many banks faced this sort of cash crunch in 2008, the Fed stepped in and loaned the banks billions of dollars in replacement funds. To critics of Wall Street, the loans from the Fed were an enormous stealth bailout. The Fed has defended the loans, arguing that central banks are supposed to provide emergency loans to banks in stressed times to contain panic and protect the wider economy.

Still, Ms. Yellen’s remarks on the need to bolster short-term debt markets indicate that the Fed does not want to be put in a position where it would have to provide loans on that scale again. “Together, these runs were the primary engine of a financial crisis from which the United States and the global economy have yet to fully recover,” Ms. Yellen said in her speech, which she gave in a video feed to a conference at the Federal Reserve Bank of Atlanta.