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Ex-officials call for measures such as relaxing SLR rules, which Congress may resist.
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The Federal Reserve's new standing repo facility is likely just the first step in reforms guarding against a repeat of September 2019's money market frictions and last March's dash for cash, though relaxing supplementary leverage ratios may be politically out of reach, former Fed officials and Congressional sources told MNI.
"This is a good first step, but we need to do a bunch of other stuff," said William Dudley, former New York Fed President. "I'd like to see access to the standing repo facility be a lot broader than just the primary dealers," he said, also suggesting central clearing for Treasury dealer-to-customer trades, changes to GSIB buckets imposing additional capital buffers on the most important banks, and better market transparency.
The repo facility, allowing primary dealers to exchange Treasuries for bank reserves on demand and giving them more flexibility to make markets in cash, collateral and other securities, was implemented as a ceiling tool but means even aggressive tapering of QE may not result in a 2013-style "tantrum," sources said. Other banks on the Fed's tri-party repo platform can express interest in becoming counterparties beginning in October, though the application process is expected to take months.
With the facility's rate set at the top of the fed funds range, it should enhance the Fed's control over money markets, which briefly spiked late in the post-financial crisis normalization cycle in September 2019. Even if Treasury yields aren't impacted much, the standing repo facility should alleviate concerns over intraday liquidity and the liquidity coverage ratio, sources said.
CONSTRAINED BY SLR RULES
But even as the overnight reverse repo facility has helped reduce overall financial system reserves, supplementary leverage ratio rules could constrain banks' willingness to allocate capital to even low-risk activities. Many ex- Fed officials advocate excluding reserves from SLR calculations, and a Treasury auction in February in which primary dealers were forced to buy almost 40% of the USD62 billion on offer spurred a multi-agency review of regulation and market structure. Political resistance to such a move, however, would be tough. (See: Fed Faces Battle To Ease Banks' Leverage Rules)
SLR rules mean banks could sometimes be reluctant to use the standing repo facility, because it would expand their balance sheets, said Dudley, also a former manager of the Fed's market desk. "I think you need relief in the SLR with respect to reserves, and I think that's coming," he said.
Quentin Vandeweyer, an outside Fed adviser who worked in the ECB's Research Directorate, said the Fed's facility will prevent a repeat of 2019 but suggested counterparty access should be expanded further to non-banks.
"Being able to mobilize liquidity within the day will allow banks to make up their intraday liquidity buffer required by regulators," he said. "Some banks will start holding more Treasuries than they used to, and this would relieve some pressure on the broker-dealers."
CONGRESS MAY RESIST CHANGE
But a person familiar with the thinking of Senate Banking Committee Chairman Sherrod Brown, an Ohio Democrat, told MNI that while he supports the Fed's new standing repo facility he does not favor exempting reserves from the SLR's leverage calculation.
Thomas Hoenig, ex-vice chair of the Federal Deposit Insurance Corporation, also stressed the need to maintain strong regulation, telling MNI: "When you get rid of or reduce the leverage ratio, you allow them to lever up more broadly across the bank."
Former Treasury Secretary Tim Geithner and former Fed Governor Jeremy Stein argue for a suite of reforms, including central clearing of Treasury trades and giving FICC access to the Fed's repo facility. The Fed has some latitude to move on its own and Congress should agree to measures that stabilize markets and reduce costs to taxpayers from government borrowing programs, they told reporters.
The repo facility is not expected to see much usage, except at quarter ends, late in the Fed's balance sheet normalization process, or during bouts of volatility. Sources said it will take time for markets to adjust to the tool, and for the Fed to learn how to best use it to influence money market rates.
MARKETS ARE STILL UNSETTLED
"I wouldn't be surprised if there were other changes, either in the operating approach or in regulatory tweaks, not primarily for financial stability, but intended to address market functioning - it's certainly conceivable, if not downright likely," said Allan Malz, a former vice president in the New York Fed markets group.
"This operating regime is not nailed down. It's not a tried and true edifice, there and acting the same way for years and years," he said. "We know that the environment is unusual now. It's been unusual for a long time, it's likely to be unusual for at least some time to come."