MNI INTERVIEW: Fed Needs More Creative Liquidity Plans-Quarles
MNI (WASHINGTON) - The Federal Reserve needs a more ambitious plan to be able to support banks in times of crisis and rethink some recent liquidity proposals that ramp up the requirement for banks to self-insure by holding more capital, former Fed Vice Chair for Supervision Randal Quarles told MNI.
"I still don't think that the Fed is being ambitious enough in how to think about liquidity. The Fed is still seeking principally to approach this as banks needing to have more self insurance of liquidity. I think that the lessons of the spring of 2023 all point to the need to reinvigorate the Fed's central provision of liquidity," he said in an interview.
The Fed has been moving to modernize the discount window and ensure banks' operational readiness in times of crisis, by updating operations and technology and exploring a requirement for large banks to maintain a minimum amount of readily available liquidity with a pool of reserves and pre-positioned collateral.
"Simply ensuring that banks have prepositioned collateral at the discount window, that's all well and good, but I think it has to be more than that, given the liquidity need of the modern banking system," Quarles said. "The Fed needs to be much more liberal about how to provide liquidity to banks."
CENTRAL PROVISION
The unprecedented pace of the runs on Silicon Valley Bank in March last year means the Fed needs to be focused on enhancing the central bank's liquidity provision, Quarles said. Panicked customers withdrew USD42 billion from the bank in one day and had been lined up withdraw USD100 billion in cash the next day before regulators stepped in.
"This is a huge sea change," he said. "If the liquidity need is going to be as great as the spring of 2023 would tell us that it might be where a bank can lose USD142 billion of deposits in the course of two days, there’s no way you can have enough liquidity to ensure a run like that and be anything other than a money market fund."
"This is an entirely different world, and you're not going to be able to address it by working on the rules around liquidity self-insurance. You've got to really revamp the whole central provision of liquidity by the Fed and really change the Fed's dis-incentivizing of banks relying on the central provision of Fed liquidity," he said, also noting the need for still greater clarity on the supervisory framework around the discount window.
"The banks respond to incentives and to supervisory frameworks and so they borrow from the Federal Home Loan Banks in order to support putting more liquid assets on their balance sheets," the former chair of the Financial Stability Board said.
The Federal Reserve's watered-down version of a landmark bank capital proposal is also facing resistance from three of the Federal Deposit Insurance Corporation's top officials, even after Fed Vice Chair for Supervision Michael Barr repeated last week the proposal for a 9% capital increase will receive a "broad consensus" at the Fed Board. Quarles said it appears regulators' Basel III plans are on hold until after the election.
GRADUAL CUTS
The Fed cut its policy rate by 50 basis points to a range of 4.75% to 5% at its last meeting September 18. The Fed is not likely to repeat another large cut at its next meeting November 6-7, Quarles said. (See: MNI INTERVIEW: Fed To Slow Cuts As Inflation Lingers - Roberts)
"The economy is still pretty robust, particularly after the recent data revisions," he said. "All the underlying measures of strength in the economy are quite a bit more robust and indicative of continued inflationary uplift."