MNI POLICY: Fed Reviewing Stress Test Impact on Repo Squeeze

By Jean Yung

     WASHINGTON (MNI) - The Federal Reserve is reviewing how post-crisis

liquidity stress tests may have created a preference for bank reserves over

liquid assets like Treasuries and disrupted repo markets, Vice Chair Randy

Quarles said. 

     "We have identified some areas where our existing supervision of the

regulatory framework the structure of the framework itself may have created some

incentives that were contributors" to extreme volatility in repo markets in

September, he told the House Financial Services Committee on Wednesday. "They

were probably not the decisive contributors, but they were contributors, and we

need to examine them." 

     Liquidity regulations were intended to be structured so that banks would be

indifferent between central bank reserves and Treasuries in satisfying their

high-quality liquid asset retention requirements, Quarles said. The liquidity

coverage ratio does not treat reserves differently from Treasuries. 

     However, some banks in their "internal assessment of how their liquid

assets will perform in a future period of stress have put a heavy emphasis on

central bank reserves as the most liquid assets," Quarles said. Treasury

securities take a day to settle, and markets can be disrupted in the event of

extreme events, for example. 

     "So that does create a thumb on the scale for central bank reserves,"

Quarles said. "We are reviewing some of these supervisory measures."

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

[TOPICS: MMUFE$,M$U$$$,M$$CR$,M$$FI$,MN$FI$,MN$MM$,MN$RP$]