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WASHINGTON (MNI)

Federal Reserve Vice Chair Randal Quarles said Wednesday he is optimistic for a continued strong economic recovery from Covid-19 and the nation's resilient banks don't deserve stress tests that exacerbate any strains.

"I am optimistic that the recovery from the COVID event will continue to be robust," he said in a speech, adding it still has a "ways to go." The weaknesses include a "deeply depressed" job market and some measures of inflation expectations that have ticked down, he said.

Banks have seen lower loan losses and have been "healthy" with ample levels of liquidity, he said. Quarles, the Fed's vice president of supervision, said despite the better-than-expected rebound "there are certainly reasons to be vigilant" over financial stability risks.

Consumer and mortgage lending "seem to be holding up well so far," he said in remarks at a Hoover Institution event, but the performance of these loans also "needs to be watched closely in light of the forbearance policymakers have encouraged and the possibility of a reduction in fiscal support for households."

"Interest rates are likely to remain low for quite some time, putting downward pressure on banks' net interest margins and their profitability more generally. The high level of corporate debt and elevated evaluations in commercial real estate going into the crisis, combined with prolonged uncertainties…could lead to higher-than-expected losses on loans," he said in Q&A.

FUNDING MARKETS DIAGNOSIS

In September the Fed extended the suspension of stock repurchases on large banks and capped their dividends into the fourth quarter. The Fed is conducting another round of stress tests, Quarles said, using two new severe downside scenarios published last month, and will release bank-specific results from both scenarios before the end of the year.

"We want to make sure that our supervisory and regulatory actions do not exacerbate the fallout from what was the most extreme deterioration in economic conditions on record," Quarles said.

The Fed has made progress in diagnosing why markets seized up earlier this year, he said, adding he's not ready to put the blame on any specific part of an integrated financial system and will turn over some results at a G20 meeting next month. The problem spots included "vulnerabilities in money market funds (as I discussed earlier); dealers' capacity and willingness to intermediate; market structure in the core government bond markets and, potentially, the role of leveraged investors; and fragilities in US dollar cross-border funding," he said.

MNI Washington Bureau | +1 202-371-2121 | evan.ryser@marketnews.com