Fed's Barr: New liquidity requirements might be needed to stem bank runs

Bloomberg News

The Federal Reserve's top regulator said current liquidity management practices might not be enough to contend with the speed of modern bank runs.

In a speech delivered Friday morning at a forum hosted by the European Central Bank in Frankfurt, Germany, Fed Vice Chair for Supervision Michael Barr said the failure of Silicon Valley Bank "changed everyone's perception of the possible speed of bank runs" and exposed weaknesses in emergency funding systems that are still being evaluated today.

"What occurred in two or three weeks or, in some cases, many months in previous episodes may, in the modern era, now occur in hours," Barr said. "These issues are top of mind as we review and consider future adjustments to the way in which we should supervise and regulate liquidity risk."

As a result, Barr said, the Fed is weighing whether adjustments are needed for the regulatory frameworks designed to help banks insure themselves against losses. These include the liquidity coverage and net stable funding ratios, which are designed to ensure banks can fund themselves through 30 days of deposit outflows. 

"These requirements may not, on their own, be sufficient to stem a rapid run," Barr said. "The speed of bank runs and the impediments to rapidly raising liquidity in private markets that may be needed in hours rather than days suggest it may be necessary to re-examine our requirements, including with respect to self-insurance standards and to discount window preparedness."

Barr said high-quality liquid asset buffers put in place following the subprime mortgage crisis — which require banks to hold certain levels of assets that can easily be converted into reserves — remain important tools for keeping individual banks solvent and protecting broader financial stability. But he noted the failures earlier this year demonstrated how operational shortcomings can keep banks from actually monetizing those assets quickly. 

Barr extolled the benefits of the Fed's last-resort lending facility, known as the discount window. He reiterated calls that he and other Fed officials have raised in recent months for banks to position assets at window and test their abilities to use the facility regularly. The Fed also emphasized the importance of the discount window in new guidance it issued on liquidity management in July.

He acknowledged that many banks still shy away from the facility because of the stigma that goes along with it, but added that the Fed is working to combat this notion on all fronts. 

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"In light of this, we at the Federal Reserve have been underlining the point to banks, supervisors, analysts, rating agencies, other market observers, and the public — through numerous channels — that using the discount window is not an action to be viewed negatively," he said. "Banks need to be ready and willing to use the discount window in good times and bad."

Barr also highlighted the shortcomings of private sources of liquidity, including the Federal Home Loan Bank system and the private repurchase agreement markets, known as repos, which cannot provide liquidity at the same speed or volume as the Fed.

"Sharp shifts in calls on private repo market capacity, particularly by firms experiencing stress, may not be easily met," he said.

Barr said some banks have used the past several months to better position them to use the discount window. They have assessed their "operational readiness" to borrow from the facility and adjusted the amount of assets they have available to pledge relative to their "runnable liabilities," even testing where possible.

This stands in contrast to the period leading up to failures of this spring, when many institutions that could have benefited from access to the discount window were caught flat-footed, having not tested recently or pre-positioned enough collateral to cover potential losses.

"In the case of some banks, the amount of collateral prepositioned was also a tiny fraction of potentially flight-prone liabilities going into the stress event," he said. "This lack of pre-pledging is a concern for several reasons, including that certain collateral types can require more time to pledge."

Barr added that certain types of permissible high-quality liquid assets can take longer to liquidate than others and therefore should not be relied upon for immediate funding. Yet, he added, such assets are ideal candidates for the discount window, because they would take even longer to be converted by private repo lenders. 

He also noted that the discount window, while a useful tool for financial stability and monetary policy, is not a panacea — nor is it a replacement for proper risk management. No amount of additional borrowing capacity would have saved Silicon Valley Bank or Signature Bank, he said, given the rapid rate of deposit withdrawals they faced. 

Still, he noted, it could be a useful tool for other firms during "less acute events."

"Greater operational readiness can provide for greater optionality when a bank hits a bout of turbulence," he said. "Ready access to sufficient liquidity provides breathing room for a bank to determine and execute its path forward."