Federal Reserve bank liquidity rules may have contributed to this fall’s repo market volatility, which in turn caused the Fed to resume open market activities, Fed Vice Chairman for Supervision Randal Quarles told the House Financial Services Committee today.
The Fed is reviewing its regulations, and Quarles said the agency “may have created some incentives that were contributors” as part of a “complex set of factors.” He added that “I think we need to examine them, particularly among them, the internal liquidity stress tests that we run that create a preference—or can create a preference—at some institutions for central bank reserves over other liquid assets, including Treasury securities.”
An American Bankers Association Data Bank post in September explored the role regulations may have played, pointing out that post-crisis liquidity and capital regulations have made it more expensive for banks to engage in repos. When a combination of factors drove up demand for cash, “banks did not step in to meet the increased demand, in part because they are constrained by the level of reserves and other high-quality liquid assets they need to hold to be in compliance with the liquidity coverage ratio.”
