Quarles Concedes Fed Might Be Part of the Problem in Repo Crunch

(Bloomberg) --

The Federal Reserve's banking regulation chief granted that Wall Street may have been right that the agency shares blame in September's alarming strain in money markets.

Vice Chairman Randal Quarles agreed Wednesday that Fed supervisors have potentially created an impression that banks should prize cash reserves over stockpiled Treasuries when the firms try to keep their levels of liquidity above regulatory minimums. So, when the bankers argue that those demands prevented them from making that cash available to ease September's repo turmoil, Quarles agreed they may have a point.

Quarles told lawmakers at a House hearing on banking oversight that his agency has looked at its supervision of the big banks and said it “may have created some incentives that were contributors,” though they probably weren't the major drivers of the liquidity shortage in those markets.

“I think we need to examine them,” Quarles said. “Particularly among them are the internal liquidity stress tests that we run.”

Unexpected scarcity of lenders in overnight funding markets caused yields to spike in mid-September, briefly pushing the Fed's benchmark rate outside its target range. Since then, the Fed has been injecting liquidity into overnight markets and on Oct. 11 announced it would begin buying $60 billion of Treasury bills per month to restore an ample level of reserves in the system.

One of Wall Street's chief lobbying arms, the Bank Policy Institute, made that argument on the group's website after the market tumult -- co-written by Bill Nelson, a former senior official at the Fed who is now chief economist at BPI.

“Why didn't banks step in and supply the missing repo financing?” the group asked. “The answer is that doing so would have required them to obtain the funds from their own deposits at the Fed or by borrowing. Regulations or supervisory expectations stood in the way of either course of action.”

But Quarles wasn't willing to have the Fed take the lion's share of the blame.

“There were a complex set of factors that contributed to those events in September,” Quarles said. “Not all of them were related to our regulatory framework.”

To contact the reporter on this story: Jesse Hamilton in Washington at jhamilton33@bloomberg.net

To contact the editors responsible for this story: Jesse Westbrook at jwestbrook1@bloomberg.net, Alister Bull, Gregory Mott

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