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From Banking and Finance Law Daily, February 10, 2016

Lender of last resort authority still alive, Fed’s Fischer says

By Richard A. Roth, J.D.

Dodd-Frank Act reforms left the Federal Reserve Board with significant lender of last resort powers, according to Fed Vice Chairman Stanley Fischer. While Federal Reserve Act amendments eliminated the Fed’s ability to make loans to individual nonbanks, individual loans to solvent banks and broad-based credit facilities that support specific markets remain viable tools the Fed can use to respond to future financial crises, he said in remarks prepared for a Committee on Capital Markets Regulation conference on the lender of last resort function.

Fischer said that Dodd-Frank Act reforms reduce the likelihood that the Fed will need to use its lender of last resort authority in the future. Large bank holding companies now must hold more capital, and large banking organizations are subject to liquidity requirements. Four nonbanking companies so far have been designated systemically important financial institutions that are subject to Fed supervision and regulation.

Remaining lending powers. Should it be necessary, the Fed still can make discount window loans to insured banks, Fischer reminded the conference. This credit must be collateralized, he noted, and all of the discount window loans made during the recent financial crisis were repaid “in full, on time, and with interest.”

In an emergency, the Fed can establish broad-based credit facilities to provide financial market liquidity, the Fed vice chairman continued. This type of credit was crucial to keeping some markets functioning during the crisis. Regulations adopted under the Dodd-Frank Act make clear that such credit programs cannot bail out insolvent borrowers, must be adequately collateralized, and must carry penalty interest rates. Also, there must be at least five eligible borrowers.

The Dodd-Frank Act did eliminate the Fed’s ability to lend to individual nonbanks, Fischer conceded. However, the damage that could result from such a company’s failure will be mitigated by reliance on the company’s living will or, if necessary, use of the Federal Deposit Insurance Corporation’s orderly liquidation authority.

Remaining concerns. The Fed vice chairman noted, however, that he has concerns about potential weaknesses after the Dodd-Frank Act reforms.

First, there is a stigma that discourages banks from using discount window credit, as doing so could imply weakness. The Dodd-Frank Act might have aggravated that problem by requiring the Fed to make more explicit disclosures about borrowers.

Second, while stronger regulations are needed, regulators still must have enough flexibility to respond to crises as they happen. “Strengthening fire prevention regulations does not imply that the fire brigade should be disbanded,” Fischer said. Further restrictions on the Fed’s lender of last resort powers would be “a serious mistake.”

Third, the system that exists after the Dodd-Frank Act reforms “has not undergone its own stress test.” Another financial crisis will come, Fischer warned, and only then will it become clear whether regulators still have the ability to respond effectively.

MainStory: TopStory DoddFrankAct FederalReserveSystem FinancialStability

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