MNI BRIEF: Fed's Bowman Calls For Liquidity Regulation Reform

Regulation that induce banks to set aside excessive liquidity reduces lending to businesses and forces the Federal Reserve to keep a large balance sheet, Fed Vice Chair of Supervision Michelle Bowman said Tuesday, in remarks previewing potential liquidity reforms later this year. 

"Maintaining liquidity resources in excessive amounts may impose unnecessary costs on the banking system and the broader U.S. economy," she told the Committee on Capital Markets Regulation in Washington. "This liquidity hoarding reduces credit availability to the economy. In addition, by increasing the demand for reserves, it also requires the Fed to maintain a larger balance sheet to meet that demand."

During normal times, banks over-allocate to high-quality liquid assets to meet their liquidity coverage ratio requirements but are reluctant to use them for fear of falling below the LCR. "The LCR effectively becomes an isolated, unusable buffer. This reluctance exacerbates stress, forcing banks to convert less liquid assets into cash to meet obligations," she said. 

Meanwhile, traditional Fed sources of liquidity like daylight overdrafts, the discount window and and standing repo facilities are stigmatized, Bowman said, calling for "modernizing the discount window to serve as an effective liquidity backstop. (See:  MNI POLICY: Long Road To Scarcer Reserves For Warsh)