WASHINGTON — Federal Reserve Board Gov. Daniel Tarullo said Thursday that his top concern continues to be access by the largest financial firms to wholesale funding markets that can tip off runs and liquidity freezes.
Speaking at the sidelines of the International Monetary Fund's Spring Meeting to Bloomberg TV, Tarullo said U.S. financial institutions are much safer than they were four years ago as a result of yearly stress tests that have doubled the amount of common equity capital they hold and a resolution regime created by Congress to safely unwind banks.
But he said the job of making the financial system safer isn't finished.
"There's still a ways to go, and my concern in particular is the intersection of 'too big to fail' and the very largest institutions with very large wholesale funding markets that are subject to runs and then eventually to liquidity freezes," said Tarullo.
In February, he stressed additional reform measures were needed to improve supervision of the shadow banking system and vulnerabilities related to wholesale short-term funding.
"These vulnerabilities involve both large, prudentially regulated institutions, and thus 'too big to fail' concerns, and the broader financial system," said Tarullo.
In his interview, he also stressed the importance of capital, but said it was not the single, ultimate backstop to protecting the financial system.
"The crisis in 2007, 2008 was set off in the near term by liquidity problems, which are related to capital, related to questions of solvency of firms, but they're not only that," said Tarullo. "The liquidity problems come from uncertainty in counterparties about where markets will be and thus there is a real need to focus on the wholesale funding question. I think that's where we need to be paying attention right now."
Tarullo also noted his own preference would have been to have "somewhat higher" Basel III ratios and capital surcharges imposed on global systemically important financial institutions.
"We were in the range of ratios that I thought was reasonable, but it was in both cases a bit of the lower end of the range that we at the Fed and I think really the international process had assessed as appropriate for providing the kind protection that the public expects," said Tarullo.
The JPMorgan Chase & Co.'s London Whale trading loss seemed to reinforce the lesson of the importance of the largest firms having a "very substantial capital cushion" to reduce the ripple effect to the rest of the economy and good governance, he said.
"You don't always know what problems are going to arise in a large institution. Having a well-grounded capital base provides a kind of protection no matter what the source of the problem," he said. "The second thing we learned is that there does need to be continued attention to governance within all kinds of financial institutions, but particularly the largest ones."