Fisher on the rate rise, financial excess, and political pliancy (Part 3 of 8)
Dallas Fed’s Richard Fisher discusses macroprudential supervision
Dallas Fed Chief, Richard Fisher spoke at the Annenberg School for Communication and Journalism, at the University of Southern California on Wednesday, July 16, about the inherent risks in the Fed’s current accommodative monetary policy. In his speech titled “Monetary Policy and the Maginot Line,” he discussed his views on macroprudential supervision in curbing risks to financial stability. He likening it to a financial Maginot Line.
What is macroprudential supervision?
After the financial crisis of 2008, when the stability of financial markets was in question, policymakers advocated the practice of macroprudential supervision. Macroprudential supervision studies linkages between large financial institutions including common risk exposures, clearing and settlement systems, group or “herd” reactions, and market failures in response to externalities, which could potentially translate into larger shocks and impact financial markets in a major way.
In contrast to micro-prudential tools, which study the risks to financial firms in isolation and independent of each other, macroprudential tools are designed to examine the collective risks to the financial system. They aim to prevent situations that are potentially destabilizing for the entire financial system.
Bank stress tests
An example of macroprudential tools are bank stress tests conducted regularly by the U.S. Federal Reserve. The annual Comprehensive Capital Analysis and Review (or CCAR) and Dodd-Frank Act (or DFA) stress tests are regulatory tools used by the U.S. Federal Reserve to ensure that financial institutions have robust capital planning processes and adequate capital to continue operations throughout times of economic and financial stress that account for their unique risks.
What is the Maginot Line?
The Maginot Line was a fortified border between France and Germany during World War II. Named after France’s Minister of War, Andre Maginot, the line was constructed in the 1930s as a way of safeguarding France from German invasion.
Richard Fisher’s take on macroprudential supervision for financial institutions
Richard Fisher explained that the term “Maginot Line” is commonly used to indicate a strategy that clever people hoped would be effective, but instead failed to do the job. He said that he was skeptical about macroprudential tools as a safeguard for financial instability risks. Just as the Maginot Line was outflanked in World War II, macroprudential safeguards while important in curbing systemic risks, would be ineffective in ensuring financial stability because depository institutions cover only about a fifth of the entire financial system.
“I also think it’s important to remember that this isn’t your grandparents’ financial system. The Federal Reserve and the banking supervisory authorities used to oversee the majority of the credit system by regulating depository institutions. Now, depository institutions account for no more than 20% of the credit markets,” he said.
Strengthening the FSOC process
The Financial Stability Oversight Council (or FSOC) was formed in order to monitor and address risks posed by systemically important financial institutions (or SIFIs). The FSOC consists of members of the Fed as well as members of other regulatory bodies.
While strengthening the FSOC would help address these risks, Mr. Fisher believes that the hyper-accommodative monetary policy followed by the Fed and other central banks around the world in recent years, has been a “catalyst for a search for yield.” This has also lowered risk perceptions among market participants. The latter would try to bypass any regulation and supervision implemented by the FSOC and other such bodies, reducing their effectiveness in curbing risks.
Large financial institutions such as those included in the SPDR Financial Select Sector ETF (XLF), the SPDR S&P Bank ETF (KBE), and the Vanguard Financials ETF (VFH) are subject to bank stress tests and other forms of macroprudential supervision. XLF, KBE, and VFH include banks such as JPMorgan and Goldman Sachs. Both institutions are part of the S&P 100 Index (OEF) and the Dow Jones Industrial Average (DIA).
In the following section, we’ll discuss Richard Fisher’s views on adjusting the Fed’s monetary policy stance in response to such systemic risks.
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