Dealer of Last Resort Construct Emerges
In this report, we analyze a major working paper released last week by the Office of Financial Research on a new approach to controlling shadow banking. The paper takes a very different approach to this topic than ongoing work at the Financial Stability Board (see Client Reports in the SHADOW series), focusing only on asset managers and the instruments they use as money equivalents. Arguing that these instruments have become a serious financial-stability concern because of market reconfigurations due to low interest rates, the OFR approach details an approach the FRB could deploy to curtail this type of shadow-banking risk. Importantly, the OFR paper also concludes that the reverse-repo program effectively gives non-banks access to central-bank liquidity. Given growing FRB worries in this arena and the limited number of tools it has under current standards, we believe the FRB will take OFR’s recommendations under careful consideration as the reverse-repo program constructed to handle a tapering “soft landing” is brought into larger use. The issues addressed in the paper also will play a significant role as the FRB determines the extent to which broker-dealers or others in the short-term financing market should have access to its liquidity facilities and the FRB becomes the “dealer of last resort.” As a result, clients may wish carefully to consider OFR’s informal recommendations and, OFR has invited comment on them. Issues in the paper – i.e., the leverage risk posed by increased concentration in asset-management holdings – also will play a role in FSOC action on OFR’s recent paper on systemic risk in this sector (see Client Report SYSTEMIC71).
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