Fed’s Fischer: Insight Into Shadow Banking Still Limited

By Jeff Bater

The U.S. banking system has strengthened since the 2007-2009 financial crisis, but regulators’ understanding of the shadow banking sector remains incomplete, the vice chair of the Federal Reserve said.

Stanley Fischer, in remarks for an International Monetary Fund event June 27 in Washington on financial stability, said the overall banking system is better capitalized and more liquid, while resolution mechanisms for big banks are stronger.

He said regulatory capital at large banks is now at “multidecade highs.” Borrowing is subdued, aside from auto and student loans. Banks have shifted away from more run-prone short-term wholesale sources of funds toward more stable sources, such as core deposits.

‘Limited Insight’

But he said it would be “foolish” to think all risks have been eliminated. “For example, we still have limited insight into parts of the shadow banking system,” Fischer said, adding, “Uncertainty remains about the final configuration of short-term funding markets in the wake of money funds reform.”

In his remarks, Fischer focused on asset valuations, noting that in the stock market, price-to-earnings ratios stand in “the top quintiles of their historical distributions.” Corporate bond spreads are near their post-crisis lows. Commercial real estate (CRE) prices have grown faster than rents for some time, Fischer said, but valuation pressures in single-family residential real estate markets appear, at most, modest.

Fischer said leverage in the financial sector is at historic lows. “The increase in prices of risky assets in most asset markets over the past six months points to a notable uptick in risk appetites, although this shift has not yet led to a pickup in the pace of borrowing or a sizable rise in leverage at financial institutions,” he said.

Following changes to money market mutual fund regulations by the Securities and Exchange Commission (SEC) last fall, vulnerabilities associated with liquidity and maturity transformation appear to have decreased, Fischer said.

“While the current configuration of money markets reveals a reduced financial stability risk compared with the situation prior to the recent reforms, this configuration may not yet represent the final equilibrium,” he said. “It will be important to keep an eye on the growth of alternative investment vehicles that perform liquidity transformation in money markets.”

To contact the reporter on this story: Jeff Bater in Washington at jbater@bna.com

To contact the editor responsible for this story: Michael Ferullo at MFerullo@bna.com

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