Rep. Frank Calls for Financial Services
Risk Regulator

With markets in turmoil primarily because of a failure to manage the risk of complex securitized financial instruments, House Financial Services Chair Barney Frank has called for the creation of a federal Financial Services Risk Regulator to assess risk across financial markets regardless of corporate form. The new regulator would be expected to act when necessary to limit risky practices or protect the integrity of the financial system. More broadly, Rep. Frank called for reform of financial regulation to consolidate the current duplicative regulatory structure. In remarks to the Boston Chamber of Commerce, the chair said that the risk regulator could either be a brand new entity or an adjunct of the Federal Reserve Board.

In exchange for potential access to the discount window for non-depository institutions, noted Mr. Frank, the new financial risk regulator would have enhanced tools to receive timely market information from market players, and inspect institutions. The risk regulator would also report to Congress on the health of the entire financial sector. The risk regulator must focus on the substantive regulation of market behavior, and not the form of it. Since the repeal of Glass-Steagall, observed Rep. Frank, a host of new players have emerged and old ones are doing new things. To the extent that anybody is creating credit, he believes that they should be subject to the same type of prudential supervision that now applies only to banks.

In the chair’s view, the current market crisis has revealed that consumer protection and systemic risk are intertwined. The crisis has also shown that seemingly well-capitalized institutions can be frozen when liquidity runs dry and particular assets lose favor, leaving many policymakers calling for enhanced liquidity risk management.

Recently, due to the increasing securitization of assets, the Basel Committee on Banking Supervision said it intends to update its guidance for managing liquidity risk. While the guidance issued in 2000 remains generally relevant, a Basel working group has identified areas in need of updating and strengthening. Enhanced best practices for managing liquidity risk will be issued later this year. Also, UK FSA Chair Callum McCarthy has called for a uniform international policy on liquidity risk management to provide clarity to global financial institutions and other market participants.

Liquidity risk management is designed to ensure a financial institution’s ability to fund increases in assets and meet obligations as they come due. The increasing complexity of financial instruments has led to a heightened demand for collateral and to uncertainty on prospective liquidity pressures from margin calls, as well as a lack of transparency that can contribute to asset market contraction in times of stress.