We find your January 31 letter to Federal Reserve Board Chair Janet Yellen both misleading and misguided.
It is in the best interest of U.S. citizens and our financial system that the Federal Reserve (and all the other U.S. regulators) continue to participate actively in international financial-standard-setting bodies. The Congress has many opportunities to hold the Fed accountable for its regulatory actions, which are very transparent. We hope that the new U.S. Administration will support the Fed’s efforts to promote a safe and efficient global financial system.
Your letter is filled with false assumptions and assertions....
Ever since Bagehot, central banks acting as lenders of last resort have tried to distinguish banks that are illiquid, who should be eligible for a loan, from banks that are insolvent, who should not. The challenge persists. As one analyst put it recently: “Liquidity and solvency are the heavenly twins of banking, frequently indistinguishable. An illiquid bank can rapidly become insolvent, and an insolvent bank illiquid.” The lesson is that the appropriate level of a bank’s capital and the liquidity of its assets are necessarily related.
Forged in the crucible of the financial crisis, Basel III took this lesson to heart, creating a new regime for liquidity regulation to supplement the capital rules that were originally developed 30 years before.
Many people criticize the way in which bank capital regulation is done.They know that banks can and do game complicated regulatory rules, a form of regulatory arbitrage. One focus of their criticism is risk weighting – the idea that banks should hold capital commensurate with the riskiness of their assets.The more risky the loans and securities a bank holds, the bigger the capital buffers should be to ensure that banks and the banking system are robust.
