In a speech entitled, “Financial Stability and Shadow Banks: What We Don’t Know Could Hurt Us“, Federal Reserve Vice Chairman Stanley Fischer cautioned that while much has been done to reduce shadow banking risk, more needs to be done.
The theme appears to be gaining momentum at the Fed as the address by Fischer to the Federal Reserve of Cleveland comes on the heels of a similar speech delivered by Daniel Tarullo just several weeks prior. Fischer, a member of the Board of Governors of the Federal Reserve System since May of 2014, warned about the dearth of information regarding Shadow Banking institutions;
“When it comes to financial stability, what you do not know really can hurt you–and there remains a good bit we do not know”
Fischer highlighted the invisible hand of the market that challenges policy maker’s myopic attempts to manage risk, and potentially raise more;
“The more stringent regulation of the banking sector may push short-term financing activities to less regulated entities. To limit such regulatory arbitrage, the Federal Reserve will be developing regulations that would establish minimum margins for securities financing transactions on a marketwide basis.”
Fischer reflects on the demise of Lehman and challenges of AIG in 2008, along with the near financial apocalypse associated with Long-Term Capital Management (LTCM) in 1998, as points of caution. “Data are not enough. We need theory too”, stated Fischer.
Fischer points no fingers, and draws no profound conclusions, but firmly believes there is a compelling need to understand the connections between non-bank financial institutions and the more traditional market participants. History is a painful teacher;
“History has demonstrated that risks evolve in response to regulatory pressure and the animal spirits that emerge as memories fade, as well as to animal spirits. As a result, the infrastructure needed to learn the things we don’t know needs to be put in place.”
The Fischer speech is embedded below.