Fed focuses on shadow banking as it gauges financial risk

[WASHINGTON] Federal Reserve officials, fresh from the latest round of tests designed to ensure the safety of the biggest banks, are now peering into the darker corners of the financial system as they assess the risks of another crisis.

One source of concern: tighter regulation of banks is prompting more borrowers to seek funding through the US$25 trillion shadow banking system - money-market mutual funds, hedge funds, brokerages and other entities that face fewer restrictions.

"These institutions are a significant and growing source of credit in the economy," Dennis Lockhart, president of the Atlanta Fed, said in a March 20 speech. "They are part of an interconnected financial system that, in extreme circumstances, is prone to contagion." Mr Lockhart will draw more attention to the issue next week when he hosts a conference in Stone Mountain, Georgia. The event will bring together current and former Fed policymakers, money managers and academics to discuss how central banks can best identify and limit the biggest sources of risk to the financial system.

A key player in that effort is the Fed's financial stability committee, headed by Vice Chairman Stanley Fischer, who will deliver a speech at next week's forum.

"To say that the non-bank sector today appears less vulnerable than it did during the global financial crisis is not to say that authorities in the United States have tamed the non- bank sector," he told an audience in Frankfurt on Friday.

Mr Fischer's committee is mapping different parts of the shadow banking system and trying to figure out which regulator has authority over each portion.

Among the measures under consideration by Fed officials: stricter margin requirements for broker-dealers that can serve to limit the amount of borrowed money that firms such as hedge funds use to finance investments.

"Some activities have moved into the shadow banking sector, and the question is do we have regulatory or other means of controlling, mitigating, the possible negative impacts of those things," Mr Fischer said in response to questions following a speech to bankers and economists in New York this week. "We need to get some coherence about who does what and how those decisions are made."

BLOOMBERG