TOP FED officials yesterday warned against the risks to financial stability posed by European debt and pushed for banks to hold more capital against future crises.
Kansas City Federal Reserve president Esther George said the leverage ratio is one buffer in the financial system that is historically there to absorb losses, and that there must be an emphasis on leverage “no matter how difficult and costly”.
“With regard to correcting the incentives in banking, the most important challenge we face is in constructing an appropriate, but carefully limited, public safety net,” she explained.
However, she also warned against expanding the regulator’s roles on the basis that moral hazard could arise in more and more areas, where state backing boosts incentives for risky behaviour.
Meanwhile Boston Fed president Eric Rosengren warned money market funds could be dangerously over-exposed to European sovereign debt.
The funds are designed to invest in very safe assets, providing a similar risk and liquidity profile to bank accounts.
However, Rosengren warned the debt crisis was endangering that low-risk structure – and could transfer some of that risk into the US.
“A significant source of the credit risk in many prime money market funds over the past year has been the large exposure to European banks,” he said.
Because of their large size, “money market funds remain an important potential transmission channel to the US.”