Some Preliminary Financial Stability Lessons from the COVID-19 Shock
Governor Lael Brainard
At the 2021 Annual Washington Conference, Institute of International Bankers (via webcast)
It has now been one year since the devastating effects of the first wave of the COVID-19 pandemic hit our shores, a year marked by heartbreak and hardship.1 We look forward to a brighter time ahead, when vaccinations are widespread, the recovery is broad based and inclusive, and the economy fully springs back to life. But we should not miss the opportunity to distill lessons from the COVID shock and institute reforms so our system is more resilient and better able to withstand a variety of possible shocks in the future, including those emanating from outside the financial system.
The runs on offshore MMFs that hold dollar-denominated assets like commercial paper underscore the importance of working with international counterparts to increase the resilience of short-term funding markets. We are supporting the work of the Financial Stability Board to assess options for mitigating the vulnerabilities of MMFs globally and report on them later this year.
A number of possible reforms have been suggested to strengthen the resilience of the Treasury market. For instance, further improvements in data collection and availability have been recommended to enhance transparency related to market participants, such as broker-dealers and hedge funds. Some have suggested that the Federal Reserve could provide standing facilities to backstop repos in stress conditions, possibly creating a domestic standing facility or converting the temporary Foreign and International Monetary Authorities (FIMA) Repo Facility to a standing facility.9 Other possible avenues to explore include the potential for wider access to platforms that promote forms of “all to all” trading less dependent on dealers and, relatedly, greater use of central clearing in Treasury cash markets.
CCPs could consider the effects of the market dysfunction on their liquidity risk-management plans, including their assumptions regarding the ability to raise cash from noncash assets or securities. In addition to reassessing their liquidity planning, CCPs could also assess the tradeoffs between their own risk-management decisions and broader financial stability concerns, particularly in light of how CCPs may have contributed to deleveraging by some market participants in March by the magnitude of the increases in financial resources they collected when trading and volatility spiked. CCPs could assess their margin models, consider improvements to reduce pro-cyclicality, and consider increased transparency to help clearing members anticipate margin calls during periods of volatility.
The full speech is available at https://www.federalreserve.gov/newsevents/speech/brainard20210301a.htm