Op-Ed: Show Them the Money: Why the Fed Should Adopt CLFs

Originally published by Risk.net

Events over the past 15 years have shown how important it is for major financial institutions to remain highly liquid. That lesson was encapsulated in the regulatory response to the 2008 financial crisis. The foremost new requirement was the Basel Committee on Banking Supervision’s liquidity coverage ratio (LCR), which requires banks to hold a minimum amount of high-quality liquid assets.

In 2014, the definition of HQLAs was expanded to encompass borrowing capacity at a committed liquidity facility. Although CLFs – contractual arrangements whereby a central bank promises to provide a commercial bank with funds on demand – have been adopted in a couple of jurisdictions, major economies, including the US, have proved reluctant to follow suit. This is a pity, as the facilities would serve numerous policy goals and solve important problems faced by the Federal Reserve.

CLFs would benefit Main Street as well as Wall Street by allowing banks to lend more to US businesses and consumers and make fewer loans to the federal government. Currently, banks primarily satisfy their liquidity requirements by owning Treasury securities (loans to the federal government) and reserve balances (loans to the Fed that are, in turn, invested in Treasuries). If the Fed created a CLF, and if any line of credit extended under the facility were recognised as an HQLA, a bank could instead lend to a small business, a student or a farmer and use the loan as collateral to back its line of credit with the US central bank. …