By Ryan Tracy and Pedro Nicolaci da Costa
WASHINGTON--Federal Reserve Chairwoman Janet Yellen and another
top Fed official defended the prospect of stricter regulation for
large, nonbank financial firms like asset managers as Washington
looks to rein in risks emerging outside the traditional banking
sector.
Ms. Yellen, testifying before a Senate panel on Thursday, said
bringing large asset managers in for tougher supervision would be
justified if their failure could threaten financial stability.
Before imposing stricter rules on non-banks, Ms. Yellen said
regulators first need to do a detailed analysis "to really identify
clear ways in which the failure of these firms" would pose risks to
the financial system.
But if the failure of one firm could cause a systemwide crisis,
"that's a reason for them to be designated and subject to risk
standards and potentially capital and liquidity standards that
would reduce the odds that they could fail," Ms. Yellen said.
Her comments were echoed earlier Thursday by Fed. Gov. Daniel
Tarullo, the Fed's regulatory point man, who said there is a "need
to broaden the perimeter of prudential regulation" beyond the
banking system. Regulators must look for threats posed by risky
financial activities regardless of whether banks are involved, he
said.
The concerns come as U.S. officials begin to worry about risks
building outside the banking system, which has been the primary
focus of postcrisis rules. Since 2008, regulators have attempted to
tighten bank rules by forcing them to raise additional capital and
reduce leverage. Concern is now growing among regulators that such
restrictions are forcing financial activity into the "shadow
banking" sector and outside the purview of regulators.
Much of the Fed's regulatory responsibilities relate to
overseeing large banks, but the 2010 Dodd-Frank financial law also
gave the Fed broader powers to supervise and impose capital
requirements on any nonbank firm designated as "systemically
important" by the Financial Stability Oversight Council. The FSOC,
which includes the heads of the Fed, Treasury Department and other
financial regulators, has already designated Prudential Financial
Inc., American International Group Inc. and the financing arm of
General Electric Co. and has begun to evaluate the risks of asset
managers like BlackRock, Inc. and Fidelity Investments.
Ms. Yellen, responding to questioning from Sen. Kelly Ayotte
(R., N.H.), declined to say which firms the oversight council is
examining most closely, but said "there is no one size fits all"
approach to analyzing the risks associated with an industry.
"Certainly asset managers have very different characteristics than
banking organizations," Ms. Yellen said.
On Wednesday, Ms. Yellen and others on the oversight council
also said they are monitoring whether new business practices by
firms outside the banking systems pose "emerging threats," issuing
a report that mentioned nonbank mortgage-servicing companies and
asset managers as areas to watch. The report cited in particular
certain guarantees that asset managers make as part of their
securities lending businesses, which aid investors in hedging and
short selling. Asset managers make these financial guarantees
without holding capital against them as a bank would, the report
noted. A person familiar with the regulators' thinking said the
concern mentioned in the report wasn't related to any particular
type or size of asset management firm.
The potential for more regulation of large asset managers has
worried the industry, which argues that it is already regulated and
Fed oversight isn't appropriate. It has also raised eyebrows among
officials at the Securities and Exchange Commission, which already
regulates investment funds that the managers oversee.
The Fed is "intent on increasing the scope of their authority
and power well beyond banks," SEC Commissioner Michael Piwowar said
in an interview. "It's clear that they're not going to be satisfied
until they have success in fulfilling what some are calling a
'Noah's ark' approach of picking two large companies in every
industry" and subjecting them to stricter oversight.
Ms. Yellen and Mr. Tarullo have also said the Fed is considering
broader rules focused on particular financial activities, such as
margin requirements for short-term wholesale funding
transactions.
Both also said they were less concerned about risks posed by
small institutions, with Mr. Tarullo suggesting that regulators
could use an even higher threshold -- $100 billion in assets
instead of the existing $50 billion--to consider banks
"systemically important."
"It would be worthwhile to have a policy discussion of statutes
that might be amended explicitly to exclude community banks," Mr.
Tarullo said, citing the Volcker rule and incentive compensation
requirements of Dodd-Frank.
Write to Ryan Tracy at ryan.tracy@wsj.com and Pedro Nicolaci da
Costa at pedro.dacosta@wsj.com