Fed’s Powell open to more than one Libor alternative

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WASHINGTON — Federal Reserve Chairman Jerome Powell told senators Wednesday that his agency is open to exploring a separate alternative reference rate that would be credit sensitive as the industry prepares for the transition away from the London interbank offered rate.

Libor, the most dominant interest rate benchmark around the globe, will likely be unavailable starting at the end of 2021. The secured overnight financing rate has been developed as a substitute and has gradually gained market share, but some market participants have said they would prefer a rate that incorporates a credit risk element.

“We can't assume that [Libor] is going to be published past the end of ’21, so that hasn't changed and everyone needs to take that on board,” Powell said during a Senate Banking Committee hearing, his second appearance on Capitol Hill in two days.

Nevertheless, some banks have expressed concern that SOFR could result in a “mismatch” between bank assets and liabilities in the event of economic stress.

“A number of banks have come forward and said that they want to work on a separate rate, which would not replace SOFR, but would be credit sensitive, and so they're doing that now and ... we're working with them to support that process,” said Fed Chairman Jerome Powell.
“A number of banks have come forward and said that they want to work on a separate rate, which would not replace SOFR, but would be credit sensitive, and so they're doing that now and ... we're working with them to support that process,” said Fed Chairman Jerome Powell.

“One of the challenges of replacing Libor is that Libor has an embedded credit risk element,” said Sen. Pat Toomey, R-Pa. “It's an interbank rate, whereas SOFR is a [credit] risk free rate because it's essentially a repo rate, and that mismatch could conceivably create some problems.”

Powell acknowledged that a number of banks have publicly said that they would prefer using a different rate than SOFR, and that the Fed is supportive of the possibility of creating a different rate.

“A number of banks have come forward and said that they want to work on a separate rate, which would not replace SOFR, but would be credit sensitive, and so they're doing that now and ... we're working with them to support that process,” he said. “We're open to that, but it doesn't mean that this the transition away from Libor to SOFR will stop. It has to go forward.”

Several senators also pressed Powell about a speech Fed Vice Chairman for Supervision Randal Quarles gave last month in which Quarles laid out a number of comprehensive recommendations for overhauling the Fed’s supervisory regime.

Quarles suggested that the Fed should incorporate tailoring into its supervision framework, basically meaning that how the regulator oversees a bank is partly tied to the institution's size. That would align the Fed's supervisory process with rules it finalized last year that similarly tailor post-crisis regulatory requirements for banks of different risk categories.

Powell said at a press conference last month that he supported Quarles’ recommendations, and he echoed his support to senators Wednesday.

“I think it's a very thoughtful process of looking at that and asking how can we make it more transparent with more due process, but still effective, because supervision has to be firm and fair,” he said.

While the ideas from Quarles’ speech are “not quite at the stage of being proposals yet,” Powell said, the Fed chairman did confirm that some of the recommendations would be issued through rulemaking, while others may come in the form of guidance or revisions to previous guidance.

His comments came just a day after Sen. Elizabeth Warren, D-Mass., wrote a letter to Powell questioning Quarles’ recommendation that the Fed limit its use of “matters requiring attention” and “matters requiring immediate attention” to violations of law and material safety and soundness issues.

“This troubling proposal is misguided,” wrote Warren, a candidate for president who did not attend Wednesday’s hearing. “MRAs serve as an important early warning system, ensuring that banks and their boards are aware of emerging problems in time to mitigate them.”

She added that limiting MRAs would inhibit the Fed's ability to address issues that might negatively affect consumers, even if those issues don't yet rise to a violation of law or regulation.

Separately at the hearing, Powell reiterated that the Fed is still in the beginning stages of exploring whether the agency will develop a digitial currency, and that — depending on the design of any such currency — the central bank would seek congressional approval if it chose to move forward.

The Fed has said previously it has not yet decided whether it would be appropriate to create a digital dollar but is weighing the costs and benefits of such an endeavor.

For one thing, a Fed-issued digital currency could promote greater financial inclusion, but it could also come with an increased cyber risk, Powell said.

“I'd say we're working very broadly, including working with other central banks around the world on this, and there's just a lot of thinking and experimentation and understanding that we're gaining,” Powell said. “If we conclude that we need more authority and that this is something appropriate to do, then we will ask for the authority.”

Both Republicans and Democrats at Wednesday’s hearing encouraged Powell and the Fed to remain at the forefront of the adoption of global technology.

“As I have stated in past hearings, it seems to me that technological innovations in this space are inevitable and the U.S. should lead in developing what the rules of the road should be,” Senate Banking Committee Chairman Mike Crapo, R-Idaho, said in prepared remarks.

Sen. Mark Warner, D-Va., expressed concern about China's moving “aggressively” on a digital currency, and what that might mean for the U.S.

“A number of us who are on the Intelligence Committee [have] concern about the rise of China in a series of areas, and I think it is clear that China may move quicker than us on a digital currency,” he said.

Powell said the Fed is focused not only on China’s involvement in digital currencies, but also on cryptocurrencies developed by private-sector companies.

“We have to ask the question, what would it mean if China had a digital currency that had fairly wide adoption, including to other countries?” he said. “We've also got to ask, what if a private-sector entity, you know, a large company with a large network of users, has a digital currency?”

Facebook’s Libra cryptocurrency project “lit a bit of a fire” around the world on the question of digital currencies, Powell added.

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LIBOR Regulatory reform Regulatory relief Regulatory guidance Cyber security Digital currencies Jerome Powell Federal Reserve Mike Crapo Libra
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