On July 12, 2016, US Federal Reserve Board Governor Daniel Tarullo discussed the risks of shadow banking activities at the Center for American Progress and Americans for Financial Reform Conference. He focused his remarks on the characteristics of shadow banking-related financial activities and institutions that are most likely to pose risks to financial stability, namely the risk of “runnable liabilities,” defined as short-term, “pay-on-demand” transactions that are not insured by the federal government. These transactions are thought to pose a severe risk to financial stability since their pay-on-demand feature implies that, in the event of stress caused by credit-risk concerns, wide swings in short-term interest rates, or deteriorations in market liquidity, investors may behave as they would during times of stress and redeem shares, unwind transactions or decide not to roll over positions. Tarullo stated that this type of runnable funding, while less prevalent than before the financial crisis, is a key area for prudential regulators to focus analysis and policy initiatives. He stressed that while liquidity standards, stress testing and resolution planning exist to help curb the risk of runnable funding for prudentially regulated firms, liquidity runs that could threaten financial stability may exist in the non-regulated sector. Governor Tarullo suggested a number of key issues to be considered in creating a regulatory framework for these transactions, including whether one versus multiple agencies should regulate the industry and whether or not regulation should be uniform or should be tailored to take into account the characteristics of the market actors and business models involved in the funding relationship.
Governor Tarullo’s speech on shadow banking is available at: