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Fed Vice Chair Yellen Discusses Interconnectedness, Systemic Risk

Fed Vice Chair YellenSince the 2007–08 financial crisis, industrialized nations have enacted a multifaceted set of reforms meant to manage systemic financial, which is heightened by the increased interconnectedness of global markets. But policy makers and regulators must consider the costs these reforms impose on market participants, Federal Reserve Board Vice Chair Janet L. Yellen said during a January 4 speech.

Preserving benefits, managing side effects
"The difficult task before market participants, policymakers, and regulators with systemic risk responsibilities such as the Federal Reserve is to find ways to preserve the benefits of interconnectedness in financial markets while managing the potentially harmful side effects," Yellen said in remarks at the American Economic Association/American Finance Association luncheon in San Diego. "Indeed, new regulations required by the [Dodd-Frank Act] and changes in supervisory practices by the Federal Reserve and other financial regulators are intended to do just that."

In a lengthy address, Yellen summarized research that illuminates the benefits and risks produced by the vastly increased interconnectedness and complexity of 21st century financial markets. She also discussed particular reforms. For example, enhanced capital standards for global systemically important banks—formulated by the Basel Committee on Banking Supervision and endorsed by the Group of Twenty industrial nations—are an important tool for managing systemic risk, Yellen said.

But they are not the only tool.

"In fact, the multifaceted nature of the [Basel Committee] reform program is an important design principle," Yellen explained. "One of the lessons of the recent financial crisis was that capital alone is not sufficient to prevent or stem a crisis. Multiple channels for reform initiatives will enhance systemic stability."

Targeting derivative risk
In addition to banking reforms, the G-20 also committed to reduce risk in over-the-counter derivatives markets, she noted. Reforms in this area aim to increase transparency and decrease counterparty exposures among market participants.

"These efforts, of course," the vice chairman said of all reforms, "must account for the costs of new rules and ensure that these costs are clearly outweighed by the benefits. I am confident that the policies I have described today will make the economy more resilient to financial shocks and help reduce the risk of another crisis, while properly balancing these important benefits against the necessary costs."

January 30, 2013


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