In a speech prepared for the Federal Reserve (Fed) Bank of Atlanta's 2014 Financial Markets Conference, Chair Janet Yellen centred her comments on financial system regulation.

Investors were alert for possible comments regarding the prospect of interest rate hikes in 2015, but Yellen focused instead on initiatives to help banks make it through periods of financial stress. She explained that current rules on bank capital requirements may not be enough and that the Fed is considering additional measures.

Two possible rules could be the requirement for large banks to hold more capital or market-wide margin requirements for repurchase agreements and other securities.

Markets barely reacted as they shrugged off comments that did not touch on monetary policy. One possible reading into Yellen's speech, although it could be considered a stretch, is that tighter regulation that addresses specific risks could allow monetary policy to remain accommodative for longer.

US equity markets remained broadly flat while the US dollar declined slightly as a mixed set of economic indicators were being released Stateside.

New bank capital and liquidity requirements are implemented

Yellen explained further that the Basel Committee on Banking Supervision responded to the financial crisis by first strengthening bank capital requirements in Basel III, which the US implemented last summer.

Second, Basel III developed new liquidity standards for global banking firms but Yellen pointed out that these do not fully address the financial stability concerns associated with short-term wholesale funding. The global liquidity rules are being phased in between 2015 and 2019, but the Fed could tighten some of those rules.

"These standards tend to focus on the liquidity positions of firms taken in isolation, rather than on the financial system as a whole. They only apply to internationally active banks, and not directly to shadow banks, despite the fact that liquidity shocks within the shadow banking system played a major role in the crisis," said Yellen.

Thus, the Fed will consider additional measures and their trade-offs, to which Yellen cited a Basel study that found a tightening of risk-based capital and liquidity requirements would, on net, provide economic benefits even with higher levels of risk-based capital.

"While it would be a mistake to give undue weight to any one study, this study provides some support for the view that there might be room for stronger capital and liquidity standards for large banks than have been adopted so far," Yellen concluded.

JP

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