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March 21, 2014

Shadow Banking Deals Prompt SEC Plan to Cap Broker Leverage

“U.S. regulators concerned that banks and brokerage firms remain too dependent on risky types of short-term funding are weighing new rules designed to reduce reliance on parts of what is often called the shadow banking system.”

“The SEC is considering new funding rules for brokers as well as a limit on leverage similar to those used by the Federal Reserve and other regulators for banks, according to a regulatory document and SEC officials familiar with the matter.”

“The initiatives are aimed at financing tools such as repurchase agreements, or repos, that were relied on by Bear Stearns Cos. and Lehman Brothers Holdings Inc. until their failures accelerated the 2008 financial crisis. Lehman’s bankruptcy provoked criticism of the Securities and Exchange Commission for lax oversight of investment banks.”

“We all learned during the crisis that the shadow banking system, of which broker-dealers are a part, is subject to runs just like banks,” said Phillip L. Swagel, a professor at the University of Maryland who served as a Treasury Department assistant secretary during the crisis. “What seems like highly liquid collateral can turn illiquid during the next crisis.”

“Federal Reserve officials have warned for years that the $4.5 trillion web of repo deals remains prone to unravel during a panic, potentially leading to fire sales of assets that could spread losses across the financial system. Federal Reserve Bank of Boston President Eric Rosengren said last year that the SEC’s current rules for broker-dealers haven’t changed enough since the financial crisis.”

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Read full Bloomberg article here.

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