Quarles says Fed could better align Treasuries, reserves to ease repo pressure

(Reuters) - U.S. Federal Reserve Vice Chair Randal Quarles said Thursday policymakers should consider changes that would make it easier for banks to treat Treasury holdings as similar to reserves held with the central bank when meeting liquidity requirements.

Quarles listed several options Fed officials could adopt to give financial firms more flexibility when meeting liquidity requirements while not loosening the standards for how much liquidity banks need to hold, Quarles said.

"I think it is worth considering whether financial system efficiency may be improved if reserves and Treasury securities' liquidity characteristics were regarded as more similar than they are today," Quarles said in prepared remarks to be delivered at an event organized by the Money Marketeers of New York University.

"To be clear, the ideas I will discuss do not involve any decrease in banks’ liquidity buffers," he said.

For example, Quarles said Fed officials could adopt a policy where financial firms are sometimes allowed to include the discount window, a backup source of funding from the Fed, as part of their liquidity planning during stress scenarios. The discount window is rarely used because some firms fear there is a stigma associated with it, but Quarles said an adjustment could give banks more incentive to incorporate the tool.

A liquidity crunch in mid-September disrupted money markets and led to a spike in short-term borrowing rates. The Fed calmed markets by injecting billions of dollars into the markets for repurchase agreements, or repo. Officials also moved to permanently increase the level of reserves in mid-October by purchasing $60 billion a month in short-term Treasury bills.

Fed Chair Jerome Powell said last week that the repo operations are likely to continue until April and that the pace of Treasury purchases could slow in the second quarter as the central bank reaches an "ample" level of reserves.

Some analysts were concerned there could be a repeat of volatility in the repo market at the end of last year, when large banks were expected to pull back on lending in short-term markets in an effort to shrink their balance sheets and avoid capital surcharges. Quarles said Thursday that Fed officials are "actively considering" a change that could address that issue by relying less on year-end inputs and more on average figures when evaluating liquidity requirements for globally systemically important banks.

The policymaker said officials are still considering a standing repo facility, which would make it easy for dealers to swap Treasury holdings for cash. But he said, "There may be benefits to working first with the tools we already have at our immediate disposal."