Yellen Says US Must Address Vulnerabilities in 'Shadow Banking'

U.S. Treasury Secretary Janet Yellen wants more oversight for the nonbank sector.

In remarks to the National Association for Business Economics annual conference Thursday (March 30), Yellen addressed the need to regulate both nonbanks and traditional lenders as the government continues to grapple with a recent banking crisis.

"We must also address vulnerabilities in the nonbank sector," she said. "Some nonbanks — or shadow banks — consist of financial companies that carry out traditional banking functions, but are outside of, or only loosely linked to, depository institutions."

This sector, she said, includes things like hedge funds, money market funds, and digital assets, the last of which the Biden administration is continuing to evaluate. She paid close attention to stablecoins, which she said have a structure that creates the types of "run incentives" found in the traditional financial system.

"Stablecoin holders often have a 'first-mover advantage' to redeem in times of stress — before conditions deteriorate further, fire sales become necessary and the value of reserve holdings fall," Yellen said.

"As we saw in 2008 and 2020, runs and fire sales can spread like a contagion. A run on one stablecoin can lead to panicked runs on other stablecoins — causing even broader selloffs."

Yellen — as she and other regulators have in recent weeks — stressed that the overall banking system was sound, but said more regulations could be needed.

"Any time a bank fails, it is cause for serious concern," she said. "Regulatory requirements have been loosened in recent years. I believe it is appropriate to assess the impact of these deregulatory decisions and take any necessary actions in response."

Yellen's remarks came days after reports that the White House was preparing to call on Congress to approve tougher regulations for mid-sized banks following the recent collapses of Silicon Valley Bank and Signature Bank.

President Joe Biden has already proposed laws that would apply stricter penalties on bank executives responsible for the failure of the institutions.

But a report by the Wall Street Journal said the administration could also recommend restoring provisions of the Dodd-Frank law and other regulations changed under the Trump administration and either temporarily extending federal deposit insurance to all bank customers or increasing the cap above the current maximum of $250,000.