US Treasury highlights importance of quality collateral
28 February 2018 Washington DC
Image: Shutterstock
The importance of secured lending against high-quality collateral is underlined by the inclusion of the topic in a paper published by the US Treasury, summarising its views on the Orderly Liquidation Authority (OLA).
The OLA is a fund created under the Dodd-Frank act as a new federal receivership process under which the Federal Deposit Insurance Corporation (FDIC) may serve as receiver for large, interconnected financial companies.
These include broker-dealers, whose failure is seen as posing a significant risk to the financial stability of the US.
The Treasury said the report is a response to the Presidential Memorandum of 21 April 2017 directing Treasury to propose recommendations to align OLA with the Core Principles for Financial Regulation and determine whether the Bankruptcy Code should be reformed to better enable resolution of financial companies.
The Treasury explained that its recommendations ensure that taxpayers are protected by
strengthening the bankruptcy procedure for a failed financial company and retaining OLA in
very limited circumstances with significant reforms.
Treasury secretary Steven Mnuchin, said: “Treasury recommendations seek to ensure that our financial system is resilient while protecting taxpayers and promoting market discipline.”
“The bankruptcy reforms that we propose will make the shareholders, management, and creditors of a financial company bear any losses from its failure. The policy of this administration is clear: we will not tolerate taxpayer-funded bailouts.”
With respect to the use of the Orderly Liquidation Fund (OLF), the Treasury recommended that guarantees of private sector lending be used as opposed to direct loans. It added that premium rates of interest or guarantee fees, as applicable, be charged to encourage a prompt return to reliance on private-sector credit markets.
According to report, the FDIC should lend only on a secured basis to ensure that taxpayers are
protected. The FDIC has indicated that it would expect its lending to be done on a secured
basis. To the extent it is not able to limit the use of the OLF to guarantees of private sector funding, the FDIC should commit to providing any direct loans on a secured basis, and the Treasury should not advance funds to the FDIC unless it does.
The Treasury’s report stated that the FDIC should seek high-quality assets as collateral and should publish a list of collateral it deems eligible to secure OLF loans.
It noted that the collateral acceptable to Federal Reserve Banks for discount window lending provides a helpful starting point for identifying acceptable collateral. If the FDIC proposes to accept as security for an OLF loan any collateral of a type not previously identified by the FDIC as being eligible, such proposed collateral should be approved by the Secretary of the Treasury on a case-by-case basis.
Lending only on a secured basis, based on verified fair market asset values and at premium rates, would align use of the OLF with long-established principles of central banking. Lending on such terms will protect taxpayers and reduce the potential for moral hazard.
To further incentivise the use of private funding markets, the FDIC should only lend funds at a premium interest rate and should only provide guarantees after charging a premium guarantee fee.
The Dodd-Frank Act provides that the Secretary of the Treasury shall determine the rate of return of any lending to the FDIC and requires the Secretary to take into consideration the current average yield on outstanding Treasury securities of comparable maturity plus an interest rate surcharge to be determined by the secretary.
The OLA is a fund created under the Dodd-Frank act as a new federal receivership process under which the Federal Deposit Insurance Corporation (FDIC) may serve as receiver for large, interconnected financial companies.
These include broker-dealers, whose failure is seen as posing a significant risk to the financial stability of the US.
The Treasury said the report is a response to the Presidential Memorandum of 21 April 2017 directing Treasury to propose recommendations to align OLA with the Core Principles for Financial Regulation and determine whether the Bankruptcy Code should be reformed to better enable resolution of financial companies.
The Treasury explained that its recommendations ensure that taxpayers are protected by
strengthening the bankruptcy procedure for a failed financial company and retaining OLA in
very limited circumstances with significant reforms.
Treasury secretary Steven Mnuchin, said: “Treasury recommendations seek to ensure that our financial system is resilient while protecting taxpayers and promoting market discipline.”
“The bankruptcy reforms that we propose will make the shareholders, management, and creditors of a financial company bear any losses from its failure. The policy of this administration is clear: we will not tolerate taxpayer-funded bailouts.”
With respect to the use of the Orderly Liquidation Fund (OLF), the Treasury recommended that guarantees of private sector lending be used as opposed to direct loans. It added that premium rates of interest or guarantee fees, as applicable, be charged to encourage a prompt return to reliance on private-sector credit markets.
According to report, the FDIC should lend only on a secured basis to ensure that taxpayers are
protected. The FDIC has indicated that it would expect its lending to be done on a secured
basis. To the extent it is not able to limit the use of the OLF to guarantees of private sector funding, the FDIC should commit to providing any direct loans on a secured basis, and the Treasury should not advance funds to the FDIC unless it does.
The Treasury’s report stated that the FDIC should seek high-quality assets as collateral and should publish a list of collateral it deems eligible to secure OLF loans.
It noted that the collateral acceptable to Federal Reserve Banks for discount window lending provides a helpful starting point for identifying acceptable collateral. If the FDIC proposes to accept as security for an OLF loan any collateral of a type not previously identified by the FDIC as being eligible, such proposed collateral should be approved by the Secretary of the Treasury on a case-by-case basis.
Lending only on a secured basis, based on verified fair market asset values and at premium rates, would align use of the OLF with long-established principles of central banking. Lending on such terms will protect taxpayers and reduce the potential for moral hazard.
To further incentivise the use of private funding markets, the FDIC should only lend funds at a premium interest rate and should only provide guarantees after charging a premium guarantee fee.
The Dodd-Frank Act provides that the Secretary of the Treasury shall determine the rate of return of any lending to the FDIC and requires the Secretary to take into consideration the current average yield on outstanding Treasury securities of comparable maturity plus an interest rate surcharge to be determined by the secretary.
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