Podcast: Financial innovation and stability in the US

Financial innovation – whether in asset classes, payments or regulations – often goes hand in hand with financial stability considerations. This is a key part of the ongoing research conducted this episode’s guest, Larry Wall.

Wall is director of the Federal Reserve Bank of Atlanta’s Center for Financial Innovation and Stability.

In the episode, he shares his views of a range of issues facing US regulators today – from stablecoins and their possible implications for financial stability, to new credit loss accounting standards and the dollar’s role as a reserve currency.

Wall argues that despite big promises by backers that stablecoins will dramatically reduce the cost and speed of cross-border payments, this may not be the case in reality.

“Some of the impediments, such as the difficulty of complying with rules on anti-money laundering and counter-terrorist financing will not go away even if cross-border transactions move to stablecoins,” he says.

If the cost and speed of cross-border payments does come down, however, this could raise the sensitivity of global investment flows, posing new financial stability threats, he says.

Wall also highlights a possible flaw in some versions of proposed stablecoins, which may create financial stability issues reminiscent of those faced by money market funds during the 2008 financial crisis. Like crisis-era MMFs, stablecoins promise a fixed payout based on a pool of underlying assets.

“Conceivably a stablecoin could come under similar pressure if it invested in assets that took a loss,” Wall says. “If we want to completely eliminate the possibility of a similar run on a stablecoin, the only asset it could hold with no credit, interest rate or liquidity risk is reserves at a central bank.”

Stablecoins could also create implications for the future role of the dollar as the global reserve currency and means of exchange, Wall says. He discusses several possible paths for the dollar under different stablecoin scenarios.

Credit loss accounting

The US and other major countries have been going through a period of transition in the way banks are required to account for losses. Since recording the episode, this topic has come under the spotlight again as the Federal Reserve and Congress took steps in March to ease the burden of transitioning to the Current Expected Credit Loss requirements during the pandemic.

While Wall’s remarks were made prior to the changes, they remain relevant to the current situation and the ongoing debate. Wall says that despite some observers arguing that the new standards could worsen a downturn, it is very important that banks practice estimating possible losses during a period of sustained weakness.

“If banks are concerned that the loss estimates could suddenly jump and possibly end up too high, there is a simple solution. They should hold sufficient capital to be able to survive a severe, but plausible, downturn,” he says.

Walls also discusses some of the key takeaways from the Atlanta Fed’s 2019 Financial Markets Conference and what observers might have expected to hear in the 2020 conference. Unfortunately, since recording the episode, the reserve bank made the decision to cancel this year’s conference due to the coronavirus.

Index

00:00 Introduction and Center for Financial Innovation and Stability

3:35 Stable coins

10:29 Dollar as global reserve currency  

15:45 Credit loss accounting  

22:40 Data in the US

24:20 Atlanta Fed’s 2019 Financial Markets Conference

To hear the full podcast, listen in the player above, or download. Future podcasts in our CB On Air: FedSpeak series will be uploaded to centralbanking.com. CB On Air is also available via iTunes or podcast apps and from Google Podcasts (Android only).