The Board of Governors of the Federal Reserve System unanimously voted at an open meeting Monday to adopt a rule limiting its emergency lending powers following pressure from lawmakers following the 2008 bailout of large failing financial institutions.
The regulation puts a Dodd-Frank provision into effect requiring the central bank to limit emergency lending to facilities with “broad-based eligibility” instead of specific firms, preventing the Fed from providing loans to insolvent “too big to fail” companies.
Fed Chair Janet Yellen defended bailouts in certain circumstances, sayings emergency lending is a “critical tool” used to mitigate potential economic crises which has only been used sparingly.
Lawmakers on both sides of the aisle have been critical of the bank bailouts after the great recession. Massachusetts Democrat Sen. [crscore]Elizabeth Warren[/crscore] teamed up with Louisiana Republican Sen. [crscore]David Vitter[/crscore] to introduce legislation last May in an attempt to limit the Fed’s lending authority by requiring a minimum of five banks that meet the criteria to be involved in any central bank lending program — a provision set to be implemented under the finalized rule.
“The Dodd-Frank Act amendments eliminated the authority to lend for the purpose of aiding a failing firm or preventing a firm from entering bankruptcy or another resolution process, such as was done with loans to Bear Stearns and AIG,” Yellen said in her opening statement.
Under the new rule, the Fed will impose a penalty rate of interest to encourage banks to pay back loans as quickly as possible and won’t be permitted to lend to any entity that hasn’t paid undisputed debts within 90 days.
“In place of this authority to lend to specific firms, Congress enacted a framework for orderly resolution and provisions that encourage large financial firms to develop plans for their resolution in bankruptcy,” Yellen continued.
The rule is projected to take effect Jan. 1, 2016.
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