Tighter broker-dealer regulation needed: Rosengren

The role of broker-dealers in short term lending markets may exacerbate financial strains in times of turmoil, and it's a problem that has yet to be addressed, Boston Federal Reserve president Eric Rosengren said Wednesday.

Eric Rosengren
Wendy Maeda | Boston Globe | Getty Images
Eric Rosengren

At a conference at the New York Fed, Rosengren reiterated a longstanding criticism of the financial institutions that are central to lubricating the money system. Taking aim at the intermediaries that play a crucial role in the buying and selling of securities, the central banker said broker-dealers pose a potential risk to financial stability.

While he acknowledged broker-dealers were "critical to market infrastructure," Rosengren said, they can trigger runs on liquidity that destabilize the entire financial system, and should be subject to tougher capital requirements.

Rosengren's remarks about the elite market makers echoed comments made earlier in the day by New York Fed president Bill Dudley, who cited risks to the wholesale funding market. He urged immediate changes before another event triggered a crisis of confidence.

Rosengren alluded to the 2008 financial crisis that drove Lehman Brothers—which had a lucrative broker-dealer operation—into bankruptcy. At their peak, broker-dealers had assets of nearly $5 trillion, a third of U.S. gross domestic product, but have since scaled back on assets and risk. However, the Boston Fed chief insisted further reform was necessary.

Read MoreDodd-Frank not final chapter on reform: Dodd

Citing the experience of the crisis, Rosengren added that the broker-dealer model—which relies on short-term cash—"remains surprisingly unchanged" despite wide-ranging financial reform.

"In short, the dependence on unstable short-term funding may in my view necessitate further increases in capital requirements," the Boston Fed chief said, adding that their regulatory model should be subject to "a major re-examination" and a hike in capital requirements.

"Given the widespread support provided to broker-dealers and the difficulties they encountered during the crisis, a comprehensive re-evaluation of broker-dealer regulation is overdue," he said.

Rosengren recommended that such financial institutions be required to hold "significantly more capital," given their reliance on "unstable" sources of short-term funding. He also suggested tighter limits on repurchase agreements, which are sometimes used to finance long-term or riskier assets.

Read MoreUh-oh: Trouble is brewing again in the repo market

Separately, Dudley said changes must be made in part because it is now more difficult, in the post-financial crisis era, for the U.S. central bank to intervene in the market if investors again lose confidence in broker-dealers.

"Important issues and vulnerabilities remain," Dudley said in kicking off a conference on wholesale funding risks. "It is essential to make the system more stable."

Read MoreDudley: Need wholesale funding change

--Reuters contributed to this article.

By CNBC's Javier E. David