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January 31, 2014

Federal Reserve policy still poses risks, Kansas City Fed president says

In an address in South Africa, Esther George called recent Fed policy changes “modest” and said “unintended, negative side effects” of the still aggressive policy may reach the banking industry.

Recent cutbacks in the Federal Reserve’s aggressive economic stimulus haven’t eliminated risks and costs to banks, Fed member Esther George said Friday in South Africa.

George, president of the Federal Reserve Bank of Kansas City, cited “unintended, negative side effects” that the Fed’s continued policies may have on financial institutions.

They could “undermine our best supervisory efforts and could set the stage for instability,” she said, according to

a copy of her address on bank supervision

.

George, a member of the Fed’s policy committee, dissented at nearly every session the group held last year. Only in December, when the Fed made its first step toward a more moderate policy, did she endorse its actions.

The Fed has held its benchmark interest rate near zero since 2008 and bought trillions of dollars of government and mortgage-backed securities to hold down long-term interest rates.

Its policy committee agreed this week to make a second reduction in its bond buying program, which continues to buy $65 billion of bonds a month.

George called the reductions “a modest but positive step allowing financial markets to better price risk and allocate credit.” She has said the Fed’s policies risk financial distortions.

Continued bond buying and the persistent zero interest rate policy also help to create “a nearly irresistible incentive (for banks) to expand into nontraditional and higher-risk activities,” George said.

She said signs of such behavior are showing up in the form of weaker lending standards and growth in higher-risk loans such as oil and gas lending.

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