Mumbai: The Federal Reserve has extended a facility that offers investment banks emergency access to federal funds into another year amidst persisting turmoil in the financial markets.

Backed by the US Treasury and the Securities and Exchange Commission, the Fed signed a memorandum of understanding that in effect brings forward a Fed regulatory structure and implicit Fed backing for the large investment banks.

The agreement would allow investment banks like Lehman Brothers to access Fed cash for six-months, beyond the end of the year.

Previously, access to emergency funding was only allowed for commercial banks such as JP Morgan.

The agreement amounts to a direct Fed supervision after an unprecedented failure of a weak SEC – after the failure of Bear Stearns – to reach for important regulatory measures. 

The Fed involvement with the regulation of investment banks will, for the first time, pave the way for a new liability on the US government and introduce fresh moral hazards into the securities business.

The Fed is expected to issue fresh guidelines on lending next week. The new rules aim at restricting lenders from penalising borrowers who pay off loans early and prevent lending without proof of a borrower's income.

Analyst say the agreement between the Fed and the SEC will undermine the risk coefficient in market deals and hence market discipline. With the risk shifting to the Fed and the government, investors will be justified in believing that the US government will ultimately stand behind the large investment banks, they argue.

Fed put in place the emergency lending facility for investment banks in March to stabilise the financial system as Bear Stearns collapsed.

Fed chairman Ben Bernanke also sought  more powers for the central bank to supervise markets.

Policymakers expect the strain on the financial market to continue for some time and a direct supervision by the Fed would help institutions if, as the market expects, the Fed opts to raise interest rates later this year.

"Allowing Bear Stearns to fail so abruptly at a time when the financial markets were already under considerable pressure would likely have had extremely adverse implications for the financial system and the broader economy," Bernanke said.

Since the Bear Stearns bailout, analysts have assumed an eventual Fed regulation of investment banks.

''SuperFed'' has now come through administrative action rather than through legislative action, for it involved placing the resources of the US government behind the investment banking industry.