The Fed agreed to the new rules under pressure from lawmakers – led by Senator Elizabeth Warren – who felt an initial plan announced in 2013 did not go far enough.
This led to fears that the central bank could act with too much freedom in deciding which companies to save if they ran into trouble.
“In the Dodd-Frank Act, Congress reviewed the scope of the Federal Reserve’s emergency lending authority and determined to make significant modifications that enable the Federal Reserve to extend emergency credit only through broad-based facilities and programmes designed to provide liquidity to the financial system,” Ms Yellen said.
“We have received helpful and constructive comments from many sources on a rule to implement these Dodd-Frank Act provisions.
“In response to these comments, we have made significant changes to the proposed rule to ensure that our rule will be applied in a manner that aligns with the intent of the Congress and the Dodd-Frank Act.”
As part of the revisions, solvent companies will not be allowed to pass on emergency funds to insolvent firms. The Fed will also review its loan programmes every six months, deciding whether they should be ended.
Daniel Tarullo, a member of the Fed’s board of governors, said there would now be a better balance between the central bank’s need to respond in a crisis and the concern that helping specific companies considered “too big to fail” created the wrong incentives for managers at companies expecting to be bailed out.
As the financial crisis intensified in 2008, the Fed invoked its little-used emergency lending power to stave off the failure of AIG and Bear Stearns, and help other “too big to fail” companies including Citigroup and Bank of America.
The Fed’s Open Board meeting
Although the move arguably helped the US financial system at a time when it risked collapse, critics claimed it was not in line with the intended use of the Fed’s emergency authority.
In total, the Fed provided $710bn in loans and guarantees. The loans have since been repaid earning the Fed a net profit of $30bn, according to a September Congressional Research Service review.