Regulators have spent the past five years trying to siphon risk out of the financial system, but the Federal Reserve sees one major piece of unfinished business: short-term funding.

In recent decades, such funding has become a sort of oil lubricating Wall Street's gears. Lenders—money-market funds, insurance companies, pension plans and others—provide temporary cash or securities to big banks, hedge funds, asset managers or other market participants that trade stocks and bonds. The borrowers can invest the cash or use securities-on-loan as leverage for other transactions.

Relying on that system carries risks. The financial crisis proved that when Wall Street leans too heavily on short-term funding, a sudden hiccup in those loans can hobble financial firms, instigating a crisis that freezes lending for Main Street businesses.

Problems in the short-term markets in 2008 were not unlike the bank runs—mass, simultaneous withdrawals of deposits—that preceded the Great Depression, according to academics and Fed economists who have studied the topic. During the worst of the crisis in the fall of 2008, many short-term lenders moved to pull their money back at the same time. Some hedge funds failed after they couldn't obtain short-term loans to pay money they owed elsewhere. Lehman Brothers, an investment bank more than a century old, suddenly faced bankruptcy that September in part because it couldn't secure overnight funding. The shock of Lehman's demise caused lenders to pull back even more, exacerbating the credit crunch.

Risks posed by short-term funding have long been a concern at the Fed, and a string of recent public statements suggests the central bank may soon take aim at the ubiquitous practice.

Yet scaling back short-term funding isn't easy, given how commonplace such financing has become and the myriad institutions—banks, hedge funds, mutual funds—that play a role in the market. While the Fed can easily tighten the regulatory screws on banks to reduce their reliance on short-term loans, reining in other players could require the involvement of additional regulators, including overseas policy makers.

The Fed also must weigh the potential downside of any action it takes, given the market's continual reliance on short-term funding. Any move by the Fed could affect the amount of credit available for financial firms to take risks and make profits, though it is possible those firms would find a way to obtain the same funding elsewhere. Indeed, among the things the Fed is pondering is how to tamp down risk without simply shifting short-term funding activity to other countries where stricter rules—and strong oversight—don't apply.

Fed officials have discussed a two-pronged approach to make short-term-funding markets more stable. One prong would target large financial firms, forcing them to hold more loss-absorbing capital if they rely heavily on short-term loans. Another would require that all borrowers in the markets pay a sort of tax by posting minimum amounts of collateral, which could make lenders less prone to panic during periods of market stress.

The issue is likely to come to the front burner soon. Janet Yellen, vice chairwoman of the Fed and the Obama administration's nominee for chief of the central bank, has called the short-term funding markets "a major source of unaddressed risk" and last month said the Fed was contemplating new regulations. Fed governor Daniel Tarullo, the agency's regulatory point man, has beaten the drum about the need to rein in short-term lending risks in seven speeches he has given since November 2012, including one last month in which he said the risks "have not fully been countered" by the Fed's actions to date.

One central concern is the risk of a "fire sale." In a common short-term transaction, a financial firm can post a security it already holds as collateral and in return receive a short-term cash loan. During calm times, that arrangement allows the firm to put that extra cash to work, often by purchasing more securities. The engine of Wall Street revs.

But what happens during a market shock, when the value of the underlying security or the stability of a large financial firm with lots of short-term contracts is called into question? That firm might have trouble borrowing enough cash to stay afloat, so it moves to sell other assets at "fire sale" prices, which in turn makes those assets drop in value in the broader market. Now, other firms holding similar assets will have trouble borrowing against them. They move to sell their assets. Those assets drop in value. And the downward spiral begins.

"Like many lubricants, they can become accelerants when things get hot enough," Mr. Tarullo said of short-term-funding mechanisms in October.

Yale University professor Gary Gorton recently likened financial firms' growing reliance on increasingly shorter-term funding contracts in 2008 to tinder building up in a parched forest. Lehman's bankruptcy filing that year, he says, was like a lightning strike that sparked the inferno.

The Fed nodded to those risks last month when it forced big banks to include the failure of their largest counterparty in the "stress test" scenario they must pass in order to get permission to pay dividends to shareholders.

Regulators' next move is hazier, but officials have offered clues. On Nov. 22, Mr. Tarullo said the Fed could adopt new capital rules targeting large banks that engage in a lot of short-term transactions, pushing them either to do fewer short-term deals or hold more capital to absorb losses.

The Fed would have to "focus on particular kinds of transactions, rather than just the nature of the firm engaging in the transactions," Mr. Tarullo said.

He and Fed governor Jeremy Stein have suggested a requirement that market participants hold a minimum amount of extra collateral on the margin, which could reduce the risk that problems at one firm spread to others."There is no presumption that the optimal tax should be large," Mr. Stein said last month, referring to extra costs a margin rule may impose. 
"Only that it may be non-zero."

 To be sure, a margin requirement comes with its own challenges. The Fed has the authority to impose such a requirement, but only on certain types of securities purchases. That means it might need to persuade other U.S. agencies or Congress to adopt similar rules. And if international regulators don't adopt similar regimes, the transactions might simply move offshore, leaving the risks to the global system in place.

Fed officials have long known the problem. Figuring out how to fix it is the tricky part.