October 24, 2013 3:03 pm

Fed proposes new liquidity rules for banks

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Ben Bernanke, chairman of the Federal Reserve, raised fears over policy with talk of scaling back bond buying©Bloomberg

Ben Bernanke, chairman of the Federal Reserve

The Federal Reserve on Thursday proposed new liquidity requirements for large US banks aimed at helping them withstand a credit crunch, including some tougher standards than those contained in the Basel III international regulatory accord.

Fed governor Daniel Tarullo called the Fed liquidity rules “super equivalent” to Basel because of those differences. For example, what is covered under high quality liquid assets is narrower in the Fed rules than in Basel III. The US proposal does not include covered bonds or private label mortgage-backed securities, which the Fed deems as less liquid.

The Fed is also proposing that banks fully implement the new standards one year earlier than the EU and two years earlier than Basel III. Fed officials estimate banks face a $200bn shortfall out of the $2tn in high-quality assets needed to meet the liquidity requirements.

At times, the US has been tougher on standards than regulators in Europe. For some of the largest banks, the US is also considering a higher leverage ratio that doubles the 3 per cent ratio set by Basel.

The liquidity rules require banks to maintain a minimum liquidity coverage ratio, measured by high-quality liquid assets to the total net cash outflow over 30 days, of 100 per cent. Assets considered to be of the highest quality and most liquid include Fed reserves and Treasury securities.

Another difference with Basel III is that the Fed rules would calibrate net cash outflows based on the most severe day within the 30-day liquidity stress period, as opposed to the last day of that timeframe.

Fed vice-chair Janet Yellen, who has been nominated to replace Fed chairman Ben Bernanke, expressed concern that there could be a shortage of high quality liquid assets if the Fed tapers and reduces its reserves. Fed officials said that was a concern but that is why the products covered under high-quality liquid assets are varied to include invest-grade corporate debt securities, among other instruments.

The Fed liquidity rules would force a bank to hold a minimum amount of assets that could be sold quickly in order to survive 30 days of a stressful period, according to a Fed memo to the board of governors. That time is meant to give breathing room for bank management to deal with the crisis or allow for the triggering of a resolution process.

“Liquidity is essential to a bank’s viability and central to the smooth functioning of the financial system,” Mr Bernanke said. “The proposed rule would, for the first time in the United States, put in place a quantitative liquidity requirement that would foster a more resilient and safer financial system.”

There are modified liquidity rules for banks that have assets of at least $50bn but are not active globally and, therefore, have less complex liquidity funding structures. Those firms would need to hold liquid assets to survive a 21-day period. Smaller banks and other financial businesses, such as insurance companies, are exempt from the standards.

“Since financial crises usually begin with a liquidity squeeze that further weakens the capital position of vulnerable firms, it is essential that we adopt liquidity regulations to complement the stronger capital requirements, stress testing and other enhancements to the regulatory system,” Mr Tarullo said.

In January 2015, under the Fed proposal, banks would have to meet a liquidity coverage ratio of 80 per cent, which would have to increase by 10 percentage points each year until January 1 2017, when the full 100 per cent requirement needs to be met.

The Basel III rules give banks until January 1 2019 to meet the liquidity coverage ratio requirement.

The standards were supposed to come into full effect in 2015 but earlier this year regulators decided to give banks more time in light of the slow growth in the global economy.

“Staff is recommending a shorter transition period to reflect and reinforce the significant improvement of liquidity positions of financial institutions in the US since the financial crisis,” the Fed memo said.

The proposed Fed rules will be subject to 90 days of public comment. Liquidity standards must also be proposed by the Federal Deposit Insurance Corporation and Office of the Comptroller of the Currency.

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