The Federal Reserve proposed its first-ever standardized minimum liquidity requirement for large and internationally-active banks this week. The new rules would also apply to systemically important non-bank financial companies as designated by the Financial Stability Oversight Council and ultimately subject U.S. financial institutions to more stringent reserve requirements than they would face under the dictates of the global Basel III framework.
Each institution covered by the proposal would be required to hold minimum amounts of high-quality liquid assets (HQLA) that can be converted quickly into cash. Things like central bank reserves and government and corporate debt would count toward the liquidity buffer, while other items such as private-label mortgage securities, covered bonds and municipal debt would not. Still other types of assets would count toward the buffer but only at a fraction of their value.
Firms would have to hold HQLA in an amount that's equal or greater to each institution's projected cash outflows minus its projected cash inflows during a short-term stress period. The ratio of the firm's liquid assets to its projected net cash outflow is its "liquidity coverage ratio," or LCR, which would apply to all internationally active banking organizations, which the Fed considers generally those institutions with $250 billion or more in consolidated assets, or $10 billion or more in on-balance sheet foreign exposure, as well as to the previously-mentioned systemically important non-bank financial institutions. A less stringent LCR will apply to bank holding companies and savings and loan holding companies that aren't internationally active but have more than $50 billion in total assets.
The proposal mirrors Basel III, but also diverges in important ways, most notably in how compliant institutions will have to calculate their assumed rate of outflows. The Fed will require banks to calculate their LCR using whatever particular day when the bank's outflows are at their highest, and since these outflows can vary greatly over the course of a month, this could result in a relatively large reserve requirement. Basel III would require banks to calculate a similar ratio, but on a much more lenient basis.
Another noteworthy difference is that the Fed's proposal puts banks on an accelerated timeline for compliance, which, according to the Fed, is due in part to the fact that many U.S. banks have already begun to stockpile these assets in the wake of the financial crisis. Whereas under Basel III institutions would have to comply by 2019, the Fed's transition period begins on January 1, 2015 and requires banks to be fully compliant by January 1, 2017.
"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 we have been putting in place over the past several years," Federal Reserve Gov. Daniel Tarullo said. "This rule would help ensure that the liquidity positions of our banking firms do not weaken as memories of the crisis fade."
Many have voiced concerns that the Fed's proposals, which have tended to skew towards not risk-weighting assets when calculating a bank's reserve requirements, could reduce credit availability in the U.S., particularly for low-risk transactions such as those involving trade financing. Stay tuned to NACM's eNews, blog and Business Credit magazine for more analysis on how the Fed's proposals could affect trade creditors.
- Jacob Barron, CICP, NACM staff writer