World Crisis Online

Banks and regulators are at loggerheads about the volume and quality of liquid reserves they must hold under new rules.

UK banks are lobbying particularly hard because their regulator, the Financial Services Authority, is already imposing a stricter definition of which assets qualify as “liquid” than is demanded by the Basel Committee on Banking Supervision, which defines international standards.

Insufficient liquidity was a principal cause of the financial crisis. As market nervousness increased, those banks with low liquidity reserves found it impossible to survive. The liquidity crisis compounded deep-seated problems in banks’ operations. It is ultimately blamed for having sealed the fates of a series of banks from Lehman Brothers in the US to Northern Rock in the UK.

Last December the Basel Committee’s new Basel III rule book detailed two mechanisms that it reckons would insulate banks from such problems: a net stable funding ratio (NSFR), which would oblige banks to match the duration of their assets more closely to their liabilities, and a shorter-term liquidity coverage ratio, to ensure banks have enough liquid reserves to withstand a month of very high withdrawals of funds.

However, banks complain that the cost of hoarding the requisite liquid assets will make them vastly less efficient and will constrain lending capacity, at a time when governments need them to support economic growth.

On the fringes of the World Economic Forum in Davos last month, international regulators seemed to signal a greater willingness to compromise.

Although Lord Turner, the FSA chairman, insisted that new international rules to force banks to hold more high-quality capital to underpin their activities would have no negative impact on global economic growth, he suggested that there were legitimate concerns about the new leverage requirements.

“I am very confident that what we are doing on capital is not going to restrict lending and slow economic recovery,” he told the FT. “It’s on liquidity that we have to keep making sure that the total aggregate impact of our measures, and the transition path towards them, combined with the withdrawal of special central bank liquidity support, is compatible with the credit supply required for economic recovery.”

Another senior regulator in Davos said: “It is clear that the net stable funding ratio needs a pretty fundamental reworking. On the liquidity coverage ratio, there is likely going to have to be a recalibration of that, too.” Regulators have privately acknowledged for several months that the match-funding requirement of the NSFR would need to be changed if it were not to wipe out banks’ core profit potential, but there has been little discussion until now about the coverage ratio needing to change.

Bankers say that if the market for subordinated corporate bonds is to be maintained, they must be made eligible for the liquidity buffer.

Securitised assets should also be admitted, bankers say, otherwise the securitisation markets that will be vital to funding markets as central bank liquidity is withdrawn will never take off.

In the UK, the FSA has tightened the liquidity definition still further than the Basel rule book, barring senior corporate bonds and covered bonds, and restricting the buffer essentially to cash and sovereign debt.

Algebras, a London hedge fund focused on investing in banks, estimates that in Europe and the US alone there is a $4,000bn liquidity gap; the difference between current liquid reserves and those defined by the two new Basel mechanisms.

“There is just not enough money to comply,” says Davide Serra, founding partner at Algebris. “They have written the rules top down – but bottom up, where is the cash?”

Some banks have begun publishing data revealing vast differences in current levels of liquidity coverage – proof that until now this is an area that has been inconsistently monitored across the industry.

Under the Basel III definition, which will not be formally implemented until 2015, JPMorgan, for example, reported barely 50 per cent coverage, while Goldman said it was 100 per cent compliant.