Banks Win 4-Year Delay as Basel Liquidity Rule Loosened

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Global central bank chiefs gave lenders four more years to meet international liquidity requirements and watered down the measures in a bid to stave off another credit crunch.

Banks won the delay to fully meet the so-called liquidity coverage ratio, or LCR, following a deal struck by regulatory chiefs meeting yesterday in Basel, Switzerland. They'll be able to pick from a longer list of approved assets including equities and securitized mortgage debt as they seek to build up buffers of liquidity for use in a financial crisis.

"This was a compromise between competing views from around the world," Bank of England Governor Mervyn King said at a briefing following yesterday's meeting. King chairs the Group of Governors and Heads of Supervision, or GHOS, which decides on global bank rules. "For the first time in regulatory history we have a truly global minimum standard for bank liquidity."

Banks and top officials such as European Central Bank President Mario Draghi pushed for changes to the LCR, arguing that it would choke interbank lending and make it harder for authorities to implement monetary policies. Lenders have warned that the measure might force them to cut back loans to businesses and households.

"The new liquidity standard will in no way hinder the ability of the global banking system to finance a global recovery," King said. "It's a realistic approach. It certainly did not emanate from an attempt to weaken the standard."

The Bloomberg Europe Banks and Financial Services Index rose as much as 2.1 percent with Italy's Banca Monte dei Paschi di Siena SpA leading gains at 19 percent. Deutsche Bank AG (DBK) added as much as 5 percent and both BNP Paribas SA (BNP) and Barclays Plc (BARC) were up 4 percent.

"The loosening of liquidity rules has been long-signalled, and thus we wouldn't expect a huge rally, but we have been badly wrong-footed in the past," Sandy Chen, bank analyst at Cenkos Securities in London, wrote in a note to clients.

The decision to relax liquidity rules for banks may boost pre-tax profit at Barclays by around 4 percent, according to Andrew Lim, an analyst at Banco Espirito Santo SA.

U.K. banks such as Barclays, which have built up large reserves of high-quality liquid assets, will be among the biggest beneficiaries of global regulators' decision to implement a watered-down version of the LCR, Lim said in a note to clients.

Regulators at the Basel Committee on Banking Supervision struggled throughout 2012 to revise the LCR. After failing to reach a final deal last month, it was left to central bank and regulatory chiefs on the GHOS to make a final decision.

The LCR would force banks to hold enough easy-to-sell assets to survive a 30-day credit squeeze. It's a key component of a package of capital and liquidity measures, known as Basel III, drawn up to avoid a repeat of the 2008 financial crisis.

Basel III has been subject to mounting criticism for its complexity, amid delays to its implementation in the European Union and U.S.

The liquidity rule sets out a stress test that banks should apply to their books, assessing whether they would be able to generate enough cash from asset sales to meet their regulatory obligations.

A draft version of the measure was published by regulators in 2010, on the basis that it would take effect on Jan. 1, 2015.

Under yesterday's deal, banks would only have to meet 60 percent of the LCR obligations by 2015, and the full rule would be phased in annually through 2019, according to an e-mailed statement from the GHOS.

A sample of 209 banks assessed by the Basel committee had a collective shortfall of 1.8 trillion euros ($2.4 trillion) at the end of 2011 in the assets needed to meet the 2010 version of the LCR, according to figures published by the Basel group.

Banks had warned that the initial LCR proposal would force them to buy additional sovereign debt, more closely tying their fate to governments' solvency. The 2010 rule was drafted before the EU was fully confronted by a sovereign debt crisis that challenged traditional assumptions about the creditworthiness of government bonds.

"GHOS has rescued the concept of a global liquidity rule, but its reality remains up in the air," Karen Shaw Petrou, managing partner of Washington-based Federal Financial Analytics Inc., said in an e-mail. "Commitments were made by eurozone nations to comply with this agreement, but turning word into deed isn't going to be easy."

The latest LCR Rule retains the principal that allows banks to use sovereign debt to meet all of their LCR obligations, if the bonds are considered essentially risk free under international bank capital rules. The EU and U.S. have been criticized by international regulators for misapplying parts of the capital rules, allowing lenders to count more of the sovereign debt they hold as risk free.

Under the 2010 plan, banks would have been allowed to use cash and government bonds to meet the LCR, subject to some rules on the quality of the sovereign debt. Lenders could also have used highly-rated corporate debt or covered bonds to meet 40 percent of their LCR requirements.

The deal expands the range of corporate debt that banks can use, allowing some lower rated securities to count. Banks would also be allowed to use some equities and highly rated residential mortgage-backed securities.

"I suspect that some central banks will be greatly relieved that they will have more time to assess the impact of the new rules," Richard Reid, a research fellow for finance and regulation at the University of Dundee in Scotland, said in an e-mail.

"I'm also sure that many banks will also be happy to have gained some very significant concessions," Reid said. "No doubt we will see flexibility in the implementation of other regulatory measures as we go through 2013."

"The committee and the regulatory community more generally felt it was appropriate to broaden the class of liquid assets," King said. "That doesn't mean to say it's a loosening of the whole regime."

The additional securities will get bigger writedowns to their value than those that would have been eligible under the 2010 LCR. They also won't be allowed to count for more than 15 percent of a bank's LCR buffer.

Supervisors will have discretion to decide whether the reserves lenders keep with central banks will count toward the LCR. Regulators will also continue to assess how the LCR will interact with liquidity support measures provided by national central banks, the GHOS said.

"It became clear during the process of discussing all this that it didn't make sense really to think about an LCR without having a clear view about what to make of access to central bank facilities," King said.

Central banks and regulators left the treatment of covered bonds in the LCR unchanged from 2010. Covered bonds are secured by assets such as mortgages or public-sector loans and are guaranteed by the issuer.

Authorities also agreed to water down parts of the stress scenario that banks will be pitted against to calculate whether they hold enough LCR assets. Still, they expanded the range of risks on derivatives trades that will be taken into account.

Regulatory chiefs said they will give additional guidance on when banks will be allowed to use their LCR buffers.

The GHOS brings together top officials from central banks and regulators in 27 nations including the U.S., U.K., China and Japan. It is the governing body of the Basel committee.

The Basel committee will also press ahead with reviewing another draft liquidity rule included in Basel III. This measure, known as a net-stable funding ratio, requires banks to back long-term lending with funding that won't dry up in a crisis.

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