Defying industry, regulators plow ahead with long-term liquidity rule

WASHINGTON – Federal regulators are moving forward with plans to finalize one of the last significant Obama-era rules governing long-term bank liquidity despite widespread expectations by banks that the proposal was all but dead.

The rule, known as the Net Stable Funding Ratio, would mandate that systemically significant banks hold enough debt and liquid assets to keep the firms’ operations afloat for at least a year.

Regulators have been under pressure from banking industry organizations and lawmakers skeptical of Fed oversight to stall the rule, and many thought that it would be dropped or weakened under President Trump. But Federal Reserve Board officials have subtly pushed back.

Fed Chair Janet Yellen said in a speech in August that the agency is “working toward finalization of the NSFR. Fed Gov. Jerome Powell – who will soon cede his post as head of the Fed's supervisory committee after the recent confirmation and swearing in of vice chair for supervision Randal Quarles – said in remarks earlier this month that the Fed was also continuing to work on the final rule.

Olivier Douliery/Bloomberg

Powell added that their continued work doesn’t conflict with the Treasury’s regulatory blueprint, which he said only calls for calibration and delayed implementation of outstanding Basel rules.

“It was nothing like the hard stop that some people interpreted it as,” Powell said. “So we’re looking at that. I suspect we’ll move forward with [the] proposal on that.”

It's not clear when regulators will move forward with the rule, which was part of the Basel III international accord. The Fed had no further comment beyond Yellen and Powell's comments. An FDIC spokesperson said that the agency is reviewing comments and is working toward finalizing the proposal. An OCC spokesman said the agency "continues to work on developing the NSFR final rule with the other agencies."

The rule, which was proposed in April 2016, hewed fairly closely to the international standard agreed by the Basel Committee for Banking Supervision and was notable for its focus on the largest and most systemically important banks. European regulators have been urging the U.S. to finalize the rule, even as other parts of Basel III remain stubbornly unresolved.

But that international standard is itself somewhat muddied in its objectives and methods, according to Bill Nelson, chief economist for The Clearing House Association.

Nelson said that while Europe is poised to implement a watered down version of the NSFR, one of the likely effects of implementing a final rule based on the proposal would be to stifle the capital markets – particularly the overnight repo market, which plays an outsized role in the U.S. economy as compared to European or Asian markets. That would put the U.S. at a disadvantage internationally with little offsetting systemic risk benefit.

“The NSFR lacks clear, well-defined objectives, and problems with its current design and calibration will lead to many unintended consequences that are likely to result in substantial economic costs,” Nelson said. “Neither the U.S. agencies nor their international counterparts should move forward with the NSFR in its current form. Instead it should be sent back to the drawing board in Basel.”

Greg Lyons, a partner at Debevoise & Plimpton, said that the NSFR – along with its fellow Basel liquidity rule, the already-finalized Liquidity Coverage Ratio – are among the most important rules for the investment banks and therefore the rule’s biggest opponents.

Investment banks and their brokerages have historically relied on wholesale funding – which is penalized in the proposed U.S. version of the NSFR – and would have the most ground to make up under the rule. The Fed may well move forward with finalizing the rule, he said, but he would suspect that the finished version is watered down enough that the investment banks wouldn’t object too strenuously.

“This is the one the brokers are most concerned about in particular … because of the effect it has on their ability to do trades,” Lyons said. “A lot of people in the administration have brokerage backgrounds, and I do think there will be some resistance to having them come in at least in the way they were originally envisioned.”

Lyons said that the slow progress of negotiations regarding the remaining elements of Basel III have also had the effect of tamping the brakes on the NSFR and the other proposed Basel-derived rule related to single counterparty credit limits. If the urgency has been sapped from international deliberations, he said, regulators seem less sure of agreements that haven’t yet made it past the finish line.

“It’s almost like a weird version of broken windows,” Lyons said. “If it’s not happening elsewhere, then we don’t feel much urgency to move on it here, either.” -

Bartlett Naylor, a financial policy advocate at Public Citizen, said that even with Quarles’ ascension to the board, a majority of the voting members will still likely favor completing the rule rather than starting from scratch.

Quarles' influence in the immediate term will likely be to make the rule as palatable for banks as possible rather than killing it outright, he said. But if the rule is still incomplete by the time additional Trump nominees make it to the Fed board, all bets are off.

“Until the voting dynamic changes, I think this thing goes forward,” Naylor said. “What I’m seeing when the Trump regulators have the discretion, they’re pointing the compass in one direction, and that’s toward deregulation.”