Fed Diverges from Global Regulators on Liquidity Buffer

WASHINGTON — Global regulators gave banks some breathing room over the weekend by saying firms could fall below minimum liquidity requirements during period of stress, but that may not be the case for U.S. institutions.

After a meeting of the Group of Governors and Heads of Supervision on Sunday, regulators agreed to clarify pending liquidity rules to state explicitly that banks would be required to meet minimum liquidity requirements during normal times, but would be allowed to fall below them in a crisis situation.

But the statement appears to be at odds with the Federal Reserve Board's own liquidity proposal, which calls for the creation of a liquidity buffer over atop the minimum requirements. The buffer is designed to ensure banks do not fall below the minimum liquidity ratio.

"The Basel rules as the GHOS announced them yesterday say that within the rules as specified there is a buffer so that under stress you can fall below the 100% ratios and not be considered illiquid," said Karen Shaw Petrou, a managing partner at Federal Financial Analytics Inc. "In the Fed's notice of proposed rulemaking, the buffer rides atop the basic liquidity rules so you have to meet all the liquidity and still more to meet the buffer requirements."

Late last month, the Fed released a 173-page proposal clarifying how it planned to regulate the largest U.S. firms and what additional capital and liquidity requirements they would need to hold.

Fed officials agreed to punt on certain standards — like the liquidity rules — until there was greater consensus internationally on how to move forward given the number of concerns that have been raised. Banks were told they could rely on their own internal modeling in their own stress testing to ensure things are in line on the liquidity front.

But buried in the plan was a proposed "liquidity buffer" that firms with $50 billion or more in assets will need to have atop the framework agreed upon under Basel III.

Under the international proposal, firms are required to develop a liquidity coverage ratio, or LCR, that is designed to meet short-term liquidity needs typically in a 30-day period. Regulators would also require a net stable funding ratio for longer-term needs. The first ratio is scheduled to take effect in 2015 and the second in 2018.

"Consistent with the effort towards developing a comprehensive liquidity framework that would eventually incorporate the LCR standard, the proposed rule, in addition to requiring stress tests … would require a covered company to continuously maintain a liquidity buffer of unencumbered highly liquid assets sufficient to meet projected net cash outflows and the projected loss or impairment of existing funding sources for 30 days over a range of liquidity stress scenarios," the Fed's proposal says.

The Fed has said it would use the liquidity stress test to determine the size of the buffer, while also taking into account a firm's capital structure, risk profile, complexity, activities, size, and other risk factors. It would also limit the types of assets that could be used in the buffer to those that are highly liquid and can easily be converted to cash with little or no loss of value.

International regulators, meanwhile, have left it unclear exactly what they mean by allowing firms to go below the minimum liquidity threshold.

The Basel Committee has been asked to "provide additional guidance on the circumstance that would justify the use of the pool."

"The rules they are going to be releasing this year in 2012 are what the criteria are, when you might be allowed to fall below the ratios, what that buffer consists of, and how it's going to be used," said Petrou. "But the buffer in Basel is not a super charge. The buffer in the Fed's rule appears to be."

The purpose of the measure is to ensure that no firm fails because of a relative lack of liquidity.

"The aim of the liquidity coverage ratio is to ensure that banks, in normal times, have a sound funding structure and hold sufficient liquid assets such that central banks are asked to perform only as lenders of last resort and not as lenders of first resort," said Mervyn King, Governor of the Bank of England and GHOS chairman, in a statement.

Since the release of the liquidity proposal last year, the plan has worried bankers, who consider it unworkable. They argue that the current proposal calls for the market to be bifurcated between assets that are risk weighted at zero and others that are given a 100% weighting, like cash and U.S. Treasuries.

Regulators, for their part, have signaled more willingness to adjust the liquidity framework and remain committed to introducing the standard in 2015.

Even so, international regulators noted in their statement any modifications would apply only to certain aspects and would "not materially change the framework's underlying approach."

Another issue left open — a prominent concern by industry — is potential changes regarding the pool of high-quality assets and tweaks to the calibration of net cash outflows.

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