Industry wins key concession in liquidity rule

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WASHINGTON — Federal regulators have acceded to banking industry calls to ease a new liquidity requirement for large institutions in light of recent market volatility caused by the coronavirus pandemic.

The Federal Deposit Insurance Corp.'s board approved a final rule Tuesday morning implementing the net stable funding ratio. The regulation, proposed in 2016, establishes a long-term liquidity measure developed after the financial crisis by the Basel Committee. The board also revised "total loss-absorbing capacity," or TLAC, rules for large banks, provided temporary relief necessitated by the pandemic from certain auditing requirements and codified its approach to issuing regulatory guidance.

In a notable shift, the final liquidity rule — approved later by the Federal Reserve Board and Office of the Comptroller of the Currency — removed Treasurys and reverse Treasury repurchases from the liquidity requirement. Some in the industry industry had urged the change after a sudden selloff of Treasury securities following the virus outbreak, coupled with the Fed then buying up Treasurys, caused sharp price fluctuations.

Staff from the agencies said that after conducting an analysis, they determined that setting the funding requirements for those assets above zero could reduce bank participation in the Treasury and Treasury repo markets.

Treasury securities “serve as reliable sources of liquidity based on their high credit quality,” FDIC Chair Jelena McWilliams, right, said of the agency’s decision to deduct Treasurys from the net stable funding ratio. But Martin Gruenberg, a member of the FDIC board, said the change would release large banks from needing to manage certain liquidity risks.
Treasury securities “serve as reliable sources of liquidity based on their high credit quality,” FDIC Chair Jelena McWilliams, right, said of the agency’s decision to deduct Treasurys from the net stable funding ratio. But Martin Gruenberg, a member of the FDIC board, said the change would release large banks from needing to manage certain liquidity risks.

“These assets serve as reliable sources of liquidity based on their high credit quality, and they serve a critically important role in supporting the smooth functioning of funding markets,” said FDIC Chair Jelena McWilliams at the board’s meeting.

But Martin Gruenberg, the former FDIC chair who remains on the board, dissented from the NSFR vote along with Fed Gov. Lael Brainard. Gruenberg argued that reducing the "stable funding" requirement for Treasurys and Treasury repos would release large banks from needing to manage the liquidity risks of those assets.

“The entire risk is effectively transferred to the public sector, through the Federal Reserve,” he said. “That defeats the purpose of the net stable funding ratio requirement.”

The new ratio is meant to ensure a bank has enough stable liquidity to fund its makeup of assets. For banks subject to the full rule, an institution's "available stable funding" must equal or exceed its "required stable funding." Different types of assets and liabilities included in the ratio are each given a risk weight.

The final rule also offers “more favorable treatment” for certain affiliate sweep deposits and nondeposit retail funding, FDIC staff said in a memo to the board.

The final NSFR requirement would also adjust the rule to correspond with recent changes to the post-crisis prudential supervision regime for large banks. Those changes are meant to tailor regulatory requirements based on an institution's size, reserving the toughest standards for the biggest banks and providing some regional banks with relief.

"The final rule tailors the stringency of the requirements based on a bank's risk profile, with the most stringent requirements for the largest and most complex banks and less stringent requirements for firms with less risk," said Fed Vice Chair of Supervision Randal Quarles in a statement.

Under the final rule, banks with at least $700 billion of assets, as well as those with $75 billion or more of average weighted short-term wholesale funding, must still comply with the full NSFR requirement.

Meanwhile, banks with at least $250 billion of assets and less than $75 billion of average weighted short-term wholesale funding would be subject to 85% of the full NSFR requirement. Banks with between $100 billion and $250 billion of assets and at least $50 billion of average weighted short-term wholesale funding would be subject to 70% of the full requirement. The remainder of banks with between $100 and $250 billion of assets would not be required to comply with the final NSFR rule.

“While there continue to be areas that would benefit from further modifications, the final rule includes material changes that should allow the rule to better achieve its objective of encouraging banks to adopt a stable funding profile," said Bill Nelson, chief economist for the Bank Policy Institute.

But Gruenberg said too many banks would now be exempted from the liquidity requirement.

“While the global systemically important banks pose the greatest risk to financial stability, large regional banks in the United States, individually and collectively, also may pose significant financial stability risks,” he said. “Subjecting them to a reduced or no NSFR requirement, as this final rule would do, seriously undermines the purpose of the rule.”

The Fed's Brainard said "the final NSFR rule goes beyond the statutory requirements and weakens the NSFR relative to the proposed rule."

"The NSFR requirement is reduced from 100% in the proposed rule to 85% in the final rule for almost all banks in the asset size range of $250 to $700 billion, despite the clear lesson from the crisis that liquidity stress associated with maturity mismatches for large banks in this size range poses serious contagion risk," she said.

Agency staff said that a significant number of banks were already compliant with the new NSFR requirements, which will go into effect July 1, 2021, but that some would need to make up liquidity shortfalls to meet the requirement.

“This effective date provides sufficient time for covered companies to take into account the new requirement and, as necessary, to make infrastructure and operational adjustments that may be required to comply with the final rule,” FDIC staff said.

The FDIC, Fed and OCC also finalized a 2019 proposal that would amend TLAC requirements meant to ensure the largest banks hold enough capital and long-term debt to facilitate a failure resolution.

The final rule will require large banks to hold additional capital if they purchase another bank’s long-term debt for their balance sheet in order to prevent an unintended domino effect in the event of a failure.

The provision should discourage global systemically important banks from investing in other such banks’ TLAC instruments, agency staff said, and will apply to the eight United States GSIBs along with Northern Trust.

Gruenberg also voted against the rule to amend the TLAC requirement, arguing that it should also apply to other smaller financial institutions outside of the GSIBs.

The FDIC board also voted to issue an interim rule, in effect until the end of 2021, to provide temporary relief from annual independent auditing requirements. The agency said the relief was necessary to address the increase in banks' consolidated assets from their participation in government relief programs resulting from the pandemic.

The board also put forward a proposal to codify a 2018 interagency statement that clarified that supervisory guidance lacks the “force and effect of law” that is more akin to rules and regulations.

At the time, the Fed, FDIC, OCC, Consumer Financial Protection Bureau and National Credit Union Administration said supervisory guidance articulates their general views for appropriate practices but does not lead to enforcement actions or binding legal obligations.

In particular, the proposal asks for public comment on whether bank examiners should cite supervisory guidance in criticizing a financial institution — whether through matters requiring attention or supervisory recommendations. The proposal will be open for public comment for 60 days.

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Liquidity requirements NSFR FDIC Basel Committee on Banking Supervision Jelena McWilliams Treasurys Regulatory guidance Federal Reserve OCC
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