WASHINGTON Federal regulators raised the supervisory bar higher last week by requiring large banks to load up on enough liquid assets to cover a sudden funding crisis, but their work in this area is clearly just beginning.
As the Federal Reserve Board and two other bank regulators finalized the "liquidity coverage ratio," officials rattled off a list of related policies under consideration. Those include a new longer-term funding standard, an effort to incorporate liquidity risk in a capital surcharge calculation, and even steps aimed at reducing the burden of the LCR on banks and municipalities.
"There's obviously a lot of legitimate concern about the risks associated with short-term wholesale funding. The LCR goes some distance in addressing this but is probably not wholly adequate," said Fed Gov. Lael Brainard at the board's open meeting.
The new rule written also by the Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency is a tougher version than the LCR developed by the international Basel Committee. It sets criteria for the "high-quality liquidity assets" which banks with at least $250 billion in assets must hold to cover liquidity outflows for 30 days of stressed financial conditions. Smaller institutions with at least $50 billion in assets are subject to a less onerous LCR standard.
But officials at the Fed meeting also pointed out what the LCR will not do and specified how upcoming moves may address other areas related to banks' liquidity.
"We're working through multiple channels globally and domestically to fill in the gaps," Mark Van Der Weide, deputy director of the Fed's division of banking supervision and regulation, said at the meeting.
To address concerns beyond the 30-day horizon, the Basel Committee has proposed changes to its "net stable funding ratio," a longer-term assessment of an institution's liquidity profile that is meant in part to limit reliance on wholesale short-term funding. U.S. regulators will likely implement a version of the Basel NSFR standard once it is finalized. Other future policies include a similar LCR standard for "systemically important" nonbanks and one for U.S.-based subsidiaries of foreign banks, which are both subject to Fed supervision.
The Fed may also include an institution's amount of short-term wholesale funding as a component in calculating risk-based capital surcharges for the largest globally active U.S. banks. The central bank is still working on its proposal to implement the Basel Committee's surcharge framework. Another proposal regulators are exploring would impose minimum collateral haircuts on securities financing transactions.
"The LCR was a pretty important step forward in mitigating some of the financial stability risks from short-term wholesale funding. It is particularly good on maturity mismatches that go across the 30-day window and it's pretty good on very short-term wholesale funding of illiquid assets. But it's not in and of itself a sufficient solution to the financial stability risks from short-term wholesale funding," Van Der Weide said.
"It doesn't cover maturity mismatch that is entirely outside the 30-day window. It misses matchbook repo funding. It also only applies to banks. The financial stability risks from short-term wholesale funding are in banks and outside of banks in the shadow banking system. More work needs to be done. That work is being done."
While most of the additional steps would appear to be aimed at clamping down on banks' liquidity practices, one move discussed by policymakers may be more to the industry's liking. Fed officials appeared sympathetic to concerns from banks and municipal bond issuers about state and municipal securities being left off the "high quality" asset list used to meet the LCR standard, and signaled that the issue is not resolved. Officials said the agency is exploring ways to include municipal securities in the HQLA realm.
"States and municipalities seem quite worried about this [rule.] They seem to be concerned about the potential impact on their access to debt markets," Fed Chair Janet Yellen said at the meeting.
Fed staff said while the effect of the LCR on the municipal bond market is projected to be limited, the agency is considering including additional securities in the HQLA category to address municipalities' concerns.
"We don't think" the rule's impact on states and municipalities "will be significant. Estimates of banks' participation in the municipal market is relatively limited currently at 10% to 15%," said David Emmel, the Fed's manager of credit, market and liquidity risk policy.
He added that banks have not always held municipal securities as a buffer against liquidity shortages.
"They held for them for other reasons, and not just for HQLA. We expect that to continue, regardless of the final rule's implementation," Emmel said. "But, that said, as a reflection of commenters' concerns, we are looking at certain municipal securities that may qualify as eligible securities."
At the FDIC's board meeting, officials were more muted about any potential changes to the HQLA definition. Yet agency Chairman Martin Gruenberg said the FDIC "will monitor closely the impact of the rule on municipal securities and consider adjustments if necessary."
But most of the ongoing liquidity-related work spotlighted at the Fed meeting focused on additional safeguards to make funding more stable.
The original LCR proposal would have gone beyond the banking industry and applied similar liquidity coverage requirements to nonbanks labeled as "systemically important" by the Financial Stability Oversight Council. While nonbanks were left out of the final rule, Fed Gov. Daniel Tarullo said the agency will still address liquidity standards for FSOC-designated firms and is also considering a specific LCR standard for foreign banking firms supervised by the Fed.
"We anticipate a future rulemaking extending an LCR to the U.S. intermediate holding companies and branches of large foreign banking organizations," Tarullo said. "Additionally, the rule would not apply to nonbank systemically important financial companies designated by the Financial Stability Oversight Council for supervision by the Federal Reserve. Liquidity standards would be applied to those institutions through rule or order, based among other things on an evaluation of the business model of each designated firm."