WASHINGTON – In the post-financial-crisis regulatory environment, the U.S. has become known for taking a harder line when it comes to domestic implementation of international agreements with the Basel Committee, including with capital and liquidity requirements.
But the U.S. agencies hewed surprisingly close to the international agreement in their proposal released Tuesday which would require the largest banks to maintain stable sources of funding over a yearlong period.
“In a sense, it is an effort to comply with Basel and keep the framework alive, but not, as in other areas, ‘gold-plate’ it because of the concern here about cumulative impact,” said Karen Shaw Petrou, managing partner of Federal Financial Analytics. “The proposal continues the belt, suspenders and safety net approach to U.S. regulation.”
The proposal, known as the net stable funding ratio, was released Tuesday by the Federal Deposit Insurance Corp. and will be discussed by the Federal Reserve Board on May 3. The Office of the Comptroller of the Currency is expected to release the plan soon.
The proposal is substantially similar to the October 2014 final rule put forth by the Basel Committee, which required covered bank holding companies to retain stable funding for 100% of its obligations for a full year. The plan is intended to complement the short-term liquidity coverage ratio, which requires banks to hold enough high-quality liquid assets to cover obligations for 30 days.
The U.S. proposal differs from the Basel proposal in a handful of areas. For one, as with the LCR, the net stable funding ratio differentiates between the largest and most complex banks and smaller institutions. Banks subject to the “advanced approaches” framework with more than $250 billion in assets and $10 billion in foreign exposure must cover 100% of their obligations, whereas banks with between $50 billion and $250 billion must only cover 70% of obligations.
Other differences include a narrower definition of high quality liquid assets in the U.S. proposal than in the Basel rule – which is reflective of changes to capital rules codified in the Dodd-Frank Act. The law pushes the regulators away from relying on ratings agencies for supervisory purposes, which effectively narrows what can be considered high-quality liquid assets.
The proposal also includes a framework to address the risk of “trapped liquidity” – that is, market restrictions on the ability of a firm to transfer liquidity between entities. The proposal would require firms to assign a haircut for trapped liquidity in order to account for those restrictions.
Greg Lyons, partner with Debevoise & Plimpton, said that concession is useful but limited.
“That is somewhat helpful – it does allow the institutions to maneuver capital a little more within the organization,” Lyons said.
Wayne Abernathy, executive vice president for financial institutions policy and regulatory affairs at the American Bankers Association, said the biggest problem with the proposal is that its purpose has been subsumed by other advances since the crisis. The LCR would cover the short-term liquidity needs of banks in almost any stress scenario, and regulators should be able to identify a bank that faces structural liquidity shortfalls via the annual stress tests.
“Really, we’re scratching our heads and wondering what purpose it serves,” Abernathy said. “Given all of the many other prudential regulation and regimes that have been out in place over the last several years, are they really addressing anything that is a serious risk anymore?”
But some requirements of the proposal could have a more problematic effect, Abernathy said, which is to stifle banks’ ability to maximize efficiency in capital and liquidity – a phenomenon known as maturity transformation. Placing additional restrictions on banks’ ability to perform that service – especially with little obvious benefit – could be detrimental to the broader economy.
“This is an assault on the concept of what these banks are supposed to do, and that is maturity transformation,” Abernathy said. “To that extent you decrease the value of what banks provide to the economy. No one else is going to do it.”