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ECB Said to Urge Weaker Basel Liquidity Rule on Risks

The European Central Bank is pushing global banking regulators to relax a draft liquidity rule so that lenders can use some asset-backed securities and loans to businesses in a buffer they must hold against a possible credit squeeze, according to three people familiar with the talks.

The ECB, backed by the Bank of France, considers a draft version of the liquidity coverage ratio, or LCR, may hamper efforts to combat the euro-area debt crisis by curtailing lending and making it harder for central banks to implement their monetary policies, said the people, who couldn’t be identified because the discussions at the Basel Committee on Banking Supervision are private. They said the ECB stance is opposed by some other Basel members, including U.S. regulators.

The LCR was drawn up by the Basel group as part of a package of measures to prevent a repeat of the turmoil that followed the 2008 collapse of Lehman Brothers Holdings Inc. The ECB is seeking to relax the rule -- designed to force banks to hold enough easy-to-sell assets to survive a 30-day credit squeeze -- by expanding the range of eligible securities, aligning the standard more closely with its own collateral arrangements, the people said.

“As central banks have relaxed their rules” during the debt crisis in the euro area, “the LCR has become more and more out of sync with central-bank reality,” said Jesper Berg, senior vice president at Nykredit A/S, Denmark’s biggest mortgage bank.

‘Very Problematic’

The 212 largest global banks would have had a collective shortfall of 1.76 trillion euros ($2.2 trillion) as of June 2011 in the assets needed to meet the LCR, according to figures published by the Basel committee. The ratio is scheduled to take effect in 2015.

Lenders have warned that a provisional version of the LCR standard, published in 2010, would force them to cut loans by making them hoard cash and buy up more government bonds, because few assets other than sovereign debt would fully qualify.

“The ECB is concerned about its ability to smoothly manage liquidity in the money markets for the conduct of monetary policy,” Richard Reid, research director for the London-based International Centre for Financial Regulation, said by e-mail.

“In the face of the ongoing euro problems, strict application of the Basel rules on liquidity coverage at this stage could be very problematic,” Reid said. Pressing ahead with the LCR “could further restrict the ability of the banking system to provide much needed credit.”

Unintended Consequences

The Basel committee said last year that it would review the rule to address any unintended consequences, and is targeting a deal by January 2013, when central bank and regulatory chiefs will meet to decide on the plans. The group will attempt to make headway at a meeting next month.

While a number of regulators favor making some changes to the LCR, the ECB and Bank of France are among those seeking the broadest overhaul, the people said.

More closely aligning the LCR with the ECB’s collateral rules would expand the range and quality of assets that banks can use to fill up their liquidity buffers, including by giving some scope for asset-backed securities and banks’ own loans to businesses to be used.

The ECB is concerned that without an alignment, banks that borrow funds from the central bank will earmark their best quality assets to meet the LCR rule, according to two of the people.

‘Right Direction’

The Frankfurt-based ECB is also concerned that banks’ need to hoard highly liquid assets may affect the operation of short-term funding markets, they said.

“Expanding the range of eligible securities for the LCR is a move in the right direction,” Markus Heidinger, a partner dealing with financial regulation at law firm Wolf Theiss in Vienna, said by e-mail.

“There is no class of securities which by definition could not become illiquid and the solution needs to be in risk spreading,” he said.

The ECB presented its LCR plan during discussions in the Basel committee’s working groups, including a meeting in New York this month, according to one of the people. Its arguments received only limited support, the person said.

There are concerns among some Basel members, including in the U.S., that far-reaching changes to the LCR may undermine the effectiveness of the measure, which was drawn up in part to make lenders less reliant on central bank support in crises, the people said. Germany’s Bundesbank and Swedish regulators are also among members skeptical of the ECB proposals, two of the people said.

‘Superior Performance’

“The ECB accepts as collateral almost anything short of the CEO’s tie,” said Berg. “The ECB’s superior performance in the early phase” after the Lehman collapse “can to a large extent be attributed to its broad collateral framework.”

There is little support in the committee for calls from banks for either gold or equities to count as eligible assets under the LCR, the people said, with neither likely to make it into the final version of the standard. In general, euro-area regulators are among the more sympathetic to the case for including some equities.

Officials at the ECB and the Bank of France in Paris declined to comment.

Equities, Gold

“Including assets such as equities and gold as eligible for the calculation of liquidity ratios leaves the outcome far too susceptible to variations in valuation and speculative movements,” Reid said.

While equities may have been “more liquid in this crisis when compared to other types of instruments,” that isn’t necessarily a sign of “inherent stability,” Reid said.

Other nations represented on the Basel committee tend to have more narrowly targeted aims for amending the list of eligible assets, the people said. These include a push from South Africa for easing rules on corporate debt that is rated higher than the country’s sovereign bonds.

The Bank of England has raised concerns that making banks hold full LCR buffers from 2015 may hamper efforts to tackle the euro crisis, two of the people said.

The Basel committee said last year that lenders should be allowed to draw down their LCR buffers in times of market stress, so breaching the minimum level of liquid assets they would normally be expected to hold. The group is still working on the details of when and how this would function in practice.

Work Needed

Mervyn King, governor of the Bank of England, has also indicated that he supports some changes to the standard.

“Much work still needs to be done” to ensure that the LCR is “properly integrated with the regime of liquidity provision by central banks,” King said in June.

“In current exceptional conditions, where central banks stand ready to provide extraordinary amounts of liquidity against a wide range of collateral, the need for banks to hold large liquid asset buffers is much diminished, and I hope regulators around the world will take note,” King said.

Regulators in the committee’s working groups have reached a provisional deal to retain a split in the LCR between assets that banks can use to meet their entire requirements and those that can only be used to meet as much as 40 percent, one of the people said. Under that agreement, technical rules on how this two-level approach works would be adjusted.

The accord on this point is likely to be endorsed by the Basel committee at its meeting next month, one of the people said.

The Basel committee brings together regulators from 27 nations including the U.S., the U.K. and China to coordinate global bank rules.

To contact the reporter on this story: Jim Brunsden in Brussels at jbrunsden@bloomberg.net

To contact the editor responsible for this story: Anthony Aarons at aaarons@bloomberg.net

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