A proposal to make U.S. banks maintain 30-day war chests in case of a credit crisis is certain to add to borrowing costs, said a former leader of the global group that conceived of the standard.
Stefan Walter, who was secretary general of the Basel Committee on Banking Supervision when it approved an initial version of yesterday’s Federal Reserve proposal, said U.S. regulators have continued their tough interpretations of Basel III rules.
“Nothing is free,” said Walter, now a principal at Ernst & Young LLP, in an interview. “Buying more resilience in normal and good times means that liquidity will be priced-in more than before, and that will have a certain degree of impact on the cost of credit. That’s the obvious trade-off.”
The Fed proposal -- to be matched by other U.S. banking regulators -- would require the biggest banks to hold 30 days of easy-to-sell assets to make them safer in the event of another credit crisis like the one in 2008. The plan would meet international liquidity accords while forcing a much shorter timeline than non-U.S. banks will face and narrowing what U.S. banks can include among their assets.
The Fed plan is most stringent for banks with more than $250 billion in assets or substantial international reach and seeks implementation by 2017, two years ahead of the Basel deadline.
$200 Billion Short
“The proposed rule would, for the first time in the United States, put in place a quantitative liquidity requirement that would foster a more resilient and safer financial system,” said Fed Chairman Ben Bernanke. The proposal would require setting aside about $2 trillion, and the Fed estimates U.S. banks are currently $200 billion short.
The Basel Committee on Banking Supervision in January agreed on a liquidity coverage ratio meant to ensure banks can survive a credit squeeze without the kind of government aid needed after the 2008 credit crisis.
That standard would let lenders go beyond cash and low-risk sovereign debt to include some equities and corporate debt, according to the agreement. The U.S. version would permit a limited amount of government-sponsored enterprise debt while excluding private-label mortgage-backed securities.
Bank of America Corp., Citigroup Inc. (C), Goldman Sachs Group Inc., JPMorgan Chase & Co. (JPM) and Wells Fargo & Co. (WFC) already meet the earlier Basel requirement, according to an Oct. 23 Morgan Stanley (MS) research report.
“Even if they can meet the requirements, that’s not the end of the story, because liquidity has a cost to it,” said Robert Maxant, a managing partner at Deloitte & Touche LLP. “That cost is reduced margins and lowered returns.”
He said another point of the proposal -- that firms with more than $10 billion in foreign exposure are subject to it -- will target foreign-based banks with big U.S. footprints.
In the proposal, opened for 90 days of public comment, banks can use an unlimited amount of cash, Treasuries and central-bank reserves to fulfill the requirement and can also keep 40 percent of it in less liquid assets. Those other assets can include sovereign debt with a 20 percent risk weight and debt from Fannie Mae and Freddie Mac (FMCC) -- subject to a 15 percent haircut. A narrower 15 percent of the liquidity can be in investment-grade corporate debt and publicly traded company stock, with a 50 percent haircut.
Yesterday’s proposal is also tougher than Basel when determining the outflow of cash in a crisis -- calling for a bank to figure its most costly day in the 30-day period rather than using the 30th day, according to the staff memo to the board.
Banks with more than $50 billion in assets and under the $250 billion threshold would be subject to a more limited version of the liquidity rule, requiring a 21-day minimum of liquid assets on hand.
“This rule would help ensure that the liquidity positions of our banking firms do not weaken as memories of the crisis fade,” said Fed Governor Daniel Tarullo. The proposal, which he said represents a regulatory breakthrough, is “more stringent in a few areas” -- making it “super-equivalent” to Basel.
“I call it ’super-sized’,” said Karen Shaw Petrou, managing partner of Washington-based research firm Federal Financial Analytics Inc., in an e-mail. “That is, as in so many other regulatory areas, the U.S. will be the toughest cop on the beat regardless of the impact this has on cross-border harmony or the competitiveness of the very largest U.S. banks.”
Financial rules on everything from capital to liquidity are set at the global level by the Basel committee, a group of central bankers and regulators from 28 nations including the U.S., U.K. and China. The liquidity coverage ratio was at the center of an international tussle last year, as some central bankers and regulators warned that a draft version of the standard risked causing a credit crunch, while others urged against a wholesale watering down of the measure.
“This move by the U.S. highlights the different emphasis on either side of the Atlantic about the best way to underpin financial stability,” Richard Reid, a research fellow for finance and regulation at the University of Dundee in Scotland, said in an e-mail. “It serves as a reminder that there are limits to regulatory convergence given the underlying differences in financial structure and economic circumstances.”
In previous measures to satisfy Basel committee accords, U.S. regulators have also been tougher than the international body. For example, the leverage limits for eight of the largest U.S. banks proposed by the agencies in July as much as doubled the 3 percent set in Basel as the minimum capital the banks, including JPMorgan and Bank of America, must hold against their assets.
Another related rule would create a yearlong funding requirement is still under construction in Basel. That so-called net stable funding ratio, initially approved by the Basel committee in 2010, will be matched by a consistent proposal in the U.S., Tarullo said.
The latest Fed proposal -- one of several liquidity and capital rules the industry is still bracing for -- raises the floor under an industry still flush with post-crisis cash reserves, said Walter, who left the Basel committee in 2011.
“It’s like buying insurance,” he said. “You’ve got to pay a premium for it.”