Banks may face greater difficulty complying with minimum liquidity rules drawn up by global regulators than they will meeting higher capital requirements.
The Basel Committee on Banking Supervision, which meets in the Swiss city tomorrow, plans to discuss how to implement rules designed to ensure banks hold enough easy-to-sell assets to survive a 30-day credit squeeze and can back up long-term lending with stable sources of funds.
“The way the liquidity ratios are designed at the moment is going to cause a lot of banks a lot of problems,” said Monika Mars, a PricewaterhouseCoopers AG director in Zurich. “Liquidity is a much bigger challenge” for banks than meeting Basel capital rules, especially for smaller lenders and those in emerging markets, she said.
The liquidity rules are part of the last year’s Basel III deal to bolster the defenses of the world’s financial system by more than tripling the amount of core capital that banks have to hold. This week’s talks will also examine capital surcharges for banks whose failure would create turmoil across the globe. HSBC Holdings Plc, Citigroup Inc. and Deutsche Bank AG are among lenders facing the highest levy, Morgan Stanley analysts said in a June 19 note.
Regulators at the Basel meeting are set to discuss how to fulfil a commitment made last year to review and possibly adjust the two liquidity standards before they enter into force.
The ratios have triggered unease among some banks and regulators for risking unintended consequences for some lenders that have to work hard to meet Basel III’s demands.
“If you struggle with the capital rules you risk a much greater struggle with the liquidity requirements,” said Jesper Berg, senior vice president at Denmark’s biggest mortgage bank, Nykredit A/S.
The Basel capital and liquidity requirements may combine to form a vicious circle, Berg said, as banks that sail too close to minimum permissible levels of capital might appear weak to the market, and so struggle to attract the depositors and investors they need to meet the liquidity rules.
The liquidity coverage ratio, or LCR, is the first one scheduled to be implemented. The measure, to be phased in by 2015, requires banks to hold enough assets that can be sold under stressed market conditions. The idea is to enable a lender to survive a crisis situation in which credit lines are withdrawn and the bank faces a sudden outflow of deposits.
Lenders including HSBC and Deutsche Bank have warned that the list of assets that banks are allowed to count toward meeting the LCR is too restrictive, and overly concentrated on government bonds.
Banks’ ability to meet the LCR may be hampered by difficulties they are likely to face over the next two years in refinancing senior debt that falls due, Berg said.
As a result the impact could be that banks have to cash in liquid assets to make up their shortfall in funds that arises from their inability to replace maturing bonds.
“One thing is how the liquidity numbers look now, the other is how they will look over the next two years when the funding falls due,” Berg said. Banks have “a lot of funding” coming to maturity over this period.
The second liquidity rule, known as the net stable funding ratio, or NSFR, may be even more challenging.
Assessing the impact that the NSFR will have on banks margins is “one of the greatest difficulties in forecasting bank returns going forward,” Jonathan Tyce, senior analyst for Bloomberg Industries European banking team, said in a telephone interview.
Stable funds are resources that banks can expect to have for at least a year even in stressed market conditions, for example term deposits and long-standing retail deposits.
The measure, scheduled to become binding at the start of 2018, will set a minimum amount of stable funds that banks will have to use to finance different types of lending.
The NSFR was designed to prevent a repeat of events such as the near-collapse of Northern Rock Plc. The British lender was nationalized in 2008 following the first bank run in the U.K for 140 years, caused when the lender’s model of using short-term borrowing to finance mortgage lending left the bank vulnerable in the credit crunch.
“Removing the ability to mismatch assets and liabilities will squeeze margins, and coupled with lower leverage, the cumulative result is undoubtedly negative, but it’s still unclear to what extent,” Tyce said.
The NSFR is “very crude,” Mars said. It will penalize banks that “have a big loan book, do lots of lending supporting the real economy, and do not have an inordinate amount of retail deposits.”
A mismatch in maturities between lending and borrowing activities is “inherent in banking systems,” she said.
Regulators are split over the practicality of the liquidity rules. Nout Wellink, the outgoing chairman of the Basel committee, last week criticized the lack of a clear commitment by the European Union to implement the standards.
Michel Barnier, the EU’s financial services chief, said last month that he would delay making a decision on whether to implement the NSFR as a binding rule in the 27-nation region.
U.S. Federal Reserve Governor Daniel Tarullo told lawmakers last week that revisions are inevitable at least for the stable funding rule.
“I don’t believe the NSFR is going to be implemented as a binding requirement,” Berg said. It “is sort of running against the DNA of banking.”
The Basel committee last year published an impact study showing that a total of 263 banks would have faced a shortfall of 2.89 trillion euros ($4.16 trillion) in stable funds had the NSFR been in place at the end of 2009.
They would have faced a 1.73 trillion-euro shortfall in the assets needed to satisfy the LCR. The Basel committee has said it is working on a follow-up study, to be completed by August, which will be based on end-2010 data.
This week’s Basel meetings, which run until June 25, will also seek agreements on rules for banks’ disclosure of pay and bonuses, two people familiar with the talks said. The committee sought views on a draft of the rules last year.
The regulators also intend to endorse draft proposals for the orderly winding down of failing banks and for imposing losses on bondholders at crisis-hit lenders, according to the people, who couldn’t be named because the discussions aren’t public. The Basel group will then seek opinions on the possible rules, they said.
The Basel committee has said all banks should hold core Tier 1 Capital of 7 percent of their risk-weighted assets, and is considering additional requirements for those banks it considers systemically important financial institutions, those firms whose collapse would harm the global economy.
HSBC, Citigroup, Deutsche Bank and BNP Paribas, are among lenders who may be subject to a surcharge of about 2.5 percent, Morgan Stanley said in its June 19 note.
The Basel group may require the biggest banks to hold as much as 3.5 percentage points in extra capital if they grow, two people familiar with the talks said this month.