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Banks Can Breach Basel Liquid-Assets Rule During Crises

Banks Can Go Below Basel Minimum Liquidity Levels
Some U.S. bankers, including Jamie Dimon, chief executive officer of JPMorgan, have called for an overhaul of the current risk-weighting plan. Photographer: Scott Eells/Bloomberg

Banks will be allowed go below minimum liquidity levels set by global regulators during financial crises to avoid cash-flow difficulties.

“During a period of stress, banks would be expected to use their pool of liquid assets, thereby temporarily falling below the minimum requirement,” the Basel Committee on Banking Supervision’s governing board said in a statement on its website yesterday, following a meeting in the Swiss city.

The aim of the measure, known as a liquidity coverage ratio, is to ensure that lenders hold enough easy-to-sell assets to survive a 30-day credit squeeze. The requirement, one of several measures from the Basel group designed to prevent a repeat of the 2008 financial crisis, is scheduled to enter into force in 2015.

Banks have argued that the rule may curtail loans by forcing them to hoard cash and buy government bonds. Bank supervisors say the standard is needed to prevent a repeat of the collapses of Lehman Brothers Holdings Inc. and Dexia SA, which were blamed in part on the lenders running out of short-term funding. Global regulators said last year that they would amend the rule to address unintended consequences.

Liquidity Buffers

“There will be a concern nevertheless that banks won’t want to draw down their liquidity buffers because of how such a move may be received by the markets,” said Patrick Fell, a director at PricewaterhouseCoopers LLP in London. “A bank that is seen to draw on the buffer could feel itself to be weakened and compromised.”

Regulators must still clarify which assets banks should be allowed to count towards liquidity buffers and how much funding lenders should expect to lose in a crisis, the group said. Work on the main elements of the liquidity rule should be completed by the end of 2012, it said.

The proposal to allow lenders to draw down their liquid assets “makes a lot of sense,” said Jesper Berg, senior vice president at Nykredit A/S, Denmark’s biggest mortgage bank. “Buffers that cannot be used are not buffers.”

The Basel committee will provide further guidance on when lenders will be allowed to breach the minimum rule, and make sure the standard doesn’t interfere with central-bank policies, the group said.

Sound Funding Structure

The aim of the liquidity coverage ratio “is to ensure that banks, in normal times, have a sound funding structure and hold sufficient liquid assets,” Mervyn King, the governing board’s chairman, said. This should mean that “central banks are asked to perform only as lenders of last resort and not as lenders of first resort,” said King, who is also governor of the Bank of England.

The Basel committee’s criteria for judging which assets can count towards meeting the liquidity rule don’t match up with central banks’ rules on what securities they accept as collateral, Berg said in an e-mail.

“There is a conflict” between the two sets of standards, Berg said. “There has to be more flexibility in defining liquid assets in line with the calls national central banks make in setting their collateral rules.”

The liquidity rules were part of a package of measures adopted by global banking regulators in 2010 to strengthen the resilience of banks. The new rules also included tougher capital requirements that more than tripled the core reserves that lenders are required to hold.

Capital Rules

Separately, the governing board said that the Basel committee will carry out “detailed” peer reviews of whether nations have correctly implemented capital rules for lenders. The assessments will include whether lenders are correctly valuing their assets, it said. The results of the reviews will be published, with the U.S, Japan and European Union the first to undergo the exams.

Some U.S. bankers, including Jamie Dimon, chief executive officer of JPMorgan Chase & Co., the largest U.S. lender, have called for an overhaul of the current risk-weighting plan, which allows banks to use their own models to assess the safety of assets and how much capital they need to hold. Dimon has said that the way the rules are applied could disadvantage U.S. banks.

The proportion of risk-weighted assets to total assets at European banks is half that of U.S. lenders, according to a report last year by Simon Samuels and Mike Harrison, analysts at Barclays Capital in London.

Forcing lenders to hold more capital won’t be enough on its own to calm concerns that banks would be vulnerable if a European government defaults on its debt, according to Moody’s Investors Service.

“Any sustained improvement in bank creditworthiness will require a resolution” of the region’s fiscal crisis, Moody’s said in its Weekly Credit Outlook today. This would in turn “require credible steps towards much closer fiscal integration and increased mutual support among member states,” Moody’s said.

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