Fed to Propose Banks Hold Funds for Credit Drought

Banks would have to hold enough easy-to-sell assets to survive a 30-day credit drought under a rule to be proposed today by the Federal Reserve that may have the greatest effect on banks with big trading operations such as JPMorgan Chase & Co. and Goldman Sachs Group Inc.

The demand for 30 days of liquidity is intended to satisfy global Basel III accords for strengthening the financial system. Increasing the banks’ liquid assets is meant to make them less vulnerable in a crisis like the one that struck in 2008.

“It’s always been viewed as something that had more relevance for the trading banks,” said former Fed lawyer William Sweet, adding that it will hit them harder because of their more urgent need for short-term funding. Banks’ broker-dealer units must raise money in the market because they can’t rely on deposits to finance their activities.

In January, the Basel Committee on Banking Supervision agreed on a liquidity coverage ratio meant to ensure that banks can survive a 30-day credit squeeze. The standard to be fully implemented by 2019 allows lenders to go beyond cash and low-risk sovereign debt to an expanded range of assets including some equities and securitized mortgage debt, according to the agreement.

The rules to be advanced by the Fed today must also be proposed and opened to public comment by the Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency.

In previous measures to satisfy Basel committee accords, U.S. regulators have sometimes been tougher than the international body. For example, leverage limits proposed by the agencies in July for eight of the largest U.S. banks would as much as double the 3 percent level set in Basel as the minimum capital that banks must hold against their assets.

‘More Rigorous’

“The implementation by the U.S. of the Basel rules have had more rigorous requirements than those implemented elsewhere,” said Sweet, a partner at Skadden, Arps, Slate, Meagher & Flom LLP in Washington.

The multiagency liquidity proposal will probably target the largest banks, according to a Morgan Stanley research report yesterday, which said Bank of America Corp., Citigroup Inc., Goldman Sachs, JPMorgan and Wells Fargo & Co. all indicate they already meet the Basel requirement. Morgan Stanley said the proposal will probably allow government-sponsored enterprise debt while excluding private-label mortgage securities.

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. They are in turn overseen by the Group of Governors and Heads of Supervision, which is led by Bank of England Governor Mark Carney, with meetings attended by central bankers such as Fed Chairman Ben S. Bernanke and the European Central Bank’s Mario Draghi.

Liquidity Tussle

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.

The European Central Bank and the Bank of France were among authorities that warned of negative side effects. ECB president Draghi told lawmakers that the draft standard “strongly penalizes interbank lending.” Regulators also expressed concern that it would curtail lending and make it harder for banks to implement monetary policies.

The Basel liquidity rule agreed on in January expanded beyond an earlier version in what counts as high-quality liquid assets, including acceptance of a limited amount of corporate debt, riskier sovereign debt and common equity. The watered-down rule also gave banks more breathing room, pushing full compliance out another six years.

“It’s clearly a significant component of the overall Basel III capital and liquidity framework,” said Luigi L. De Ghenghi, who advises banks on regulation at Davis Polk & Wardwell LLP in New York. He said it’ll be watched with “great interest.”

(Corrects spelling of law firm in last paragraph.)
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