Bank Liquidity Rules Excluding Munis Set for Approval

U.S. regulators set requirements for the amount of high-quality, liquid assets big banks must stockpile to survive a 30-day liquidity drought, taking a major step in efforts to prevent a repeat of the 2008 credit crisis.

Rules approved yesterday by the Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. leave banks about $100 billion short of the $2.5 trillion in easy-to-sell assets needed to meet the liquidity standard, according to the Fed. Municipal bonds are excluded from the category of assets that can be used to reach the target.

The agencies also proposed a rule on collateral for swaps traded outside of clearinghouses and wrapped up rules on how much loss-absorbing capital must be held against total assets.

The liquidity and leverage-ratio rules are based on accords reached by the 27-nation Basel Committee on Banking Supervision. They’re meant to keep banks running in a crisis by limiting how indebted they can get and demanding they hold stable assets such as Treasuries, corporate debt and stocks.

“As the financial crisis demonstrated, most of our largest and most systemically important financial institutions used excessive amounts of short-term wholesale funds and did not hold a sufficient amount of high-quality liquid assets to independently withstand the stressed market environment,” Fed Chair Janet Yellen said before the vote.

Daily Calculation

The final liquidity rule exempts non-bank financial companies and delay the demand for daily calculation of banks’ assets -- giving lenders with more than $700 billion in assets until July to begin that process. The rule also expands the universe of corporate bonds and equities that count as suitable assets, and the Fed is weighing adding some frequently traded munis in a later rule.

“Instead of promising revisions in the future, we believe regulators should take necessary actions now,” Richard Foster, vice president and senior counsel at the Financial Services Roundtable, said in a statement. The U.S. rule is a “clear divergence” from the Basel accord in pushing banks to drop munis and mortgage-backed securities, Foster said.

Since the crisis, the largest U.S. banks have built stockpiles of high-quality assets. Banks have four months to reach 80 percent of their targeted liquidity level at the start of the year, and will have another two years to reach full compliance by Jan. 1, 2017. Most say they’re within easy reach.

‘Strategic Challenges’

“The very biggest U.S. banks are largely fine with regard to the ratio, although the new standards raise significant strategic challenges in the context of current market conditions and the new leverage rules,” said Karen Shaw Petrou, managing partner of Washington-based research firm Federal Financial Analytics Inc. The regulators’ demands are creating “a scarcity of eligible assets,” she said.

As supplies of high-quality assets run low, the need may open a new line of financial innovation, industry experts say.

“I would expect to see people trying to structure debt products so that they meet the high-quality liquid asset definition,” said Oliver Ireland, a lawyer at Morrison & Foerster LLP in Washington. “There will be pressure on the regulators to accept them. That’s the way it always turns out.”

Lee Schneider, a lawyer at Debevoise & Plimpton LLP in New York, also expects “more financial innovation” and said he anticipates that broker-dealers will launch debt securities that meet regulators’ requirements.

‘New Opportunities’

“The financial services sector gets creative when they think there are new opportunities to make money,” Schneider said, predicting that the next couple of years will see new products that carry hallmarks of security, such as guarantees. “If the industry and the regulators work together to create these instruments, that’ll be beneficial to everybody,” he said.

Along the way, bankers hope the final rule sees some industry-friendly tweaks to fix what American Bankers Association President and Chief Executive Officer Frank Keating called “significant flaws, with the potential for adverse and unintended consequences.”

While the liquidity rule calls for keeping safe assets on hand, the leverage rule demands a simple ratio of capital against total assets. The rule finalizes adjustments for what qualifies as assets, making some concessions to how banks can offset or reduce the weight of certain assets as the agencies brought the new regulations closer to the Basel standard.

With the OCC having approved its “heightened expectations” for banks’ risk-management standards on Sept. 2, the financial regulators’ top officials will have fewer items left on their to-do lists when they appear at a Sept. 9 Senate Banking Committee hearing examining “Wall Street Reform.”