The introduction of the first set of global liquidity standards for lenders is no small step. Regulators want to avoid another Lehman Brothers or Northern Rock-style liquidity crunch, and forcing banks to insulate themselves from market shocks by holding high quality liquid assets restricted to cash, central bank money and government debt, was a strong start.
The Liquidity Coverage Ratio is a headline-grabbing policy that is easily explained with a simple tag line — crisis protection.
But banks lobbied hard against the first proposals and the restrictive list of securities eligible for the LCR, regularly bellowing out concerns that over-zealous regulation would stifle lending to the real economy and scupper the recovery.
More than two years later, they have got their way — to an extent. But while the new requirements will certainly be less onerous for banks, and thus, presumably, for the companies and individuals that borrow from them, the celebration is limited to the banking world. Announcing the new proposals, Mervyn King, governor of the Bank of England and chairman of the group which oversees the Basel Committee, said the delayed phase-in would ensure that the new liquidity standard would “in no way hinder the ability of the global banking system to finance a recovery.”
He must have had that line drilled into him by so many industry lobbyists that he said it without thinking. It certainly sounded like it on Sunday’s conference call.
Drill into the new requirements and the changes look less spectacular, leaving the LCR still seeming an obstacle to banks’ flexibility in lending.
First of all, the estimates on how quickly money could stream out of a bank in trouble have been eased, but some of these will still be much tighter than banks have been used to. As EuroWeek argues in a separate piece, the loan market is likely to feel a sharp pinch when the LCR is implemented.
On the top of the ratio — the assets banks are allowed to count as highly liquid — Basel has also made concessions, though modest ones.
Commercial paper, which most CP specialists never dared hope would make it into the LCR, despite their best efforts to promote it, is permitted under the new requirements, alongside a wider range of corporate debt and some residential mortgage-backed securities.
This is undoubtedly good news for banks. First, it eases the pressure on them to stockpile government debt to fill their buffers, and second, their LCR portfolios will be more diverse — surely a good thing. They have also been assured that in times of stress, when they are dipping into their buffers, their LCRs can drop below 100% — although this should really have been a no-brainer.
But let’s not get carried away. The LCR assets will still be heavily weighted towards sovereign debt. At a time when senior officials from the European Commission are talking about breaking the negative feedback loop between banks and governments, not to mention unifying projects such as European banking union, the Basel Committee is playing catch-up in this respect.
Moreover, the newly eligible assets that so excited the markets after Sunday’s announcement mostly belong to the level 2B part of the liquid assets stock. They will be subject to a harsh 50% haircut and level 2B can only make up 15% of the entire buffer. This limits the diversification benefit they can offer.
Corporate bonds rated A+ to BBB- will be permitted in level 2B — but banks will surely be more inclined to use holdings at the lower end of this scale, since they will yield more, but be subject to the same haircut. These could prove less liquid in a crisis.
Perhaps the biggest positive for the banks, and one of the main points of celebration on Monday, is the delayed implementation date. Banks must now fill 60% of the LCR by the start of 2015 and ramp it up by 10 percentage points a year, reaching 100% by 2019.
But ask a non-banker whether they think that because banks can hold a few more corporate bonds and a little bit less government debt they are suddenly going to ramp up lending, and you’ll get a wry laugh.
Yes, these changes will give banking stocks a boost and push their bonds up a few points, but ultimately, it’s a victory for the banks, their shareholders, and their creditors — not their customers.
As for the taxpayer, well, we’ll just have to find out. So thanks for the platitudes, Merv, but tell it like it is.