Racehorses in Running as Regulators Debate Loose Liquidity Rules

From: Bloomberg

By Ben Moshinsky & Jim Brunsden

As regulators sparred last month over international liquidity rules in Basel, Switzerland, one suggested racehorses could be used as collateral to access cheap cash at central banks in a crisis.

While the remark was said in jest, it highlights the split between regulators over how low to set the bar for the types of assets banks must hold to protect against funding shocks, according to a government official familiar with the talks who asked not to be identified because the negotiations were confidential. The December meeting of regulators didn’t yield a final deal on the so-called liquidity coverage ratio.

Their bosses from central banks around the world, anxious that tough liquidity rules might sap the strength of the global economy, agreed at additional meetings on Jan. 6 to give banks more time and the right to use more types of securities to meet the LCR, a buffer of easy-to-sell assets for banks to survive a 30-day credit squeeze.

Will the new rules “do the job? My personal opinion is it won’t,” Robert Jenkins, a member of the Bank of England’s Financial Policy Committee, said at a Jan. 17 financial regulation conference in London. “And that’s the opinion of a growing body of academic research. This is a long game and it’s not over yet.”

Financial rules on everything from capital to liquidity are set at a global level by the Basel Committee on Banking Supervision, a group of central bankers and regulators. They are in turn overseen by the Group of Governors and Heads of Supervision, which is led by U.K. Bank of England Governor Mervyn King and meetings are attended by central bankers such as the U.S.’s Ben S. Bernanke and the European Central Bank’s Mario Draghi.

Shares Soar

There is a growing debate over whether the rules, toughened to prevent a repeat of the 2008 financial crisis, are being weakened in response to current economic realities.

Bank shares soared after the Jan. 6 deal on liquidity rules. ECB President Draghi had argued that the original version of the LCR, published as a draft in December 2010, would choke interbank lending and make it harder for authorities to implement monetary policies. Lenders had warned that the measure might force them to cut back loans to businesses and households.

Policymakers have “consistently underestimated bank funding as a transmission mechanism of sovereign risk and a brake on lending,” Huw Van Steenis, head of European banking analysis at Morgan Stanley (MS), said in a research note. “This re-calibration is welcome.”

Uneasy Truce

The deal marked an uneasy truce between the European Central Bank and authorities in the U.K. and U.S. over whether rules designed to prevent another financial crisis are actually slowing an economic recovery.

The debate will turn to whether lenders can count on central bank support when calculating whether they meet the LCR, potentially leading to further relaxation of the rules on assets banks can count as highly liquid.

“The idea of a globally defined liquidity standard and nationally defined collateral frameworks for central bank operations continue to be in conflict even after the latest changes to the LCR,” Jesper Berg, senior vice president at Nykredit A/S, Denmark’s biggest mortgage bank, said in an e-mail.

Sovereign Bonds

Racehorses may be an extreme example of how low the bar can go, but the ECB has in the past accepted low-rated Greek and Portuguese sovereign bonds, as well as securities backed by car loans, as collateral for funding in times of crisis.

The subject came up in the December Basel meeting as regulators pushed back against calls from the ECB for the LCR to be expanded to include all assets that central banks accept as collateral.

According to two people familiar with the talks, authorities warned that the ECB plan would amount to tethering the LCR to frequently changing, and internationally varied, central bank standards — a situation in which it would be possible, hypothetically, for anything to become an LCR-eligible asset.

“Eventually the liquidity standards will have to reflect the national collateral frameworks, which has the added benefit that they reflect national financial structures,” Berg said.

Regulators at the Jan. 6 meeting could only reach a deal on the LCR by agreeing to keep the issue of its interaction with central bank policies under review, possibly setting up future clashes.

Work Remains

“Important work” on the LCR “remains to be completed at the global and European levels,” the European Commission said in a statement after the Basel deal.

The review of how central bank facilities are treated could affect what assets banks can count towards their LCR buffers, the commission said.

The ECB position was resisted by some other regulators, including in the U.S., which argued that it would undermine of the LCR’s goal of making banks better able to withstand crises without central bank support, the people said.

Regulators were also concerned that the ECB move might create legal uncertainty over which assets are highly liquid, as central banks loosen their collateral rules in crises, they said.

The LCR is a key component of a package of capital and liquidity measures, known as Basel III, drawn up to avoid a repeat of the 2008 financial crisis. A draft version of the standard was published in 2010.

A sample of 209 banks assessed by the Basel committee had a collective shortfall of 1.8 trillion euros ($2.4 trillion) at the end of 2011 in the assets needed to meet the 2010 version of the LCR, according to figures published by the Basel group.

Increased Buffer

Stefan Ingves, the Basel committee’s secretary general, has said the changes agreed on this month would boost the average LCR buffer held by a sample of 200 international banks from around 105 percent of the minimum requirement, to around 125 percent. Still, he said that the assets are unevenly spread among lenders, and that some banks will have shortfalls.

“It’s very important we maintain the position in which banks do not see the central banks as lenders of first resort, but nevertheless we still can find a way in which to allow the LCR to reflect access to central bank facilities,” Bank of England Governor King said at a briefing following the Jan. 6 meeting of regulatory chiefs.

“It’s about whether you want the central bank really to be the lender of last resort or as much a part of day-to-day operations as core depositors,” Karen Shaw Petrou, managing partner of Washington-based Federal Financial Analytics Inc., said in an e-mail. “In this question lies the difference between banks as quasi-agents of the state or private companies.”

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