Long-Term Liquidity Plan Is Costly and Redundant, Banks Argue

Long-Term Liquidity Plan Is Costly and Redundant, Banks Argue

September 2016

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WASHINGTON — A new proposed long-term liquidity requirement confers little benefit while adding compliance costs and contradicting existing regulations, according to banks and financial industry trade groups.

In a joint letter to the regulators, several trade groups representing large banks argued that the Liquidity Coverage Ratio, a liquidity measure finalized in 2014 that requires banks to ensure they could survive a funding crisis lasting 30 days, already accomplishes what the agencies are seeking to do.

"The Associations continue to support the maintenance by banking organizations of stable funding and liquidity profiles, but believe that key reforms already enacted, including the Liquidity Coverage Ratio, will ensure these profiles will remain stable over time," said the letter, which was signed by the American Bankers Association, the Securities Industry and Financial Markets Association, the Financial Services Roundtable, the Commercial Real Estate Finance Roundtable, the Institute for Independent Business and the Clearing House Association.

"These intervening regulatory changes call into question whether the proposal's purported incremental benefits would outweigh the costs that would be imposed on the U.S. economy and job growth if the NSFR is implemented as proposed."

Other industry comments similarly criticized the proposal's consideration of certain assets in light of other regulatory moves.

Andres Gil, director of the Chamber of Commerce's Center for Capital Markets Competitiveness, said the proposal prepares the financial market participants to withstand an unprecedented degree of upheaval, while in the meantime stifling economic growth and competitiveness.

"The Chamber is particularly concerned that the proposed rule lacks a clear description of the market scenario underlying the proposal's calibrations," Gil said. "These calibrations would ultimately subject nonfinancial corporates to undue economic burdens unrelated to safeguarding financial stability."

The net stable funding ratio — along with its short-term counterpart, the LCR — is required as part of the post-crisis Basel III accords in order to ensure that the largest and most systemically risky banks had enough liquidity on hand to keep their essential businesses operating even in the event of prolonged market stress. During the crisis, many banks and other financial services firms relied heavily on short-term wholesale funding to meet their day-to-day liquidity needs, and when that credit dried up, central banks had to step in to ensure that those firms did not collapse.

The U.S. version of the Basel rule — which the Federal Reserve, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency proposed in April — hewed closely to the international minimum standards and set out different requirements for banks based on their total asset size, singling out the largest and most systemically risky banks for the most stringent requirements.   

Barclays — one of the few foreign banks who submitted comments — argued that the way the net stable funding ratio is structured unduly penalizes securities trading activity.

Thomas McGuire, the treasurer for Barclays America, said that the funding weightings for securities inventory — that is, the extent to which those sources of income are assumed not to perform in times of stress — is several orders of magnitude more stringent than the haircuts that regulators already apply to triparty repurchase agreements. In many cases, they are as stringent or nearly as stringent as the short-term liquidity rule, while not helping stability, he said.

"The [required stable funding] for securities is significantly higher than current secured funding haircuts, particularly for equity securities and securities issued by financial institutions," McGuire said. "Properly calibrated RSF factors could deliver the intended objectives of the proposed rule at lower costs to covered companies and end users."

Many in the finance industry also take exception to certain provisions in the proposal and how they would affect their particular business models. The custody banks State Street, Northern Trust and BNY Mellon said in their joint comment letter that the plan did not take the unique considerations of the custody bank business model into account.

Custody banks — of which there are only a handful worldwide and which manage large accounts from institutional investors — rely on so-called operational deposits to fund their clients' investment portfolios and serve their clients' needs. The proposal does not deal with how stable those deposits can be, the letter said, and should recalibrate the rule to better accommodate the custody bank business model.

"Since custody banks maintain the primary operational accounts of their institutional investor clients, they are the recipients of substantial deposit inflows associated with normal course transactional activities," the custody bank letter said. "We believe that certain aspects of the Basel III liquidity framework and its implementation in the U.S. do not properly account for the particular characteristics and risk profile of operational deposits."

Robin Vince, the treasurer of Goldman Sachs, likewise criticized the proposal for its treatment of certain securities. Under the NSFR, margin posted to back up certain securities and derivatives are deemed more risky even though they are treated as high-quality liquid assets for purposes of the LCR. Thus, the NSFR effectively requires banks to convert securities to cash — additional transactions that might increase financial instability rather than reduce it.   

"Under the proposed NSFR, counterparties with securities collateral would have to execute additional secured financing transactions to convert their securities to eligible cash collateral to post," Vince said. "The proposed NSFR therefore leads to these additional transactions, which would unnecessarily increase interconnectivity and gross up balance sheets."

Wall Street reform advocates, meanwhile, generally endorsed the proposal. Dennis Kelleher, president of Better Markets, argued that banks should be required to report information about their liquidity more frequently than quarterly — as the proposal suggests — but was otherwise supportive of the plan.

Kelleher specifically rebutted industry arguments that the NSFR was redundant in his comment letter. The LCR addresses the problem of converting assets to cash in stress scenarios, he said, which was one major problem that arose in the 2008 financial crisis. But the NSFR addresses liquidity transformation — that is, how banks' inflows relate to their outflows, even in a stress environment.

"In other words, the NSFR is not 'redundant': it is an essential complement to the Liquidity Coverage Ratio, focused on a different liquidity risk that affects large financial institutions the risk arising from maturity transformation and maturity mismatches," Kelleher said.

 

This article was written by John Heltman from American Banker and was legally licensed through the NewsCred publisher network.

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