The amended Liquidity Coverage Ratio (LCR), approved by the Governors and Heads of Supervision (GHOS) of the Basel Committee on Banking Supervision, will now be phased in from its planned introduction date of 1 January 2015. It will begin at 60%, rising by 10% a year to reach 100% by 1 January 2019.
The new approach aligns with the planned introduction of new capital adequacy requirements under the international banking agreement known as Basel III. The amendments, which also include changes to the type of assets banks will be required to hold liquid assets against under the new rules, are intended to prevent "disruption to the orderly strengthening of banking systems or the ongoing financing of economic activity", the GHOS said.
Sir Mervyn King, chairman of the GHOS, said that the LCR was a "key component" of the Basel III reforms.
"The agreement reached today is a very significant achievement," he said. "For the first time in regulatory history, we have a truly global minimum standard for bank liquidity. Importantly, introducing a phased timetable for the introduction of the LCR and reaffirming that a bank's stock of liquid assets are usable in times of stress will ensure that the new liquidity standard will in no way hinder the ability of the global banking system to finance a recovery."
The GHOS is the body which overseas the work of the Basel Committee on Banking Supervision. It is made up of central bankers from 27 countries and chaired by Sir Mervyn King, the outgoing governor of the Bank of England.
The Basel III agreement introduces new baseline requirements for capital, leverage and liquidity. Banks will have to increase both the quantity and quality of capital they hold, while accounting for higher levels of risk-weighted assets. The requirements of the agreement will be officially phased in between 2013 and 2022.
Liquid assets are those held in cash or in a form that is easy to sell. By forcing banks to hold a higher proportion of their assets in a liquid form, regulators believe they will be less vulnerable to 'runs' where lots of customers try to withdraw their money at the same time. Minimum capital requirements, also being proposed under the Basel III agreement, will make banks more able to absorb losses.
The LCR provides that banks must hold enough unencumbered high quality liquid assets (HQLA) to meet their liquidity needs over a 30 day time period during a 'stress scenario' specified by the Committee. The original draft, published in 2010, stated that only sovereign debt, top-quality corporate bonds and cash would count towards HQLA. The final version will also allow banks to include some equities, lower quality corporate bonds and some mortgage-backed securities towards 15% off their total buffer.
“These proposals allow a lower grade of asset class than was previously allowed to qualify as a liquid asset,” said banking law expert Edward Sunderland of Pinsent Masons, the law firm behind Out-Law.com. “There is no certainty that there will be a buyer of such assets at face value if there is another global crisis, meaning that this may not actually solve the kinds of problems experience in 2007 and in the years since then.”
Tony Anderson, a banking law expert with Pinsent Masons, said: “Banks should be reviewing the their products to ensure that they are achieving the optimal treatment for risk weighting under the Basel III requirements, as well as under the UK’s own Banking Reform proposals.”
The final rule also confirms that banks will be allowed to 'dip into' their HQLA reserves in times of particular financial difficulty, as announced by the GHOS last January. Although the 100% threshold will ultimately be a minimum requirement in normal circumstances, banks will be able to temporarily fall below the threshold during periods of stress without penalty. National banking supervisors will be responsible for providing guidance on when banks will be able to use these assets, the GHOS said.
The GHOS said that it will now "press ahead" with its review of the third element of the new framework, the Net Stable Funding Ratio, which is designed to limit banks' reliance on unstable methods of funding. This final strand is due to be implemented in 2018.