Changes in US Banking Regulations – Liquidity
An article by New York Institute of Finance regulation and compliance instructor Jack Foster.
By far the most difficult challenge for regulators, since the crisis of 2008, is to ensure that banks maintain adequate liquidity. Banks, by their very nature are illiquid. They borrow short and lend long. With a normal yield curve, they make their profit from the spread between short-term borrowing and longer-term lending
In a world of hedge funds and selling short, however, banks in a liquidity crisis, by their very nature are subject to runs on their short-term deposits. For example, a Congressional Committee estimated in 2009 that without the Troubled Asset Relief Program and the intervention of the Federal Reserve all but one of the eighteen major US banks and investment banks would have failed.
Basel III and U.S. regulators are attempting to lessen liquidity risk by implementing new liquidity standards. The standards consist of two new Liquidity Ratios – the Liquidity Coverage Ratio and the Net Stable Funding Ratio.
Basel III designed the Liquidity Coverage Ratio to ensure that sufficient high quality liquid resources are available for a one-month survival in case of a stress scenario. Recognizing the difficulty in implementing this ratio, Basel III delayed its introduction until January 1, 2015.
Basel III designed the Net Stable Funding Ratio to promote resiliency over longer-term time horizons by creating additional incentives for banks to fund their activities with more stable sources of funding on an ongoing structural basis. Again, recognizing the difficulty in implementing this ratio, Basel III delayed its introduction until January 1, 2015 as well.
Finally, Basel III provided additional liquidity monitoring metrics focusing on maturity mismatch, concentration of funding and available unencumbered assets.
Unfortunately, in a world of hedge funds and selling short, these efforts will do little to stop a liquidity crisis. On the other hand, like bank stress tests that force banks to evaluate their capital assuming a prolonged recession, liquidity ratios will force banks to focus on areas that might slightly reduce their vulnerability to a liquidity crisis.
By far the greatest focus of Basel III and U.S. regulators is on capital. Capital is easier to measure and adequate capital is the first and most important line of defense against a bank liquidity crisis. For that reason, as outlined in the article on capital, by far the greatest regulatory changes effect capital requirements.
Therefore, while liquidity standards are important, they are difficult to implement and far less important than adequate capital. For this reason, liquidity standards will result in far less controversy then other areas of Basel III and Dodd Frank.
About New York Institute of Finance
With a history dating back more than 90 years, the New York Institute of Finance is a global leader in training for the financial services and related industries with course topics covering investment banking, securities, retirement income planning, insurance, mutual funds, financial planning, finance and accounting, and lending. The New York Institute of Finance has a faculty of industry leaders and offers a range of program delivery options including self-study, online and in classroom.
For more information on the New York Institute of Finance, visit the homepage or view in-person and online finance courses below: