Uphill Challenge Awaits Despite Easing of Basel III Liquidity Requirements

On 7 January, the revised Basel III Liquidity Coverage Ratio (LCR) capital adequacy stipulations were released by the Basel Committee in Switzerland. The latest paper entitled ‘Basel III: The Liquidity Coverage Ratio and Liquidity Risk Monitoring Tools’ is perhaps the final version of the rules concerning the calculation of the LCR that will be forthcoming and, as such, it has immense implications for bank capital levels and, ultimately, funding for corporates.

Some of the changes to the original Basel III stipulations are eye catching. The principal revisions include:

• The phasing in of the LCR requirement from 2015 to 2019, rather that the full 100% requirement from the outset. Initially the ratio will be set at 60% of the calculated cash outflow, then increasing by 10% each year over the next four years.
• Wider range of assets to be included as high quality liquid assets (HQLA). They may now include equities and retail mortgage backed securities.
• Lower run-off rates than previously suggested for many items. For example, retail deposit that is covered by appropriate government deposit guarantee schemes can have a run off rate of 3% rather than the previous 5%.
• Options for jurisdictions that have difficulty with the availability of HQLAs have conditions of eligibility as well conditions with regards to equivalence clarified.
• Increased dependence on peer review of supervisory practice in relation to implementation of the LCR and liquidity measures.

Overall many observers have seen the introduction of a phasing in period and the increase in the items that can be included in the HLQA as a victory for bank lobbying, easing the post-crash capital adequacy requirements for the banks which had threatened an even tighter banking lending crunch for smaller corporates than is already in place. Trade finance could also be adversely impacted under the new rules.

Given the current economic conditions particularly in Europe and the United States, however, the introduction of these revised Basel III measures can be seen as pragmatic as relaxing the rules may help support economic growth. Furthermore, with regards to the make-up of the HQLA, the original assets were narrowly defined and clearly favoured the holding of government assets. The very fact that an asset is eligible for the HQLA buffer is likely to distort its liquidity characteristics. By widening the eligible assets, this effect should be reduced.

Conclusions

The Basel III requirements are more detailed in comparison to the 2010 paper and look to be more complex regarding implementation. There are also more places in the rules for national discretions and disclosures. The result may be that the global implementation of this measure may be less uniform than originally thought. Firms will need to enhance their control infrastructure which includes integrated risk and regulatory systems capable of performing the required liquidity analysis in a way that is coherent and aligned with the control capital and profitability.

Remember, for all the perceived dangers of watering down the proposal, we have to be aware that currently the world has not implemented a globally comparable measure. Some of the changes will have the effect of making the new regime workable where it was not previously, and this is a good thing.

The new liquidity regime will represent a considerable challenge for large parts of the banking sector. Its impact on treasurers is yet to be seen but it will be felt. In appraising the effectiveness of the Basel III revisions observers need to consider the impact of the enhanced controls, reporting to regulators, public disclosure, stronger internal and external liquidity reviews, as well as the level of liquidity buffers. There is no escaping that even its current form the sector has a lot of work to do.

Most of the benefits that were sought from this measure from the outset have been maintained. Furthermore, the regulators still have considerable powers to further address unforeseen weakness.