WASHINGTON — For many months, regulators have relaxed regulatory standards in order to help banks weather the COVID-19 crisis. But an impending liquidity benchmark will test the largest institutions’ ability to support the fragile economy while complying with new rules.
The federal agencies are poised soon to finalize the Net Stable Funding Ratio, a measure of long-term liquidity strength developed after the financial crisis by the international Basel Committee.
But some in the industry and other analysts say finalizing the rule, not long after the coronavirus outbreak triggered volatility in the liquidity markets, is playing with fire. They point to the sudden selloff in Treasury securities in the spring, which led the Fed to buy up Treasuries, saying that the new liquidity ratio could make it hard for banks to respond if the market suffered another such shock in the future.
The Bank Policy Institute warned in a recent blog post that “adopting the NSFR at this time would be both ironic and reckless.”
Bill Nelson, the chief economist at BPI, said in an interview that the NSFR’s treatment of Treasury securities would have exacterbated the market volatility that necessitated an unprecedented intervention from the Fed. He noted the events of this past spring proved that banks could weather the storm without a new liquidity requirement.
“It does make it ironic that they are adopting this in the wake of events for which it was demonstrably not needed, and it would have made it worse,” Nelson said in an interview.
Banks are already complying with a short-term funding measure known as the Liquidity Coverage Ratio, which gauges banks’ ability to withstand a sudden market crisis over a 30 day-period. In contrast, the NSFR assesses a bank’s ability to fund the asset side of its balance sheet for one year.
According to the 2016 proposal by the Federal Reserve Board, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency, the rule would apply risk weights to different types of assets and liabilities. An institution’s “available stable funding” would have to equal or exceed “required stable funding.” The proposal would generally apply to banks with over $250 billion of assets, although less complex institutions would comply with a modified version. The NSFR proposal hewed fairly closely to the international standard set by the Basel Committee.
Despite hope from many big banks that the NSFR was all but dead, Fed Vice Chairman for Supervision Randal Quarles said last week that he believes the rule will be finished “quite soon.” The Fed is leading the charge among the regulators to complete the rule, according to Politico.
Quarles, speaking at an event for Harvard Law School, suggested that regulators will finalize the NSFR as well as a separate package of other Basel III requirements.
The COVID event and the fact that there are only 24 hours in a day, I think, slowed us up a bit in implementing that,” Quarles said. “But we’ve picked all of that back up and that will proceed at pace as well. I think those will be complete over the near to medium term and that will be all the major elements then that we sought to address will be addressed.”
Some analysts say even though banks’ liquidity profiles today are not overly risky, the rule is still necessary to ward off risky behavior in the future.
“As an analyst, I’ve seen this over time that if you don’t have any guardrails or any rules, you will create bad actors,” said Chris Marinac, director of research at Janney Montgomery Scott. “Maybe the acting is not bad today, but it could be bad tomorrow because you didn’t have any guardrails.”
But Nelson suggested that the Fed should weigh the rule against the recent volatility in the Treasury market. For example, the final rule could set the stable funding requirement on Treasury purchases and reverse Treasury repurchases to zero in order to mitigage balance-sheet constraints and…
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