Regulators are not yet setting rules on how much ready cash or cash-like assets a bank has to have, which seems strange since the financial crisis of 2007-2008 featured banks that became insolvent because their securities were losing value and their repo lenders were fleeing and they couldn’t get their hands on enough cash to meet their financial obligations.
“In 2,615 pages of financial reform legislation introduced in the U.S. Congress, there are no rules to ensure that banks keep enough cash-like assets when credit disappears,” writes reporter Yalman Onaran in a Bloomberg News story March 29.
Basel regulators are working on setting a “liquidity coverage ratio,” that would say how much safe assets banks have to keep on hand to meet obligations in a crisis, and a “net stable funding ratio,” that would require them to better match their long-term lending with long-term sources of fund, but implementation is years away.
From the Bloomberg story:
Lehman was funding as much as half of its $800 billion balance sheet through overnight or other short-term loans, according to two former executives with knowledge of its operations. That accounted for about one-seventh of the U.S. repo market. Asset-backed securities were used as collateral for one-third of the firm’s overnight borrowing, one of the executives said. Those became increasingly difficult to sell when the mortgage market collapsed.
While regulators knew of the risk that this collateral could become illiquid, they never pushed Lehman to sell assets or to find other ways of funding, one of the executives said. …
“Why is setting liquidity rules not a priority even though regulators keep talking about it as the source of the crisis?” said Mark Williams, a former Fed examiner who’s now a professor of finance at Boston University and whose book on the lessons of Lehman’s failure, “Uncontrolled Risk,” is being published this week. “We need more specific rules on liquidity risk.” …
Liquidity is not a new issue. Continental Illinois National Bank & Trust Co. failed in 1984 because its overnight lending grew costlier as lenders worried about its viability, according to Allan Meltzer, a professor of political economy at Carnegie Mellon University in Pittsburgh and author of a three-volume book on the Fed.
“Banks should have learned by now it’s dangerous to rely on overnight lending,” Meltzer said. “You’d think they’d learn.”