Banks prepare to fight Basel’s repo-related ratios

The only rules that have been proposed specifically to lessen the systemic risk caused by the repurchase market will force the largest banks to do business in a more cautious way, and the banks are gearing up to fight them, according to an American Banker report June 2.

The Bank for International Settlements, which coordinates worldwide financial regulations from its headquarters in Basel, Switzerland, has proposed that banks must change the mix of their assets and liabilities, so the banks will be less vulnerable to panics, or runs.

Specifically, the Basel bankers are proposing:

— A “liquidity coverage ratio” that would require banks to have enough cash or cash-like instruments on hand to survive a severe 30-day financial crisis. This standard is due to be implemented January 2015. On average, large banks were 83 percent in compliance at the end of 2009, compared to 98 percent for all other banks, Basel reported June 1.

— A “net stable funding ratio” to better match the maturities of deposits, loans and repos, so fewer long-term securities will be financed with short-term loans that lenders can suddenly refuse to renew. This standard is due to be implemented January 2018. On average, large banks were 93 percent in compliance, compared to 103 percent for all other banks.

The big banks, led by JP Morgan, are gearing up to fight these proposals, especially the liquidity ratio, reported Donna Borak in the American Banker.

The largest U.S. banks are quietly preparing to push back against proposed Basel III liquidity requirements that they argue could wreak havoc in the market by artificially deflating the value of certain assets….

“It’s an issue in the industry and the CFOs and the treasurers of the major U.S. banks are working together on a summary and approach that we can provide to regulators in the government,” said Joe Bonocore, corporate treasurer of JPMorgan Chase, in an interview with American Banker.

The liquidity coverage ratio as currently proposed by the Basel regulators gives banks no credit for its consumer deposits, triple-A-rated asset-backed securities, Federal Home Loan Bank advances or gold, Borak reported. Regulators believe these instruments would flee or lose value in a crisis. Banks get credit only for their long-term U.S. Treasuries.

 Basel regulators discussed ways banks might implement the two ratios in their June 1 report, and they said they might be willing to change their proposals:

Banks that are below the 100 percent required minimum thresholds can meet these standards by, for example, lengthening the term of their funding or restructuring business models which are most vulnerable to liquidity risk in periods of stress. It should be noted that the shortfalls in the liquidity coverage ratio and the net stable funding ratio are not additive, as decreasing the shortfall in one standard may also result in a decrease in the shortfall in the other standard.

Mr Nout Wellink, Chairman of the Basel Committee on Banking Supervision, noted that “the Basel III capital and liquidity standards will gradually raise the level of high-quality capital in the banking system, increase liquidity buffers and reduce unstable funding structures. The transition period provides banks with ample time to move to the new standards in a manner consistent with a sound economic recovery, while raising the safeguards in the system against economic or financial shocks”. He added that in the case of the liquidity standards, “we will use the observation period for the liquidity ratios to ensure that we have their design and calibration right and that there are no unintended consequences, at either the banking sector or the broader system level”.

 The problem with both of these ratios is that they may strengthen individual firms but they do little to strengthen the system as a whole, the International Monetary Fund has noted.

Still, experts who believe the solution to financial crises is for Basel to require banks to have more equity and hold more stable assets and liabilities are counting heavily on these two new ratio requirements.