DP1/22 – The prudential liquidity framework: Supporting liquid asset usability
The global financial crisis of 2007/2008 exposed a number of cases where banks did not hold an adequate quantity of sufficiently liquid assets. In response, the Liquidity Coverage Ratio (LCR) was introduced to promote the short-term resilience of the liquidity risk profile of banks. A net stable funding ratio (NSFR) was also introduced to ensure that banks maintain a stable funding profile over a longer horizon in relation to the composition of their assets and off-balance sheet activities.
The UK’s prudential framework is calibrated to ensure that banks have sufficient liquidity to continue their activities through severe stresses. But it is important that banks feel able to draw on their liquidity, as appropriate, to reduce the risk of contractionary or destabilising actions. Failure to do so could cause unnecessary adverse impacts on the wider economy and financial system, and perhaps damage banks themselves. So, while in normal times banks are expected to maintain LCRs of 100% or more, firms may draw down their HQLA, even if it may mean that LCRs decline below 100% in stress.
However, the Bank and the PRA have been concerned for a number of years that banks may be reluctant to draw on their HQLA in periods of unusual liquidity pressures, possibly to such an extent that it is limiting the benefits of the flexibility built into the framework. Evidence from the last few years has reinforced these concerns.
The full discussion paper is available at https://www.bankofengland.co.uk/prudential-regulation/publication/2022/march/prudential-liquidity-framework-supporting-liquid-asset-usability