Basel Committee's Walter dismisses reports of Liquidity Coverage Ratio (LCR) overhaul – Risk Magazine

The Basel Committee is working on criteria to decide what counts as a liquid asset, but secretary general says no decisions have yet been taken on how – or whether – to change the LCR.

Stefan Walter, secretary general of the Basel Committee on Banking Supervision, has hit out at reports suggesting the liquidity coverage ratio (LCR), one of two new liquidity ratios introduced by Basel III, is on the verge of major surgery. The measure has attracted criticism from regulators and market participants across the globe – and a Basel working group is developing a set of criteria that can be used to determine which assets are included – but Walter says the committee has no specific changes in mind.

“Recent media coverage has created the impression that there is a set of proposals waiting in the wings to weaken the standard, or change it to make it less onerous for banks. That just isn’t the case,” he says. “As we have made clear for a number of months, we are going through an observation period, which involves a quantitative impact study to review the ratio in a rigorous way. We are open to change if we find any aspect of the measure is penalising or destroying business models we think should be viable, but we’ll need to see new, analytical evidence to support this.”

Walter took the same line in remarks at Risk’s European conference at the start of April.

Recent media coverage has created the impression that there is a set of proposals waiting in the wings to weaken the standard, or change it to make it less onerous for banks. That just isn’t the case

The LCR is designed to ensure banks have enough liquid assets – primarily government bonds – to cover expected net outflows during a 30-day period of stress, and is due for implementation in 2015. That could be a challenge. According to a quantitative impact study released in December 2010 by the committee, internationally active banks had an average LCR of only 83%. In its half-year results, published on August 2, Barclays – one of the few banks to have publicly disclosed its current LCR – said the ratio had reached 86%, from 80% at the end of 2010.

The principal criticism of the LCR is that its list of eligible assets is too narrow. Initially, the Basel draft text said only cash, central bank reserves and highly rated government bonds would count as liquid – a standard that many jurisdictions, including Hong Kong, Australia, South Africa and Denmark, said their banks would struggle to meet because of a shortage of domestic bonds. Under the amended final rules, high-grade debt from non-government issuers plus bonds issued by less-creditworthy sovereigns can also make up a proportion of the LCR – but are subject to a haircut of 15%.

That has not satisfied the rule’s critics, who call for a further widening of the ratio’s scope – to include more mortgage and covered bonds or, in some cases, equity. The latter is an idea that Walter has already dismissed, although other regulators support the idea.

Despite these calls for more latitude, Walter refuses to be drawn on how far any changes could go: “I don’t want to prejudge the results of the observation period. Our main line in the sand is that there will be a liquidity standard that banks will have to meet, and we need to ensure that standard is rigorous in that it differentiates between sound and unsound liquidity funding profiles,” he says.
One working group within the committee will spend the observation period constructing a set of criteria to assess the liquidity of an asset, and therefore its suitability for inclusion in the LCR. Assets are expected to be judged using a number of factors, such as volatility or bid-offer spreads, but regulators are struggling with a lack of data.

There also seems to be a difference of opinion within the committee on exactly how the liquidity criteria will be used. Some sources have suggested they will be used as a periodic test, allowing assets into the LCR – or kicking them out – depending on whether they satisfy the criteria at a given point in time. A similar approach has already been suggested by Danish regulators, and attempts have been made to insert this plan into the European Union’s fourth capital requirements directive, through which the Basel III framework will be transposed into European law.
However, Walter says he is not keen on the idea of relying solely on a set of qualitative criteria to determine eligible assets, and prefers the clarity the combination of a list and criteria provides.

Michael Watt, Risk Magazine, Sept. 8, 2011

Read more: http://www.risk.net/risk-magazine/news/2107912/basel-committees-walter-dismisses-reports-lcr-overhaul

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