The Federal Reserve Board on Friday finalized a rule to include certain U.S. general obligation state and municipal securities in the range of assets large banking organizations may use to satisfy regulatory requirements designed to ensure that these banking organizations have the capacity to meet their liquidity needs during a period of financial stress.
The recent financial crisis highlighted the need for enhanced liquidity risk-management at the largest financial institutions, including having sufficient liquidity reserves to mitigate the risk of creditor and counterparty runs. The liquidity coverage ratio (LCR) requirement adopted by the federal banking agencies in September 2014 requires large banking organizations to hold a minimum amount of high-quality liquid assets (HQLA) that can be readily converted into cash during a 30-day period of financial stress.
While the LCR requirement did not initially include U.S. municipal securities as HQLA, subsequent analysis by the Federal Reserve suggested that certain U.S. municipal securities should qualify as HQLA because they have liquidity characteristics similar to other HQLA classes, such as corporate debt securities.
The final rule allows investment-grade, U.S. general obligation state and municipal securities to be counted as HQLA up to certain levels if they meet the same liquidity criteria that currently apply to corporate debt securities. The limits on the amount of a state’s or municipality’s securities that could qualify are based on the liquidity characteristics of the securities.
The final rule applies only to institutions supervised by the Federal Reserve and subject to the LCR requirement:
- bank holding companies, certain savings and loan holding companies, and state member banks with $250 billion or more in total consolidated assets or $10 billion or more in on-balance sheet foreign exposure;
- state member banks with $10 billion or more in total consolidated assets that are subsidiaries of the above entities;
- nonbank financial companies designated by the Financial Stability Oversight Council for Board supervision, to which the Board has applied the LCR requirement by separate rule or order; and
- bank holding companies and certain savings and loan holding companies with $50 billion or more in total consolidated assets, to which a less stringent LCR applies.
Community banks are not subject to the LCR requirement.
While generally similar to the proposal, in response to comments, the final rule does not include the restriction on insured municipal securities and the limit on the amount of a municipal securities issuance that may count as HQLA.
The final rule will be effective on July 1, 2016.
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