Earlier this month there was an interesting article in Bloomberg Briefs “Leveling High-Quality Liquid Assets Under Basel III Proves Difficult for Banks” by Cady North and Matthew Debrabant. It turns out calculating LCR isn’t that simple.
The basic Liquidity Coverage Ratio rules are straightforward enough: have enough HQLA to cover a 30-day outflow. But peel back a layer and there are lots of details that aren’t easy to manage. According to the Bloomberg article, some banks are having a difficult time tracking their collateral and reporting the results to their regulators. With LCR reporting eventually becoming daily for banks, the need to have universal agreement on which securities qualify for what bucket is critical (to say nothing of being able to actually track the paper). The banks aren’t all there yet.
From the article:
“…Banks are starting to find out that the analysis they’ve done on a certain security they hold may not match the analysis that another bank has done. This will undoubtedly create a red flag for regulators. In the U.S., the Federal Reserve is demanding that U.S. filers report (under FR2052a) using enough granularity that the regulators can recreate their LCR calculations and double check the banks’ work…”
“…it’s not enough to flag all securities that are backed by U.S. government-sponsored entities as level 2A assets. In the U.S., filers have to do some additional analysis to determine whether the asset is “liquid and readily marketable.” To be fully compliant, banks have to have a process in place to measure whether there’s more than two committed market makers in the secondary market, have a large number of non-market maker buyers and sellers and provide the relevant pricing and volume analysis…”
Determining if a security is “liquid and readily marketable” is not going to be easy. Requiring two committed market makers is an awkward test. What exactly does “committed” mean in this context? Who can vouch that there are many involved investors? Volume data is sketchy.
Eligibility rules vary across countries. Merging the data under those circumstances is going to be a nightmare.
“…For instance, in the U.S. only GSE-backed residential mortgage-backed securities, or RMBS, are allowed as HQLA, while in the European Union, private label RMBS are allowed in some cases. Because of these jurisdictional differences, when in doubt banks tend to rely on the interpretation methods they feel most comfortable with at the home country level…”
“…In the U.S., municipals are not HQLA-eligible, though regulators are reviewing this status. In the EU and other jurisdictions, they may be eligible depending on the origin and risk weight. Different interpretations on the eligibility and level of regional and local governments by banks will yield very different results…”
Once NSFR comes, the exercise will get even more complicated. To report all this data daily, there will have to be a lot of automation. Will the regulators be able to handle the crush of information? Will they be able to get into the weeds to figure out how securities are bucketed? Any when liquidity changes – as it always does in a stressed environment – what happens then?