Basel’s Diluted Liquidity Rule Compounds Capital Failure

This weekend banks got a big win from Basel, easing liquidity requirements more than expected. Banks surged after screen shot 2013-01-07 at 4.33.27 amunexpected win over the weekend.

How memories fade. Five years ago the UK had witnessed the first run on a bank – Northern Rock – since 1866 while the panic that followed a year later when Lehman Brothers collapsed led to £65bn of taxpayer money being poured into Royal Bank of Scotland, Lloyds and HBOS.

Indeed in 2010 Lord Turner, chairman of the Financial Services Authority, was calling for “tighter capital and liquidity controls on all banks”.

Yet on Sunday night banks wrung a crucial concession from international banking regulators based in the Swiss city of Basel who gave them another four years to build up enough cash to survive a 30-day credit crunch. The banks could hardly contain their glee, describing the announcement from the Bank for International Settlements committee of banking supervisors as a “twelfth night present”. Little wonder that the impression is that the banks have once again outwitted their regulators.

The decision by the 27 bodies that make up the Basel committee to give banks a further four years to build up their liquidity buffers – and count more types of assets as “liquid” – comes after months of lobbying.

Four years on, the banks will now no longer need to meet new rules by 2015 but have instead been given the same 2019 deadline set by the Basel regulators for separate requirements to hold more capital.

The rules were devised with events such as the run on Northern Rock in mind; the bank ran out of ways to fund itself (although the problem was also due to capital levels). Global regulators will argue they are being pragmatic, and as outgoing governor of the Bank of England Sir Mervyn King put it on Sunday night, there are now rules for the first time on how much and what type of liquid instruments can be held.

The reality is that economies were not expected to be this fragile five years after the run on the Rock.

The Major 2 ideas behind additional special forms of capital requirements designed by the Basel Committee on Banking Supervision in Basel III. The first is a “Liquidity Coverage Ratio” (LCR), which is designed to make sure that a financial firm has sufficiently liquid resources to survive a crisis where financial liquidity has dried up for 30 days. The second is a “Net Stable Funding Ratio,” which is designed to complement the first rule and seeks to incentivize banks to use funds with more stable debts featuring long-term horizons.


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