The recent report from the Basel Committee on Banking Supervision, published by the Bank for International Settlements (BIS) in August, which monitors the implementation of Basel III standards among the twenty-seven Basel Committee member jurisdictions reports notable progress in the implementation of its two central elements, the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR).
Conceived as a response to the global financial crisis, which highlighted the inaccurate and ineffective management of liquidity risk, Basel III’s framework for liquidity risk measurement, standards and monitoring (the liquidity portion of Basel III) is designed to improve the banking sector’s ability to absorb shocks arising from financial and economic stress, and thus improve financial stability, by complementing capital requirements with two minimum standards for funding liquidity – LCR and NSFR.
LCR has been implemented in all 27 member jurisdictions. It promotes short term resilience of a bank’s liquidity risk profile and requires banks to hold sufficient high quality liquid assets (which can be quickly converted into cash) to cover total net cash outflows over a 30 day period, assuming a certain stress scenario.
NSFR, which is designed to promote long-term resilience by encouraging banks to seek stable sources of financing, is defined as the amount of available stable funding relative to the amount of required stable funding, and requires a minimum ratio of 100% over a period of one year. The NSFR framework is scheduled to be transposed into national law by all member jurisdictions by January 2018. The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation invited the public to submit comments on the proposed rule through August 5, 2016.
Several valid points were made. Although the introduction of liquidity requirements will give national supervisory authorities additional tools to improve liquidity risk management, the IMF has reported that the banking industry is concerned that the rule is “structural in nature and could be potentially intrusive to the role of traditional banking in liquidity/maturity transformation; could impair banks’ ability to support financial intermediation and harm investment activity and economic growth.” Another reason for concern is that a shortage of stable funding sources (the NSFR gap) could lead to reductions of long-term financing or require banks to decrease the maturity of their loans to less than one year, with consequences for financial stability.
Despite some criticism, the Basel Committee report projects further additional transposition milestones:
- margin requirements for non-centrally cleared derivatives (by September 2016)
- the revised Pillar 3 framework (by end-2016)
- the standardized approach for measuring counterparty credit risk (by January 2017)
- capital requirements for CCP exposures (by January 2017)
- capital requirements for equity investments in funds (by January 2017).