Not many recently promulgated regulations benefit banks, and even fewer both banks and their corporate customers. But a new standard by the Basel Committee on Banking Supervision does.
Over the weekend, the Basel Committee relaxed some proposed new rules on bank liquidity buffers, designed to keep financial institutions from melting down in a crisis.
The watering-down of the provisions not only is a win for global banks but also reduces the likelihood that banks’ appetites for underwriting commercial lines of credit would be curbed in the coming years. Specifically, the Basel Committee eased measures that would have made some kinds of credit lines more costly to hold on the balance sheet.
The so-called liquidity coverage ratio (LCR) forces banks to maintain a level of “high-quality, unencumbered assets” to meet cash outflows for a 30-day “stressed period” — essentially, a financial crisis that causes a run on banks.
The original stress-test model produced by the Basel Committee in December 2010 assumed that during a crisis, nonfinancial companies would draw down 100% of their untapped credit lines. So banks would have had to hold a higher amount of liquid assets — which generally earn much lower returns — for each dollar committed to corporate lines of credit.
But the revised rules assume only a 30% drawdown rate for the unused portion of liquidity facilities borrowed by nonfinancial corporates, sovereigns, and central banks, according to documents released by the Bank for International Settlements.
Only credit lines classified as “liquidity facilities” are affected. Basel defines a liquidity facility as any committed, undrawn “back-up facility that would be utilized to refinance the debt obligations of a [company] in situations where such a [company] is unable to rollover that debt in financial markets.” An example would be revolvers that backstop commercial-paper borrowing.
Revolvers or loan facilities used for general corporate purposes or working capital would be classified as credit facilities, against which banks will have to hold liquid assets of only 10%.
In another change, the Basel Committee expanded the kinds of assets eligible to be held against credit lines and other obligations. The revisions deem corporate bonds rated as low as BBB- and some corporate stocks “high quality liquid assets,” which could make them more attractive for banks’ treasury departments to hold. Previously, common equity was not included and corporate debt had to be rated AA or higher.
The committee also added residential mortgage-backed securities rated AA or higher to the liquid assets list.
Not all common equity and debt would qualify; for example, the Basel rules say the corporate debt or equity would have to “have a proven record as a reliable source of liquidity in the markets even during stressed market conditions.”
Banking lobbyists have been arguing that the original LCR rules would have given banks a limited number of assets to invest in and could have caused an overreliance on investments in sovereign debt.
The American Securitization Forum applauded the inclusion of some residential mortgage-backed securities in the liquid assets basket. “Without this expansion of the LCR, efforts to bring additional private capital back into the U.S. mortgage finance system would have continued to face limited demand from bank investment offices,” an ASF statement said.
The deadlines for international financial institutions to comply with the LCR were also pushed back, to January 1, 2019, from the original 2015. The committee also said it would phase in the LCR. By 2015 banks would have to hold a ratio of liquid assets to cash outflows of 60%. That level would increase 10 percentage points each of the subsequent four years.