Basel III Liquidity Framework: Basel Committee Publishes Changes to the Liquidity Coverage Ratio

Sullivan & Cromwell LLP - January 15, 2013
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On January 7, 2013, the Basel Committee on Banking Supervision (the “Basel Committee”) published the full text (the “revised LCR standard”) of the revised Basel III Liquidity Coverage Ratio (the “LCR”), incorporating amendments that were endorsed on January 6, 2013 by the Group of Governors and Heads of Supervision (the “GHOS”), the oversight body of the Basel Committee.

Along with the Net Stable Funding Ratio (the “NSFR”) and certain related metrics (or “monitoring tools”) that aid supervisors in assessing the liquidity risk of a bank, the LCR is a key component of the Basel III liquidity framework. The Basel III liquidity framework was initially proposed by the Basel Committee in December 2009, supplemented by amendments released in July 2010 and published in December 2010 (the “2010 liquidity framework”). The LCR is defined under the Basel III liquidity framework as the ratio of the “stock of high-quality liquid assets” to “total net cash outflows over the next 30 calendar days”.

The revised LCR standard makes several noteworthy amendments to the LCR as set forth in the 2010 liquidity framework, including: 

  • The outflow assumptions for several sources of funding have been reduced. For example, the outflow assumption on (i) certain stable retail deposits is reduced from 5% to 3%, (ii) non-operational deposits provided by non-financial corporates, sovereigns, central banks and public sector entities (“PSEs”) is reduced from 75% to 40% and (iii) committed but unfunded liquidity facilities to non-financial corporates, sovereigns, central banks and PSEs is reduced from 100% to 30%. 
  • Several outflow assumptions relating to the treatment of collateral have been introduced. For example, the revised LCR standard assigns a 100% outflow assumption to non-segregated collateral that could contractually be recalled by a counterparty because the collateral is in excess of the counterparty’s current collateral requirements.
  • The operational requirements for high-quality liquid assets have been amended and generally made more robust. For example, the revised LCR standard introduces an express requirement that the stock of high-quality liquid assets be well diversified within asset classes, with certain limited exceptions.
  • There is an increased reliance on external credit ratings that, to the extent the Basel III liquidity framework is implemented in the United States, could not be included in the U.S. federal banking agencies’ regulations because of the requirements of Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). 
  • The LCR will be introduced as a minimum standard as planned on January 1, 2015. However, the LCR will begin at 60% (rather than 100% as initially contemplated) and be phased-in over the next four years in 10% increments, reaching 100% on January 1, 2019.

The revised LCR standard also reaffirms that a bank may use its stock of high-quality liquid assets in times of stress and provides guidance on this use.

Although the LCR amendments have been described as a “weakening” of liquidity requirements, in many respects the revisions appear to track more closely empirical data and in some cases the requirements have been strengthened.

The amendments reflected in the revised LCR standard do not substantively amend the monitoring tools set forth in the Basel III liquidity framework published in December 2010, and do not address the NSFR at all. The press release announcing the GHOS’s endorsement of the amendments to the LCR noted that the Basel Committee will “press ahead” with its review of the NSFR over the next two years.

The Board of Governors of the Federal Reserve System has indicated it is considering, along with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation (collectively, the “federal banking agencies”), rulemakings that would implement the Basel III liquidity framework in the United States. The federal banking agencies have not yet addressed which U.S. banking organizations will be subject to the Basel III liquidity framework.