On October 24, the Board of Governors of the Federal Reserve System, in an expected move, issued tough new liquidity requirements generally applicable to banks with assets over $250 billion and somewhat diluted liquidity requirements for banks over $50 billion. Banks with assets of less than $50 billion are exempt from the proposed rule. The liquidity proposal is based on a standard agreed to by the Basel Committee on Banking Supervision. The rule would also establish, according to the Federal Reserve, “an enhanced prudential liquidity standard consistent with section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.”  

The proposal would create a standardized minimum liquidity requirement for large and internationally active banking organizations and systemically important, non-bank financial companies designated by the Financial Stability Oversight Council. These institutions would be required to hold minimum amounts of “high-quality, liquid assets” such as central bank reserves and government and corporate debt “that can be converted easily and quickly into cash.” Each institution would be required to hold liquidity in an amount equal to or greater than its projected cash outflows minus its projected cash inflows during a short-term stress period. The ratio of the firm’s liquid assets to its projected net cash outflow is its “liquidity coverage ratio” (LCR).  

The LCR would apply to all internationally active banking organizations—generally, those with $250 billion or more in total consolidated assets or $10 billion or more in on-balance sheet foreign exposure—and to systemically important, non-bank financial institutions. The proposal also would apply a less stringent, modified LCR to bank holding companies and savings and loan holding companies that are not internationally active, but have more than $50 billion in total assets. Bank holding companies and savings and loan holding companies with substantial insurance subsidiaries and non-bank, systemically important financial institutions with substantial insurance operations are not covered by the proposal.  

The proposal defines various categories of high quality, liquid assets (HQLA) and also specifies how a firm’s projected net cash outflows over the stress period would be calculated using common, standardized assumptions about the outflows and inflows associated with specific liabilities, assets and off-balance-sheet obligations.  

Somewhat controversial is the decision of the Federal Reserve to exclude certain assets from those considered to be HQLA by the Basel Committee on Banking Supervision, such as covered bonds, mortgage-backed private-label securities and municipals. The decision to exclude such assets was criticized by the American Bankers Association’s Wayne Abernathy, executive vice president for financial institutions policy and regulatory affairs, who, according to the American Banker, called the decision “disappointing.” The Federal Reserve took the position that the proposed rule is “generally consistent” with the Basel Committee’s LCR standard, but admitted in its press release that the rule “is more stringent in several other areas besides the definition of high quality liquid assets, including the assumed rate of outflows of certain kinds of funding.” In addition, the proposed transition period is shorter than that included in the Basel agreement. The accelerated transition period “reflects a desire to maintain the improved liquidity positions that [US] institutions have established since the financial crisis, in part as a result of supervisory oversight by the Federal Reserve and other [US] bank regulators.” Under the proposal, US firms would begin the LCR transition period on January 1, 2015, and would be required to be fully compliant by January 1, 2017.  

Vice-chair and presidential chair nominee Janet Yellen reportedly indicated that the rule was only a first step in regulating liquidity, and that additional measures such as the net stable funding ratio were in the pipeline. 

The Federal Reserve developed the proposed rule with the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency, both of which are expected to propose virtually identical rules in the near future. Comments will be received through January 31, 2014.  

More information is available here and here.