According to Fitch Ratings, the agreement by regulators to change the definitions and stress assumptions in the Liquidity Coverage Ratio (LCR), delay its full implementation and allow banks to use their liquidity buffer in times of stress sets a more realistic parameter for banks. The revisions are sensible in light of ongoing market and economic pressures and reflect a pragmatic approach to changing regulation.
The widening of the liquid asset criteria could help to provide some diversification to the liquidity portfolio, although this still has to include at least 60% of the highest quality and most liquid assets - cash, certain sovereign debt, and central bank reserves and securities. The new asset classes are limited to only 15% of the buffer.
Assets in the 15% bucket can include lower-rated corporate debt, equities and residential mortgage-backed securities. These asset classes are typically less liquid under distressed conditions. But in order to be included in the LCR, the specific assets must have a proven track record as a reliable source of liquidity during a period of significant liquidity stress and a large haircut will be applied. These changes will provide the banks with more flexibility and better reflect how liquidity pools are managed.
Fitch also states the wider range of liquid assets could help minimize any market distortions caused by more narrow regulatory definitions, as banks might swap certain assets with non-bank financial institutions to boost regulatory liquidity ratios.
The stress assumptions for the total net cash outflows over 30 days - the denominator in the LCR - have also been weakened. The changes appear to be a sensible recognition of the actual inflows and outflows experienced during times of stress. For example, undrawn liquidity lines for corporates and non-bank financials have been revised to 30% and 40%, respectively, from 100%. Allowing the LCR to be lower than the 100% minimum in periods of stress provides banks with additional flexibility to manage liquidity. It allows the liquid assets to be used as intended.
The impact of the implementation delay for banks' liquid assets is likely to be mixed, with market confidence and national regulator discretion important considerations. Some of the strongest banks may look to slightly reduce liquid assets while others will maintain buffers. Some banks will need to continue to strengthen liquidity profiles.
The implementation of the LCR has been delayed by four years to 2019. The minimum requirement starts at 60% in 2015, rising by 10% each year to 100% when fully enforced.