The Basel Debate: Regulators Allow Increased Risk to Maintain Growth

The Basel Committee announced on Sunday that it plans to defang a rule that requires banks to maintain easy-to-sell assets. They committee also extended the compliance date to 2015, at which time banks will only be required to meet 60% of the required liquidity.

The liquidity coverage ratio (LCR) has been the persistent target of the banking lobby for months. The watered down requirements, which allow banks to count a wider array of riskier assets toward a required liquidity buffer, demonstrate a major victory for the banking lobby.

“The rule in its original shape,” reports the WSJ, “would have forced banks to hold enough liquid assets to cover all their expected outflows over a 30-day period in 2015. That deadline is now put back to Jan. 1, 2019, and banks will only have to show a ratio of 60% in 2015. Importantly, banks will now be able to use certain equities, corporate debt and residential-mortgage-backed securities to cover up to 15% of their LCR.”

Although the new rule will phase in over a four year period, Basel Committee members are celebrating the announcement as a high-water mark for the prevailing regulatory regime:

“For the first time in regulatory history, we have a truly global minimum standard for bank liquidity,” said Basel oversight committee chairman Mervyn King.

Basel Decision and the Economy

Although some, like the WSJ, are hailing the decision as a boon to a slow-moving economy, others, like Brooke Masters of the Financial Times, note the considerable ironies of the Basel Committee decision:

“The draft rule, for example, said banks could hold only sovereign debt, top-quality corporate bonds and cash in their liquidity buffers because those were the only truly safe assets. The eurozone crisis undermined part of that argument. Persistent warnings from bankers and traders that there simply weren’t enough ‘safe’ assets to go around did the rest.”

In other words, a hypothetical liquidity crisis is being used to excuse banks from complying with the originally sought after LCR requirement. Riskier assets are now being allowed because otherwise sufficient liquidity may not exist.

“Persistent warnings from bankers and traders that there simply weren’t enough ‘safe’ assets to go around did the rest,” said the Financial Times.

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