Regulators Dial Back Final Liquidity Rule

WASHINGTON — Regulators were set Wednesday to consider a final liquidity rule for large banks that makes a number of concessions to the industry.

The rule implementing a new "liquidity coverage ratio" would not extend the regulation to systemically important nonbanks, provide a transition period for companies subject to the rule and open the door to certain assets being added to the list of balance sheet items banks can use to cover cash outflows.

The Federal Reserve Board was scheduled to consider the rule at a morning meeting, followed by a board meeting of the Federal Deposit Insurance Corp. in the afternoon. The Office of the Comptroller of the Currency is also set to consider it.

The industry, however, did not win a key change it had sought from the draft proposal issued last year — the inclusion of municipal securities among so-called "high-quality liquid assets" banks must hold as a liquidity buffer. Still, a memo distributed to Fed board members before the central bank's meeting recommended the development of a future proposal to add municipal securities to the list.

"Staff has been working on ideas to develop some criteria for determining which such bonds fall into this category and thus might be considered for inclusion as HQLA. That work has not yet been completed, and it is important to get this final rule adopted now, so that the largest banks can begin to prepare for its implementation on January 1," Fed Gov. Daniel Tarullo said in a statement prepared for Wednesday's meeting. "However, I anticipate that staff will be coming back to us with a report on efforts to develop a proposal along these lines."

The liquidity rule is U.S. regulators' version of a Basel Committee standard requiring a stronger liquidity safeguard, which large institutions lacked at the height of the 2008 crisis. Under the rule, large banks must maintain enough "HQLAs" to cover cash outflows over a 30-day period when economic conditions became stressed.

"As the financial crisis demonstrated, most of our largest and most systemically important financial institutions used excessive amounts of short-term wholesale funds and did not hold a sufficient amount of high-quality liquid assets to independently withstand the stressed market environment," Fed Chair Janet Yellen said in a prepared statement. "In the wake of the crisis, regulatory bodies from around the globe convened to develop the first internationally consistent quantitative liquidity standard for banking firms. The final rule under consideration today will complement the Federal Reserve's enhanced supervision and regulation of these firms' liquidity positions and thus further bolster financial stability."

The LCR is principally focused on banking companies with at least $250 billion in total assets or consolidated on-balance sheet foreign exposures of at least $10 billion. The rule would also impose a simpler — or "modified" — LCR standard on those that have at least $50 billion in assets but less than the higher asset threshold.

Under the final draft, which is expected to be approved, nonbank companies designated as "systemically important" by the Financial Stability Oversight Council would not be subject to the LCR rule, but officials signaled those companies could face separate requirements under a future policy.

"Liquidity standards would be applied to those institutions through rule or order, based among other things on an evaluation of the business model of each designated firm," Tarullo said.

While the agencies resisted calls to adopt the more generous 2019 implementation deadline for international companies under Basel, the U.S. regulators are recommending a transition period to allow companies more time to begin calculating their LCRs on a daily basis. During the phase-in, firms must calculate their LCRs at the end of each month starting on Jan. 1.

The biggest banks - those with at least $700 billion in total assets or $10 trillion in asset under custody - have until July 1, 2015 to be able to calculate daily LCRs. Firms below those asset thresholds but with at least $250 billion in total assets or $10 billion in foreign exposures have until July 1, 2016. Smaller firms subject to the "modified" LCR must only calculate their ratios at the end of each month, starting Jan. 1, 2016.

Meanwhile, the final rule would remove a requirement that corporate debt securities be publicly traded on a national exchange to get HQLA treatment. Such securities could get recognition if they are investment grade, issued by a nonfinancial entity and, according to the Fed's memo, have "a proven record as a reliable source of liquidity."

Moreover, a certain category of HQLAs that are publicly traded common equity shares — that under the proposal could be recognized if listed in the S&P 500 Index — were expanded in the final version to also include those listed in the Russell 1000 Index.

Still, the final version of the rule appears largely similar to the regulators' October proposal. HQLAs are divided into three categories. Assets considered the safest are in the "level 1" category — including cash and U.S. Treasuries — and can be used to fulfill the LCR requirement without limit. The second tier, known as "level 2A" assets, includes government-sponsored enterprise securities, but they have a 15% haircut in the calculation of the ratio. The third tier, "level 2B" assets, includes certain corporate debt and equity instruments. The third category is subject to a 50% haircut. A bank's level 2B assets can make up no more than 15% of its HQLAs, while the total of 2A and 2B assets is limited to 40%.