Basel Committee Finalizes Long-Term Liquidity Rule

WASHINGTON — Global regulators released a final uniform standard Friday meant to ensure large banks have enough stable liquidity to fund their portfolios over a one-year horizon.

The Basel Committee's net stable funding ratio is the second in a pair of international standards intended to avoid the liquidity nightmares of the 2008 financial crisis. Last year, the panel issued a rule — already implemented by U.S. regulators — governing how banks prepare to cover sudden outflows in a short-term crisis. But the NSFR is aimed at strengthening a bank's liquidity over a longer period, and discouraging institutions from leaning too heavily on funding instruments that can disappear in a panic.

"A key lesson from the crisis has been the need to prevent overreliance on short-term, volatile sources of funding," Stefan Ingves, governor of Sweden's central bank and Basel Committee chairman, said in a press release. "The NSFR does this by limiting the use of volatile short-term borrowings to fund illiquid assets."

The committee made limited changes from its January proposal — mostly related to derivatives and loans made between financial institutions — but the final standard was kept largely the same. Leading up to the rule's issuance, many in the industry had worried the new ratio could limit the earnings potential of "maturity transformation" — which broadly means borrowing short while lending long. There is still time for bankers to plead their case, as the international standard now goes to each home country regulator for implementation. (The committee said the NSFR rule will be a minimum standard by 2018.)

"If the NSFR is not calibrated properly, the rule could impact liquidity in a way that would reduce the ability to manage risk, increase volatility, and reduce returns for investors," Kenneth Bentsen Jr., chief executive of both the Securities Industry and Financial Markets Association and the Global Financial Markets Association, said in a statement. "We look forward to reviewing today's final rule in greater detail and understanding its impact on GFMA's member firms and the global economy‎."

The new ratio requires each institution to keep enough durable liquidity that is equal to or greater than the funding needs of the bank's particular lineup of assets for one year. The numerator is made up all of the bank's funding instruments, but each type of liquidity is assigned a weight according to its stability. For example, regulatory capital and liabilities with maturities over a year get a 100% weight, compared to a 50% weight for shorter-term corporate borrowings. Deferred tax liabilities would be an example of an instrument getting a 0% weight.

The denominator includes assets that are also weighted, this time according to how much funding support they require. Central bank reserves, for example, have little or no funding demands and therefore get a 0% weight. At the other end of the spectrum, assets that are "encumbered" for a year or more, non-performing loans and items deducted from regulatory capital would have to be fully funded at 100%.

"A sustainable funding structure is intended to reduce the likelihood that disruptions to a bank's regular sources of funding will erode its liquidity position in a way that would increase the risk of its failure and potentially lead to broader systemic stress," the rule said.

The NSFR had originally been introduced along with the committee's other liquidity standard — the liquidity coverage ratio — as part of a broad package of reforms issued in 2010. But as with the LCR — which requires banks to keep reliably liquid assets on hand to cover outflows during a turbulent 30-day period — international regulators continued to discuss changes to the longer-term funding ratio before the final issuance.

The committee said the final NSFR standard "retains the structure" of the proposal released in January. However, the rule contained certain changes. For example, the final rule sought to provide added granularity on the treatment of derivatives-based exposures. Under the final standard, an institution faces what is effectively a 20% charge depending on the size of its derivatives book. Regulators also established an 85% funding weight for assets posted as collateral in a derivatives transaction.

The new rule also adjusted the calculation for the funding required for short-term loans between financial institutions. Under the proposal, such loans to banks required zero funding in the denominator, but such loans to nonbanks required 50% funding. In the final rule, the weight was set at 15% for both.

While Ingves said issuance of the NSFR means "the committee has essentially completed its regulatory reform agenda," there is still much work to do on the domestic front. The U.S. banking agencies will now consider a version of the NSFR, which is notable because they have opted to be more stringent than the international standard on more than one occasion, including in their drafting of an LCR rule.

Meanwhile, the Federal Reserve Board has signaled it is working on other liquidity-related reforms, including steps to incorporate the risks from short-term wholesale funding in the calculation of capital surcharges for the largest banks.