Criticism of Basel III liquidity ratios continues

The liquidity coverage ratio and net stable funding ratio in Basel III have been highlighted as among the most challenging aspects of the new capital and liquidity framework. Supervisors have promised to make alterations if necessary during the calibration process – but where is change most needed? By Michael Watt

The inclusion of new liquidity ratios within Basel III has been the cause of some of the fiercest criticism of the new capital and liquidity framework, ever since the first draft was published in December 2009. A couple of tweaks to the proposals over the past year or so have failed to calm feeling – to the extent that at least one regulator has called on European law-makers to write their own version of the rules. Other market participants have argued that the liquidity ratios should be excluded altogether from the scope of the capital requirements directive, Europe’s take on Basel III.

“The liquidity proposals set out by the Basel Committee on Banking Supervision are extremely conservative, and their impact on European banks and the wider economy has not been fully tested,” says Wilfried Wilms, Brussels-based senior adviser on banking supervision at the European Banking Federation (EBF), an industry group that represents the interests of 31 European banking associations. The EBF is one of those that have called for the liquidity ratios to be taken out of the European legislative version of Basel III. “We are not challenging the need for liquidity buffers – we have been pushing for more effort to be made in this area for a number of years. We just want to see it done properly,” adds Wilms.

The liquidity measures are split into two: the liquidity coverage ratio (LCR) and net stable funding ratio (NSFR). The former is designed to ensure banks have enough high-quality, liquid assets to survive a 30-day period of acute stress, while the NSFR is meant to eliminate funding mismatches by establishing a minimum acceptable amount of stable funding based on the liquidity characteristics of a firm’s assets and activities over a one-year horizon. This latter ratio is some distance away from being ready for implementation, some market participants claim.

“We need to recognise the NSFR still has a long way to go in terms of development. There are many impacts that haven’t been mapped out yet. At the moment, the NSFR is still very far from its final version,” says one senior European regulator.

The Basel Committee has acknowledged further calibration and fine-tuning is likely. Implementation of the NSFR is scheduled for January 2018, with final revisions to be made by 2016. Until that point, the Basel Committee will observe the impact of the ratio and make changes if necessary. The first Basel III monitoring exercise began at the end of April, and will cover data from the end of 2010.

Despite this, many bankers remain concerned about some of the knock-on effects from the ratio. The NSFR is defined as the available amount of stable funding divided by the required amount of stable funding. A minimum of 100% is obligatory under the rules.

The amount of required stable funding (RSF) is measured using supervisory assumptions on the broad characteristics of the liquidity risk profiles of a firm’s assets and off-balance-sheet exposures. A certain RSF factor is assigned to each asset type, with those assets deemed to be more liquid receiving a lower RSF factor and therefore requiring less stable funding. Under the current calibration, cash attracts a 0% RSF factor, while unencumbered loans to retail customers and small businesses with less than a year to maturity, attract an RSF factor of 85%.

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Criticism of Basel III liquidity ratios continues