Basel concession strengthens US opposition to NSFR

US regulatory agencies face an uphill struggle to finalise the net stable funding ratio (NSFR), despite a recent concession from the Basel Committee that would allow national authorities to soften the treatment of derivatives liabilities.

The Basel Committee announced in October that it was “considering whether any further revisions to the treatment of derivative[s] liabilities are warranted and, if so, will undertake a public consultation on any proposed changes”. In the meantime, it allowed national regulators to use their discretion to lower the proportion of derivatives liabilities against which a bank must hold stable funding from 20% to 5%.

This has done little to dampen the hostility of US banks to the whole concept. Alison Touhey, senior regulatory adviser at the American Bankers Association (ABA), says an easing of the add-on would be welcome, but ultimately, adjustments to the ratio are beside the point as the NSFR is superfluous and procedurally compromised, and should not be implemented at all. The US agencies consulted on a first draft implementation of the NSFR in May 2016.

“[The derivatives add-on] really speaks to the process through which the NSFR was created; that originally, at the Basel level, that 20% add-on didn’t go through their version of notice and comment – it was just attached to the final rule. And then the US carried that through to its own proposal,” she says.

“Now the Basel Committee has decided this wasn’t the proper calibration, so they are switching it to 5% – again, with no rhyme or reason; no discussion as to their analysis behind either the 20% or the 5%. That is concerning to us,” Touhey adds.

In a letter in mid-November addressed to Randal Quarles, the incoming vice-chair of supervision at the Federal Reserve, ABA chief executive Rob Nichols said the Federal Reserve can consider the task for which the NSFR was intended to have been completed already, thanks to the complex other standards and regulations banks have to follow. The Fed declined to comment for this article.

…the Basel Committee has decided this wasn’t the proper calibration, so they are switching it to 5% – again, with no rhyme or reason; no discussion… That is concerning to us

Alison Touhey, American Bankers Association

The ABA has support from former Basel Committee expert, Paul Kupiec, who is now at the American Enterprise Institute, a think-tank advocating deregulation. Kupiec, formerly a director at the Federal Deposit Insurance Corporation, chaired Basel’s Research Task Force, which was assigned with producing a report to study the effects of the NSFR. In testimony to the Senate banking committee last year, he said the process of producing the report was so flawed he refused to put his name to it.

“If a big bank gets into trouble, the only way to resolve it is to sell it to another big bank. And when they do that, they sell the deposit franchise and all the depositors are protected,” Kupiec tells Risk.net.

“Banks got into trouble [in the financial crisis] because money ran and they couldn’t fund themselves. So what do regulators do? They create rules that say, ‘well, you just have to be able to fund yourselves’. They stop the runny nose, but they are not curing the cold,” he adds.

Kupiec urges regulators to focus on the use of Prompt Corrective Action, a federal law requiring regulators to wind up a bank when its problems are still in the early, more manageable stages, when it still has a positive equity value. For the PCA process to work properly, regulators must have a clear view of the health of the bank’s balance sheet, including its funding profile. If a liquidity crisis is broader than one bank, it is a systemic issue for which the NSFR is not suited anyway, he says.

Wait-and-see approach

The NSFR is due for implementation worldwide on January 1, 2018, but no sources to whom Risk.net spoke believe this deadline will be met in the US, especially following the reopening of the ratio by the Basel Committee. The expectation is that a final US standard will be presented in the first half of 2018 at the earliest.

Michael Krimminger, a partner at Cleary Gottlieb and former general counsel at the FDIC, says Quarles has strongly indicated he will make revisions to the NSFR. He has a solid basis on which to do so – the US Treasury has recommended a review of the ratio.

“The timeline is still up in the air. Quarles is a prudent person and a lawyer by training, who takes things piece by piece. He’s going to carefully consider the issues and I expect it will be some time before they come out with the proposal. But I do think he will look to provide more leeway going forward for US financial institutions,” says Krimminger.

Randy Benjenk, a lawyer at Covington and Burling’s regulatory practice, says it is unclear whether Basel will reopen the NSFR before or after the implementation of a US final rule. He is sceptical as to how genuine the reappraisal of the rule by Basel will be, because some of the questions about it are fairly fundamental, rather than just a matter of calibration.

Not a good proxy

“Gross derivatives liabilities is not a very good proxy for a bank’s potential future funding needs for its derivatives portfolio,” he says.

Benjenk adds: “The question is: is the number the US agencies come out with – assuming they come out with one lower than 20% – low enough to smooth over feelings about the gross derivatives liabilities metric?”

The decision on the derivatives liabilities add-on could form a test case for the new administration’s willingness to move away from the Obama era practice of going beyond international standards, says Benjenk.

The US outcome may also depend on what other jurisdictions, especially the European Union, decide to do. The European Commission proposed its own implementation of the NSFR in November 2016, which is now under consideration at the European Parliament and Council. The proposal has already softened the treatment of derivatives, compared with the Basel standards, by allowing the netting of variation margin.

“If the EU came out with a number above 5% and the US agencies matched the EU, it would be harder to accuse the US agencies of gold-plating the international standard,” says Benjenk.