By watering down liquidity requirements, Basel III remains a bank’s best friend

Mervyn King has lauded the amendments to Basel III liquidity requirements as a “very significant achievement”. AAP

The Group of Governors and Heads of Supervision (GHOS), the oversight body of the Basel Committee on Banking Supervision (BCBS), met earlier this month to consider the Committee’s amendmentsto the rules governing the liquidity coverage ratio (LCR).

As expected, the recommendations were endorsed unanimously. The agreement was hailed as a “clear commitment to ensure that banks hold sufficient liquid assets"—the objective being to make them less vulnerable to unexpected mass withdrawals. Mervyn King, the present chairman of the GHOS and outgoing Governor of the Bank of England, described the agreement as a "very significant achievement”, pointing out that “for the first time in regulatory history, we have a truly global minimum standard for bank liquidity”. This is rather ludicrous: for the first 20 years of its life, the Basel Committee could not care less about liquidity. It took the global financial crisis to convince the BCBS that liquidity does matter.

The objective of these new rules is to “promote short-term resilience of a bank’s liquidity risk profile” by enhancing the LCR, announced initially in 2010 as an integral component of the Basel III accord. According to the new rules, the LCR, which should be greater than or equal to 100%, is defined as the ratio of high quality liquid assets to total net cash outflows over the next 30 calendar days. Eligible assets are cash, central bank reserves, certain marketable securities backed by sovereigns and central banks, certain government securities, covered bonds, corporate debt securities, lower rated corporate bonds, residential mortgage-backed securities, and equities that meet certain conditions. In other words, any asset is a liquid asset, and no one knows what the word “certain” means.

When the agreement was announced, bank shares rallied, which was strange given that this was supposed to be a piece of restrictive regulation. What the Basel Committee did not tell us is that the announcement was a triumph for banks for two reasons. The first is that the original plan was to meet the LCR regulation by 2015 — the deadline has now been extended to 2019. The second is that the rules are much more flexible than the original version, in the sense of being more relaxed on what is considered to be a liquid asset (hence the long list of “liquid” assets). The new rules do not constitute an enhancement, but rather a downgrading of the LCR — a downgrading that has materialised as a result of intense lobbying by bankers. It is rather bewildering that they still receive preferential treatment from regulators at the expense of the rest of the society.

It is not obvious in what sense this agreement is a “significant achievement” for regulators, given that it is the outcome of the BCBS backing down under pressure from bankers. The denominator of the LCR — net cash outflow over the next 30 days — will be estimated by using internal models, which would give banks significant leeway in determining the ratio as they wish. Furthermore, most of the “liquid” assets are not that liquid. With quantitative easing running the current pace, even US Treasuries cannot be relied on as a liquid asset, as many observers predict mass selling as a result of quantitative easing.

Bill Gross of PIMCO, the biggest player in the bond market, declared that he will not buy US Treasuries until quantitative easing (which he describes as a Ponzi scheme) comes to an end. On 12 December 2012, Bernanke announced that he will run quantitative easing at the rate of $85 billion a month until the unemployment rate goes below 6.5%, which is unlikely to happen in Bernanke’s lifetime.

The new rules are no more than a tweaking around the edges of the faulty Basel accords. Introducing a brand new LCR will not solve the fundamental problems of Basel III. It remains backward-looking, a pure exercise in compliance, and a predominantly capital-based regulation that deprives medium and small enterprises from loanable funds. However, the rules will undoubtedly help finance the massive US budget deficit at a time when international confidence in US Treasuries is dwindling.

Mervyn King and his colleagues have chosen to ignore the fact that banking regulation cannot be unified internationally. The same rules cannot be applicable to banks in the US, China, India, Saudi Arabia and the Congo. They cannot be applied uniformly even in Hungary and Russia. The Basel Committee is doing nothing apart from creating unnecessary and expensive regulatory burden and fatigue that will be paid for by bank customers. Long live Basel III, and in anticipation of Basel IV!