Liquidity in focus as policymakers proceed with bank rules overhaul

Liquidity regulations are a likely next target as policymakers move forward with a sweeping revamp of rules after the bank failures this year.

Regulators have said they are thinking about modifying and expanding key standards that currently apply to the biggest and most complex banks.

One, the liquidity coverage ratio (LCR), implemented after the Great Financial Crisis, appears to have helped increase reservoirs of liquid assets at big banks that can be used to fulfill panicked outflows of funding under hypothetical bouts of stress. Ratios at a group of big banks ranged from 108.7% to 144.3% as of the second quarter, higher than the 100% minimum, according to data from S&P Global Market Intelligence.

Still, regulators have acknowledged the stunning speed and extent of the deposit runs that sank Silicon Valley Bank, Signature Bank and First Republic Bank, and problems with selling bonds that have lost value because of interest rate increases to meet withdrawals.

Liquidity coverage ratio

The liquidity coverage ratio is designed to estimate net funding outflows during a 30-day period of stress and ensure that banks have enough high-quality liquid assets (HQLA) to cover them.

Outflows are determined according to different assumptions for different liabilities, with larger outflows assumed for uninsured deposits than for insured deposits. Within uninsured deposits, larger outflows are assumed for wholesale than for retail deposits, with as much as a 100% outflow for non-operational deposits held by other financial institutions.

At JPMorgan Chase & Co., for instance, the most recent blended outflow assumption for stable retail deposits was $21.31 billion out of $710.35 billion and $242.43 billion out of $402.25 billion for non-operational wholesale funding.

HQLA includes cash and bonds, with haircuts for some bonds meant to reflect liquidity in different markets. At JPMorgan Chase, $440.29 billion of its $768.13 billion of HQLA in the second quarter was cash, and almost all the rest was securities including Treasurys that are not subject to a haircut.

Overall liquidity in the system is largely determined by cyclical forces, with HQLA surging early in the pandemic as the Federal Reserve bought bonds and boosted reserves, and as deposits ballooned and lending slumped.

Still, the representation of HQLA on large banks' balance sheets increased markedly in the decade preceding the pandemic, which studies have attributed in part to the liquidity rules. Capital rules also tend to favor liquid assets, since they have low risk weightings.

Net stable funding ratio

A second liquidity standard, the net stable funding ratio (NSFR), is designed to ensure that large banks have enough stable funding to support assets, commitments and derivatives over a one-year horizon.

"Required stable funding" is determined by applying weights to a bank's assets, commitments and derivatives reflecting factors such as when they mature. For instance, loans that typically have high weightings and reserves at the central bank get a 0% weighting. "Available stable funding" gives high weightings to things like capital and insured deposits, and must exceed the required amount.

Among a group of large banks, the NSFR ranged from 119.8% at Bank of America Corp. in the second quarter to 126.5% at Truist Financial Corp., according to data from S&P Global Market Intelligence.

Potential changes

"We should re-evaluate the stability of uninsured deposits and the treatment of held to maturity securities in our standardized liquidity rules and in a firm's internal liquidity stress tests," Vice Chair for Supervision Michael Barr said in the Fed's post-mortem on the Silicon Valley Bank failure. "We should also consider applying standardized liquidity requirements to a broader set of firms."

Some banks appear to be readying themselves for such an expansion. Fifth Third Bancorp, which is not currently subject to the LCR rule, said in September that it expects to be compliant with the version that applies to the global systemically important banks by the end of the month.