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Wisdom of new Basel III liquidity rules put under the microscope

Last updated: Wednesday, January 09, 2013 9:25 AM


Mushtak Parker

Saudi Gazette



LONDON – How times change! Six years into the most pernicious global financial crisis since the Great Depression in the 1930’s, with the industrialized world still reeling from a credit crunch, a sovereign debt crisis and the real fear not of a double-dip but a triple dip recession, the global banking majors, largely acknowledged as the precipitators of the financial crisis, have been rewarded with a New Year’s bonus by the Basle Committee on Banking Supervision, the very organization that is supposed to regulate international banking.


The recent announcement by the Group of Governors and Heads of Supervision (GGHS) of the world’s top banking regulators chaired by Sir Mervyn King – the Governor of the Bank of England – of the “Basel III: The Liquidity Coverage Ratio (LCR) and Liquidity Risk Monitoring Tools” report once again underlines the difficulty and complexity of regulating banks and reining in the excesses of bankers, and the seeming ineffectiveness of the whole Basle banking supervision process.


The LCR standard is one of the Basel Committee’s key reforms to develop a more resilient banking sector and its main objective is to promote the short-term resilience of the liquidity risk profile of banks. It does this, according to the above report, “by ensuring that banks have an adequate stock of unencumbered high-quality liquid assets (HQLA) that can be converted easily and immediately in private markets into cash to meet their liquidity needs for a 30 calendar day liquidity stress scenario.


”The components of HQLA are predictable because they are too watered-down; disappointing because they don’t go far enough; and in at least one respect, surprising, in that they include the Alternative Liquid Asset (ALA) framework which in turn include the “development of alternative treatments, and include a fourth option for Shariah-compliant (Islamic) banks.”


Shariah-compliant banks, according to the LCR document, face a religious prohibition on holding certain types of assets, such as interest-bearing debt securities. Even in jurisdictions that have a sufficient supply of HQLA, an insurmountable impediment to the ability of Shariah-compliant banks to meet the LCR requirement may still exist. In such cases, advises the Basle Committee, “national supervisors in jurisdictions in which Shariah-compliant banks operate have the discretion to define Shariah-compliant financial products (such as sukuk) as alternative HQLA applicable to such banks only, subject to such conditions or haircuts that the supervisors may require.


”However, the Basle Committee warns that the intention of this treatment is not to allow Shariah-compliant banks to hold fewer HQLA. The minimum LCR standard, calculated based on alternative HQLA (post-haircut) recognized as HQLA for these banks, should not be lower than the minimum LCR standard applicable to other banks in the jurisdiction concerned. National supervisors applying such treatment for Shariah-compliant banks, however, should comply with supervisory monitoring, disclosure obligations and periodic self-assessment of eligibility for alternative treatment provisions as for all banks.


This is one of those rare occasions that the Basle Committee has indeed included liquidity treatment and requirements for Islamic banks in a global public document, perhaps indicating the gradual acceptance and importance of Islamic finance in the global financial system. The GGHS includes central banks and monetary authorities from only three Muslim countries – Saudi Arabia, Turkey and Indonesia.The LCR standard is aimed at improving the banking sector’s ability to absorb shocks arising from financial and economic stress, whatever the source, thus reducing the risk of spillover from the financial sector to the real economy. The Basle Committee has already come up with new capital requirements for banks and the LCR Standard is the latest in a series of reforms that will eventually comprise the Basle III accord.


This latest document sets out the LCR standard and timelines for its implementation. The LCR has two components: (a) the value of the stock of HQLA; and (b) total net cash outflows.What has given banks a welcome winter cheer is that the rules of the LCR standard have been relaxed and the timeline for implementation and adoption extended. Under the relaxed CR standard, the components of HQLA are extended to include both Level 1 and Level 2 assets. Level 1 assets generally include cash, central bank reserves, and certain marketable securities backed by sovereigns and central banks, among others.


These assets are typically of the highest quality and the most liquid, and according to the LCR document, there is no limit on the extent to which a bank can hold these assets to meet the LCR. Level 2 assets, which are two-tiered and which are subject to rating requirements, however, have raised some eyebrows. They include Level 2A assets, which include certain government securities, covered bonds, corporate debt securities rated A+ (plus) to BBB- (minus), and Level 2B assets, which include lower rated corporate bonds, AA or higher rated residential mortgage backed securities and equities that meet certain conditions, albeit they are subject to higher haircuts and a limit. Governor King said for the first time in regulatory history, “we have a truly global minimum standard for bank liquidity,” confirming that the whole point of the exercise is to require banks to build up liquidity buffers of easily sellable assets so as to prevent them from using central banks as a “lender of first resort” during financial stress. In other words, central banks are planning ahead to find alternatives to taxpayer funded bank bailouts and quantitative easing – which have proven to be controversial and unpopular with voters, but a godsend to bankers.

The GGHS, of which Saudi Arabian Monetary Agency (SAMA) Governor, Dr Fahad Al-Mubarak, is a member, is not the unified body as it may feign to be.

There is disquiet on several fronts, especially on the parallel reform of capital buffers banks will be required to hold to enable them to cope with losses in the case of financial stress and crisis without forcing them into bankruptcy. The Basle Committee has proposed a minimum capital buffer of 3 percent of a bank’s total assets to be implemented by 2019, which some regulators deem insufficient.

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