In the wake of the financial crisis of 2007/8, the international banking regulatory body, the Basel Committee on Banking Supervision, sought to ensure that the global banking system would be much safer in future. This would require that banks had (a) sufficient capital; (b) sufficient liquidity to meet the demands of customers.
The Basel III rules set new requirements for capital adequacy ratios, to be phased in by 2019. But what about liquidity ratios? The initial proposals of the Basel Committee were that banks should have sufficient liquid assets to be able to withstand for at least 30 days an intense liquidity crisis (such as that which led to the run on Northern Rock in 2007). Liquid assets were defined as cash, reserves in the central bank and government bonds. This new ‘liquidity coverage ratio’ would begin in 2015.
These proposals, however, have met with considerable resistance from bankers, who claim that higher liquidity requirements will reduce their ability to lend and reduce the money multiplier. This would make it more difficult for countries to pull out of recession.
In response, the Basel Committee has published a revised set of liquidity requirements. The new liquidity coverage ratio, instead of being introduced in full in 2015, will be phased in over four years from 2015 to 2019. Also the definition of liquid assets has been significantly expanded to include highly rated equities, company bonds and mortgage-backed securities.
This loosening of the liquidity requirements has been well received by banks. But, as some of the commentators point out in the articles, it is some of these assets that proved to be wholly illiquid in 2007/8!
Banks Win 4-Year Delay as Basel Liquidity Rule Loosened BloombergJim Brunsden, Giles Broom & Ben Moshinsky (7/1/13)
Banks win victory over new Basel liquidity rules Independent, Ben Chu (7/1/13)
Banks win concessions and time on liquidity rules The Guardian, Dan Milmo (7/1/13)
Basel liquidity agreement boosts bank shares BBC News (7/1/13)
Banks agree minimum liquidity rules BBC News, Robert Peston (67/1/13)
Group of Governors and Heads of Supervision endorses revised liquidity standard for banks BIS Press Release (6/1/13)
Summary description of the LCR BIS (6/1/13)
Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools BIS (6/1/13)
Introductory remarks from GHOS Chairman Mervyn King and the Basel Committee on Banking Supervision’s Chairman Stefan Ingves (Transcript) BIS (6/1/13)
- What is meant by ‘liquid assets’?
- How does the liquidity of assets depend on the state of the economy?
- What is the relationship between the liquidity ratio and the money multiplier?
- Does the size of the money multiplier depend solely on the liquidity ratio that banks are required to hold?
- Distinguish between capital adequacy and liquidity.
- What has been the effect of quantitative easing on banks’ liquidity ratios?