Basel rule for bank liquidity significantly more flexible than expected

With a partial solution to the US fiscal cliff agreed and many people optimistic for a prosperous 2013, the loosening of proposed bank regulation is likely to be welcome news in the financial community. The solvency of banks has been a defining issue in the global economy since 2007. Efforts to achieve a balance between legislating to prevent another banking crisis, while encouraging a healthy profitable banking industry has provoked the fury of the bankers and the general public in equal measure.

The basic objective of the rules is to increase banks’ ability to meet cash demands in turbulent times by increasing the ratio of liquid assets they have to hold. However, concerns had been raised that in their previous form the rules would have put the tentative global recovery in jeopardy by causing a squeeze on credit provision.

This weekend in Basel, agreements have been watered down. The liquidity coverage ratio, known as LCR – which reflects the proportion of highly liquid assets a financial institution must hold to meet short-term obligations – will now be able to be met by additional assets such as equities and securitised mortgage debt. Moreover compliance with the new rules has been delayed by four years. A compromise this may be, but Mervyn King, Governor of the Bank of England, described the deal as ‘a truly global minimum standard for bank liquidity’.

Ironically, banks currently hold more than the new minimum requirements, which perhaps demonstrates that while it may be welcome news that an agreement has been made, the solution to bank security is more complex than the basic notion of increasing asset ratios.