Banks Prepare For LCR Final Rule

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The Final Rule for the Liquidity Coverage Ratio (LCR) is will go into effect in just a couple of weeks, and while it won’t be fully phased-in for a couple of years, large banks have to start dealing with a rule that in many ways is stricter than the guidelines set out by Basel III.

“As with U.S. regulators’ implementation of other Basel Committee initiatives, the LCR Final Rule is in certain key respects more stringent than the international standard. For example, the LCR has a shorter phase-in period than the Basel equivalent, and certain asset classes are treated less favorably by the Final Rule than by the Basel standards,” writes the law firm Debevoise & Plimpton LLP in a client letter.

Which assets are allowed as HQLA

The LCR Final Rule requires large banks to hold high quality liquid assets (HQLA) at least equal to the next month’s total net cash outflows, but the question had been how each of those two things would be calculated. The Final Rule divides assets into three categories: Level 1, Level 2A, and Level 2B. Level 1 is mostly just Reserve Bank balances, Treasuries, and some other forms of sovereign debt, with other investment grade assets being divvied up between L2A and L2B (including some foreign sovereign debt that didn’t get included in L1; cash can’t be treated as HQLA at all unless it’s part of a Reserve Bank balance or specific foreign reserves). Only 40% of HQLA can be made up of L2A and L2B assets, and L2B can only make up 15% on its own.

Banks with more than $50 billion in assets that don’t qualify for the full LCR (less than $250 billion in assets; low foreign exposure) get a bit of relief because they only have to hold 70% as much HQLA as their larger peers relative to their cash outflows and only have to calculate HQLA once per month instead of at the end of every business day, and won’t get hit with the maturity mismatch add-on.

How the LCR Final Rule differs from Basel III

The Federal Reserve’s final LCR Final Rule is stricter than Basel III standards in two important ways. First, it’s going to come online faster than Basel III would require, with the largest banks starting to make daily HQLA calculations from next summer and everyone onboard by the beginning of 2017, instead of 2019 as Basel III requires.

Also, the Final Rule treats all corporate debt securities as L2B instead of splitting them between L2B and L2A, and it doesn’t include covered bonds, muni bonds, or private-label RMBS at all. The Fed says that munis may eventually be recognized in a future rule, but considering how quickly private label RMBS became illiquid during the crisis it makes sense that the Fed wouldn’t allow them.

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