The technical rewrite to the Basel III liquidity rules is getting a remarkable amount of public attention, very little of it flattering. The New York Times editorial board used its bully pulpit to rail against what it called a kow-tow to global banks, and most of the press has characterized the revisions as a watering-down. Is it? Many of the changes are, in fact, refinements that bring the liquidity estimates closer to the real crisis experience. Others, though, point to the continued impossibility of crafting a meaningful global rule for banks operating in wildly different financial markets. Basel is trying to keep its game face on, but the façade is cracking to the point of incredulity. And, if global regulators take up one more change – allowing banks to count access to central banks as a liquidity source – whatever credibility the global liquidity rules have will now crash into irreparable pieces that bring us back to the banking-by-border regulation Basel was meant to cure.
Trained as I am by my mother, I’ll first say something nice about Basel and, perhaps by inference about big banks. Critics of the revised liquidity rules have blasted it because new instruments count as “high-quality liquid assets” (HQLAs), usually citing the allowance for residential MBS as their bête-noir. However, a read of the turgid, technical provisions in the new rules shows how little the MBS liberalization counts in the real world – the criteria governing these securities are so tightly drawn that they bear no resemblance to the bad old MBS that featured so prominently in the crisis. I’m not sure if eligible MBS can even be originated in the U.S. or any other nation rebuilding its mortgage lending-and-securitization regime.
Another barb thrown at the Basel rules is aimed at new outflow calculations. These are the assumptions about funding-market conditions under stress on which Basel relies to set the HQLA ratios. However, a lot of hard work – some ours – has gone into calculating how certain funding sources fare under fire. One source – core insured deposits – did remarkably well in the 2008 debacle because – yes – they were insured by the FDIC and – thankfully – depositors still had some confidence in the U.S. Government as they feared for their banks. Basel has made the outflow assumptions looser for core deposits, but – unmentioned in the critiques – it limits this favorable treatment only to insured funds and, for good measure, requires that the government pre-fund the protection (as does the FDIC), not just back it with a promise. Watering down? More like realizing market reality and avoiding perverse incentives for customers to put funds into uninsured accounts, I would say.
While these fixes to the Basel liquidity coverage ratio (LCR) make it better, they don’t deal with its fundamental problem: it doesn’t make sense across borders where banks are built for completely different purposes. In the U.S., we back banks with FDIC insurance to a point (now happily reduced post TAG) and otherwise are building out the Dodd-Frank orderly-liquidation regime to make their parent companies subject to bankruptcy or other resolutions costly to shareholders and unsecured counterparties. The U.K. hopes to do the same, although anything like an FDIC or OLA are a long way off. Most other countries don’t even anticipate this disciplined framework because it’s anathema to their view of banking, premised on having a very few, very big banks that engage in a wide range of activities designed to promote national economic and policy interests. These banks are not just too big to fail, they are also too big to save absent an array of reforms home countries have little intention of implementing.
Which brings us back to the Basel liquidity standards. Beyond the fixes outlined above, the Committee conceded to the Eurozone and extended the compliance deadline to 2019 – far enough out to give some hope that dissenting nations will come around. For the same reason, Basel put off any action on the net stable funding ratio (NSFR), the one-year liquidity standard meant to build out the LCR to address the risks many observers think even more systemic than the thirty-day ones posited in the LCR. And, Basel did one more thing: it asked for comment on whether it should add one more category to HQLAs: a bank’s access to its central bank’s liquidity facilities.
Here’s where I get back to the impossibility of crafting a global liquidity rule. If banks can count access to the central bank as liquidity under stress, why bother to restructure day-to-day funding to make it match risk? All a bank would need to do under stress is call Daddy – that is, demand government support to which the Basel rules would say it has a right. How could one single standard govern banks that are supposed to fail under stress as in the U.S. and those that are, like it or not, to be propped up as in the EU? The FRB’s liquidity rules for systemic banks rightly force banks and their holding companies here to look first to themselves, making clear that the central bank’s coffers will only be opened as a last resort. That’s in fact what central banks are supposed to be: lenders of last resort.
Anticipating a global liquidity rule that just puts a stamp on wholly different national practice, the U.S. is being joined by the U.K., Germany and Switzerland in crafting liquidity rules that stop at the border. So far, these don’t ban cross-border branches, but they increasingly make them a functional impossibility. The more Basel compromises and the less it sets credible criteria, the greater the push towards putting up the banking barricades. We face a serious, soon threat of a new round of financial protectionism absent development of top-quality global standards that can then guide national regulators to a more balanced cross-border prudential system – protectionism that will ultimately cost customers, not just bankers, if it isn’t quickly reversed.