On Nov. 22, Basel published remarks on banks' liquidity risk policies.
Basel published remarks by Chair Fernando Restoy on liquidity risk policies for banks.
Restoy's speech given at the XXIIIAnnual conference on risks in Madrid, Spain.
Background
Silicon Valley Bank deposits withdrawn or planned reached 85% of total deposit base.
Deposit outflows of other banks that failed in 2023, like Credit Suisse and First Republic, were substantially larger than ones observed during Great Financial Crisis.
Clear grounds to reflect on how policy should respond in an environment where episodes of liquidity stress in weak banks could become more frequent and severe.
Policies should cover regulation, deposit insurance, supervision, liquidity support.
Regulation
Mandating use of stable funding sources and maintaining significant stock of liquid assets, authorities mitigate risks associated with liquidity and maturity transformation.
The requirements also reduce the likelihood of firms taking drastic and potentially damaging procyclical actions in order to address liquidity shocks during stress periods.
Liquidity buffers provide banks with additional time to prepare for orderly resolution.
Liquidity coverage ratio (LCR) designed to ensure banks have sufficient high-quality liquid assets (HQLA) to face liquidity stress scenario characterized by liabilities runoff.
Liabilities runoff rate for each type of liability is a function of its perceived instability.
Recent events show calibrated runoff rates for specific liabilities considerably lower than actually observed, some regulators considering review, introducing constraints.
Noted that regulatory requirements are not and should not be designed to ensure that all banks would be able to address any conceivable run of deposits or other liabilities.
Targeted adjustments to the LCR may be warranted, provided that such changes are supported by sufficient evidence on the changes' effectiveness and proportionality.
Currently no compelling case for complete overhaul of existing liquidity requirements,
Overhaul would not be most effective way to address all challenges posed by the apparent reduction in degree of deposit stability that can be expected in weak banks.
Deposit Insurance
Deposit insurance is a critical pillar of policy framework to preserve financial stability.
Following 2023 banking turmoil, observers and authorities have suggested a review of the adequacy of current coverage levels in existing deposit insurance frameworks.
FDIC proposal made to expand insurance coverage to operational payment accounts.
Diversifying funds in smaller accounts held at different institutions is costly for firms.
Blocking access to operational payment accounts when bank fails could be highly disruptive to business continuity, ability to pay employees, providers could be impaired
Moderate increases in coverage levels are unlikely to substantially alter the volume of uncovered deposits and, therefore, alter the frequency or intensity of possible runs.
More substantial changes could have significant implications for the size of deposit insurance funds and, by extension, for the costs to the banking sector and taxpayers.
Substantial increase would raise concerns about moral hazard, resource redistribution resources from sound banks to weaker competitors, distortions in resource allocation.
Supervision
Restoy more confident in role of strengthened supervision in preserving banks' stability
Through combined components of supervisory review and evaluation processes, supervisors can develop comprehensive assessment of banks' exposure to liquidity risk
Identifying the banks' structural vulnerabilities and the interaction among them should be the main outcome of the regular supervisory review and evaluation processes.
Supervision not effective if relies only on quantitative capital, liquidity requirements.
Believes there is clear scope to improve supervisory measures employed in Europe.
Success and effectiveness of supervision hinges on adequate resources, legal powers, independence and a supervisory culture that fosters early intervention when necessary
Central Bank Liquidity Support
Central banks play a vital role in reducing the probability and impact of bank runs.
Main constraint for liquidity support to solvent banks is availability of acceptable collateral, typical runnable liabilities represent around 20% to 30% of total assets.
Even with large asset haircuts, there is normally a significant margin to generate collateral for the required loans from the central bank in emergency situations.
The central banks need to put in place adequate measures to ensure that banks are fully prepared operationally and are willing to use central bank facilities if needed.
Must require all banks to have operational arrangements in place to pledge collateral, such requirements could also mandate regular testing and simulation exercises.
Observers' proposals to formally require banks to pre-position certain volume of collateral at central bank, calibrated as proportion of liabilities considered unstable.
Alternative calibrates pre-positioning as function of liabilities, excludes insured deposits
Requirements should be carefully calibrated to not directly undermine sustainability of risk, liquidity and maturity transformation business that commercial banks perform.
