August 28, 2012

ECB Pushes for Looser Basel Liquidity Rule

Fears over crisis prompt bank’s urging to allow broader asset eligibility

The European Central Bank headquarters in Frankfurt. (Photo: AP) The European Central Bank headquarters in Frankfurt. (Photo: AP)

The European Central Bank (ECB) is advocating a looser standard on eligibility of assets that can be used to satisfy a draft liquidity rule from the Basel Committee on Banking Supervision, over concerns that the current definition is too restrictive on credit in the midst of the financial crisis.

Bloomberg reported Tuesday that, according to three people with knowledge of the discussions, the ECB, with the support of the Bank of France, is urging Basel rulemakers to consider allowing some asset-backed securities and loans to businesses to be eligible for inclusion in banks’ liquidity coverage ratio (LCR).

The rule, designed to forestall any repeats of the chaos that emerged in the wake of Lehman Brothers Holdings' collapse in 2008, currently does not allow such assets to be included among the easy-to-sell holdings required to help banks get through a 30-day period of little or no credit accessibility.

However, the ECB, along with the Bank of France, are saying that such a tight definition could hinder attempts to control the eurozone crisis because it will impede lending and also make it more difficult for countries’ central banks to exercise monetary policies.

The Basel Committee, which has 27 member nations, said in 2011 that it would consider unintended consequences brought about by the draft rule, and a number of regulators are advocating changes—with the ECB and the Bank of France seeking the most drastic.

The ECB says that if there is not an alignment between the LCR and the ECB’s collateral rules, banks will hold back on their highest-quality assets for use in satisfying the LCR. It also said that if banks have to hold onto high-liquidity assets, short-term funding markets could be affected.

According to Jesper Berg, senior vice president at Nykredit, Denmark’s largest mortgage bank, “as central banks have relaxed their rules” during the eurozone crisis, “the LCR has become more and more out of sync with central-bank reality.”

Berg was quoted saying, “The ECB accepts as collateral almost anything short of the CEO’s tie. The ECB’s superior performance in the early phase” after Lehman’s collapse “can to a large extent be attributed to its broad collateral framework.”

However, a number of committee members, including the U.S., are wary of too much weakening of the rule, lest it reduce the rule’s effectiveness—part of its purpose is to discourage too much dependence on central bank support by other banks during a crisis. The Bundesbank is also dismissive of the ECB’s proposals.

Members of the Basel Committee’s working groups have agreed on a provisional arrangement that will keep a split in the LCR to define which assets can be used by banks to meet their requirements in full and which assets can only satisfy 40% of the requirement.

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