On Wednesday, several government regulators, including the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, will vote on a rule that’s designed to improve the way banks manage risk.
After the last financial crisis, regulators started to worry about the next one. At a meeting in Basel, Switzerland, they proposed a “liquidity coverage ratio.”
According to Oliver I. Ireland, a partner with Morrison & Foerster, it would require banks to hold high-quality assets “that presumably you could sell into the market at a reasonable price in order to generate liquidity to meet, for example, customer withdrawals.”
For several years now, regulators have wrestled with what constitutes a “high-quality” asset.
“There are all kind of securities that have varying degrees of liquidity,” says Lawrence G. Baxter, the William B. McGuire Professor of the Practice of Law at Duke University. There is debt you can get rid of quickly, like U.S. bonds, and there is debt that is harder to sell. For example, there wasn’t much of a market for mortgage-backed securities in 2008.
“The more liquid the assets, the safer they are, but also the less yield-bearing they are likely to be,” Baxter explains, noting the liquidity-coverage ratio could pose a problem for banks. They have been bringing in record profits, he says, and they are under pressure to keep doing that.
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