The Basel Committee’s net stable funding ratio takes is taking aim at the market for securities financing and lending.
What’s happening?
The Basel Committee on Banking Supervision (BCBS) unveiled its latest draft of the net stable funding ratio (NSFR) in January 2014. The NSFR is designed to oblige banks to match long-term assets with long-term funding. Under the ratio, a bank’s required stable funding (RSF) must be funded at least 100% by available stable funding (ASF), which is normally defined as funds with an expected maturity of more than one year. The consultation period for the draft closed in April 2014, and committee members have indicated a commitment to finalise the regulations in time for the G20 government meetings in Australia in November 2014.
What has changed?
The previous draft of the NSFR dates back to December 2010, so this version has been three years in the making. Among the 48 individual responses from industry participants and academics, one particularly strident note of alarm is that the BCBS seems to see the NSFR as a tool to be used in the debate over so-called shadow banking. This refers to certain types of wholesale funding for banks that are blamed for intensifying liquidity risks during the 2008 financial crisis.
In the case of the NSFR, regulators have set out a relatively punitive treatment for repurchase (repo) deals in which cash is lent against financial instruments as collateral. These trades are also known as securities financing transactions (SFTs), and their mirror image is securities lending. The BCBS has adopted an asymmetric approach in which repo funding by banks will count toward the RSF, but certain types of repo and reverse repo financing to the banks cannot be included in the ASF.
“The chairs of the working group on liquidity have made it very clear that they are not trying to stop maturity transformation altogether, but they do want to limit it and limit the risks associated with it,” says Hortense Huez, a senior manager at PricewaterhouseCoopers, who was previously a member of the Basel working group on liquidity during her time at the Bank of England.
What do the banks say?
Of particular concern to the industry is the fact that different counterparties for SFTs receive differing RSF treatments. Securities financing extended to banks does not count toward the RSF, but it carries a 50% RSF weight if extended to non-bank financial institutions (NBFIs).
One consequence that looks especially unintended is that central clearing counterparties (CCPs) would be defined as NBFIs based on the current draft. The Financial Stability Board and some national regulators have been looking at the desirability of clearing repo transactions centrally. Godfried De Vidts, director of European affairs at inter-dealer broker ICAP and chair of the ICMA European Repo Council (ERC), flagged up this gap in a letter to the liquidity working group chairs.
“Applying the asymmetrical treatment for loans to CCPs would be a deterrent to the centralisation of repo market clearing and provide a strong incentive for inter-bank bilateral repo trading,” notes Mr de Vidts.
What’s the alternative?
The wider concern is that reverse repos with NBFIs are an important way for market-makers to provide liquidity in securities markets without holding large inventories on the balance sheet. The ERC estimates that about 37% of bank reverse repo transactions are with NBFIs, equivalent to flows of €570bn. If the BCBS pushes ahead with its proposal, the ERC warns that the cost of 91-day repo transactions with NBFIs will jump from 18 basis points to 40 basis points.
Consequently, industry associations have proposed applying a 0% RSF to reverse repos with NBFIs, provided that the collateral used is of the highest quality. This would be easy to liquidate if needed, and therefore should not require term funding. The ERC estimates that about 70% of reverse repos and 78% of repos with NBFIs use this highest quality collateral.
Do we need it?
Perhaps the most incendiary question of all. The BCBS has already finalised a liquidity coverage ratio (LCR) designed to ensure that banks have enough highly liquid assets to cover a 30-day stress scenario in which funding markets freeze up. Tom Hurd, a professor of mathematics at McMaster University, is modelling systemic liquidity risk for the Canadian government-backed Global Risk Institute. His research suggests the LCR alone is enough to break the “cascade effect” where each bank’s behaviour in a stress scenario hits its counterparties.
“The introductions to the LCR and NSFR proposals both use the same justification – the 2008 liquidity shock. But they do not justify the need for both ratios from a systemic viewpoint,” says Mr Hurd.
He cites the work of Nobel laureate economist Jan Tinbergen, who concluded from modelling that policy-makers should use one instrument to achieve each economic target. If the aim of the BCBS is to avoid a future systemic liquidity shock, then the LCR may be the right tool to do the job without a sustained regulatory attack on repo markets.
