Acting Comptroller of the Currency Michael Hsu recently gave a speech previewing potential changes to the federal banking agencies’ liquidity regulations. Specifically, he discussed recalibrating the outflow rates for uninsured deposits in the current liquidity coverage ratio (“LCR”) and introducing a new five-day stressed liquidity requirement. In addition, and to complement potential changes to the regulatory framework, Hsu emphasized the importance of banks being operationally prepared to quickly monetize liquid assets, including through readiness to access the discount window.
Hsu did not specify to which banks the agencies would seek to apply these new requirements, instead simply stating that the proposal might apply to “midsize and large banks.” Based on their recent proposed rulemaking, however, the agencies may seek to apply these changes to all banking organizations with $100 billion or more in assets. Hsu also did not say when the proposal would be formally published.
We discuss here the potential changes to liquidity rules, and provide some key takeaways and considerations for banking organizations.
Recalibrating the LCR
Currently the Category I and II banking organizations (the U.S. global systemically important bank holding companies and banking organizations with $700 billion or more in assets or $75 billion or more in cross-jurisdictional assets) are subject to a full daily LCR. Category III banking organizations (those with between $250 and $700 billion in assets) typically are subject to a reduced daily LCR and Category IV banking organizations are only subject to the LCR if they exceed $50 billion in weighted short-term wholesale funding. Given the expansion of the applicability of certain prudential standards contemplated by the agencies’ Basel III Endgame proposal, it is possible the agencies may seek to require a larger range of Category III and IV banking organizations to comply with full daily LCR.
The LCR generally requires banks to hold high-quality liquid assets (“HQLA”) at least equal to the bank’s projected total net cash outflows over a 30-day period. In other words, the LCR is the ratio of a bank’s HQLA (the LCR numerator) to its projected total net cash outflows (the LCR denominator). The LCR denominator is determined in part by assigning a bank’s liabilities, including deposits, outflow rates based on how likely the liabilities are to flow out during a stress event.
Hsu’s speech indicates that regulators are reconsidering outflow assumptions for uninsured deposits after the run on Silicon Valley Bank, 90% of the deposits of which were uninsured. Specifically, the speech suggests that regulators may be looking to more finely distinguish between different types of uninsured deposits and assign a higher outflow rate to those deemed more likely to run. In proposing to recalibrate outflow rates, Hsu rejected the suggestion that regulators recalibrate the LCR numerator to include discount window capacity and other sources of liquidity. All else equal, Hsu’s proposal therefore would require banks to hold more HQLA to satisfy their LCR requirements.
New Five-Day Liquidity Requirement
In addition to recalibrating the classification of deposits and outflow rates in the LCR, Hsu introduced the possibility of a new, additional five-day liquidity requirement. The denominator of the new requirement would be based on uninsured deposit outflows and the numerator would consider the liquidity value of collateral pre-positioned at the discount window, as well as reserves.
The speech implied that not all uninsured deposits would be treated identically for these purposes – Hsu distinguished between the perceived riskiness of operational deposits (such as those meant to cover payroll) and non-operational deposits (excess funds kept at banks). Hsu noted that these types of deposits are defined differently across the industry and that the OCC is hosting a research symposium to discuss better classifying deposits.
The numerator of this new requirement would be intended to both reduce stigma associated with discount window borrowing – by giving banks credit for collateral pre-positioned there – and at the same time discourage over-reliance on the discount window – by limiting this credit only to the new five-day requirement as opposed to including it more broadly in the LCR.
Hsu suggested the rule also include expectations related to operational preparedness including a requirement to conduct periodic test draws.
Key Takeaways and Considerations
- Hsu mentioned the regulatory changes discussed above should be applicable to “midsize and large banks.” It is possible that, based on their recent proposed rulemaking, the agencies may propose to apply new and revised liquidity regulations to all banking organizations with $100 billion or more in assets.
- Regardless of whether new rules are implemented, it may be prudent for banks to continue their efforts to demonstrate operational preparedness by being able to quickly monetize liquid assets, including through the discount window. Banks also may wish to consider how faster payments and tokenization may affect their liquidity risk management.
- The changes discussed above would require notice-and-comment rulemaking, though Hsu did not indicate when a proposed rule would be published or when the comment period would begin. It will be important for the industry to comment on any such proposals, and in advance of any comment period, it may be useful for banks to collect data demonstrating the behavior of different types of uninsured deposits during liquidity stress events.
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