Sunday, January 8, 2012

Banks can go below Basel Levels during crisis

A Bloomberg article reports that global regulators have agreed that during a financial crisis, banks will be allowed to go below Basel required capital and liquidity levels.

This is further evidence of how meaningless capital and liquidity requirements are.

Regular readers know that if banks were required to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details, formal capital and liquidity requirements could be eliminated all together.  Market discipline would drive the banks to holding more capital and liquidity.

Banks will be allowed go below minimum liquidity levels set by global regulators during a financial crisis so that they can avoid cash-flow difficulties. 
“During a period of stress, banks would be expected to use their pool of liquid assets, thereby temporarily falling below the minimum requirement,” the Basel Committee on Banking Supervision’s governing board said in a statement on its website yesterday, following a meeting in the Swiss city. 
The aim of the measure, known as a liquidity coverage ratio, is to ensure that lenders hold enough easy-to-sell assets to survive a 30-day credit squeeze. The requirement, one of several measures from the Basel group designed to prevent a repeat of the 2008 financial crisis, is scheduled to enter into force in 2015. 
Of course, neither the capital or liquidity rules would have prevented the 2008 financial crisis.
Banks have argued that the rule may curtail loans by forcing them to hoard cash and buy government bonds. Bank supervisors say the standard is needed to prevent a repeat of the collapses of Lehman Brothers Holdings Inc. (LEHMQ) and Dexia SA (DEXB), which were blamed in part on the lenders running out of short- term funding. Global regulators said last year that they would amend the rule to address unintended consequences....
It seems to me that the real problem Lehman and Dexia had was they were insolvent and this insolvency was recognized by the market.  If these firms had liquidity to fund themselves for 30 additional days, they would still have collapsed.  It just would have been 30 days later. 
“The aim of the liquidity coverage ratio is to ensure that banks, in normal times, have a sound funding structure and hold sufficient liquid assets,” Mervyn King, the governing board’s chairman, said. This should mean that “central banks are asked to perform only as lenders of last resort and not as lenders of first resort,” said King, who is also governor of the Bank of England.
In the absence of ultra transparency, when a bank's solvency is questioned, central banks are the lender of first and last resort as private market investors, including other banks, are unwilling to lend to a bank they do not think will repay them.
The liquidity rules were part of a package of measures adopted by global banking regulators in 2010 to strengthen the resilience of banks. The new rules also included tougher capital requirements that more than tripled the core reserves that lenders are required to hold. 
Separately, the governing board said that the Basel committee will carry out “detailed” peer reviews of whether nations have correctly implemented capital rules for lenders. The assessments will include whether lenders are correctly valuing their assets, it said. The results of the reviews will be published, with the U.S, Japan and European Union the first to undergo the exams. 
Regulators on a global basis are practicing forbearance.  How could an assessment possibly conclude that lenders are correctly valuing their assets?  Just look at how many different valuations there are for Greek debt.

If lenders were doing such a great job of valuing their assets, then regulators should have no problem adopting ultra transparency and requiring the banks to disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.

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