Transparency and Banks reducing their liquidity risk

Bloomberg reports that Ben Bernanke and the Fed are going to urge banks to reduce their liquidity risk by reducing their reliance on wholesale funding.

The simplest way to do this is to require the banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

Transparency solves multiple problems including the unreliable nature of wholesale funding during the financial crisis.

Regulators “will continue to press banks to reduce further their dependence on wholesale funding, which proved highly unreliable during the crisis,” Bernanke said in a speech yesterday in Stone Mountain, Georgia. “Banks of all sizes need to further strengthen their ability to identify, quantify and manage their liquidity risks.”

Regular readers know, and the Financial Crisis Inquiry Commission subsequently confirmed, that the reason the interbank funding and wholesale funding markets froze is that banks and investors with funds to lend could not assess the risk and solvency of the banks looking to borrow.

As a result of not being able to assess the borrowing bank's risk and solvency, banks and investors opted not to lend.

Transparency solves this liquidity risk very easily.

With ultra transparency, banks and investors with funds to lend have the information they need to assess the risk and solvency of banks looking to borrow.  As a result, the frozen interbank and wholesale funding markets unfreeze and remain unfrozen.

More importantly, with transparency, because banks have nothing to hide, wholesale funding actually becomes more stable.  Banks and investors that are comfortable with a borrowing bank's risk and solvency will naturally tend to rollover their exposures.