Mervyn King, governor of the Bank of England, last month offered an enlightening insight into prevailing regulatory thinking towards the end of his presentation alongside Stefan Ingves, governor of Sweden’s Riskbank, of the Basle Committee’s revision to the liquidity coverage ratio.
Notoriously, when first framed in December 2010, this ratio had required banks to build up large buffers of high-quality liquid assets, tightly and rather conveniently at a time of investor outflows from sovereign debt, defined as government bonds, to protect against a rapid flight of deposits and short-term funding in a crisis.
Banks complained that they were being compelled to lend to governments at very low yields, despite the fact that government bonds were not particularly liquid and their credits were of doubtful quality, in a way that restricted earnings and organic capital building and also constrained capacity to lend to the economy.
"We wanted to make sure this is not seen as being imposed by the regulators," King confessed, while half-heartedly claiming that it had been "the market" all along that was incentivizing banks to lend less.
So apparently the desire to avoid blame now trumps the desire to regulate as central bankers think they should.
Whatever their motives, the governing group of central bank governors and heads of supervision on the Basle Committee have certainly backed down to a degree that might yet signal a new era in relations with the banks. They have accepted that their earlier framework for both the likely extent and rapidity of deposit, interbank and other short-term funding flight through a 30-day period was simply excessive when compared with banks’ actual experience during the recent crisis.
Here one might have some sympathy with the Basle Committee’s initial instincts two years ago. It was only widespread government guarantees of bank liabilities that halted bank runs in 2008 and 2009 and the whole thrust of policy since has been to remove this taxpayer put. Central banks, in theory the lenders of last resort, have been propping up so many banks for so long that they are now at risk of looking like lenders of first resort.
The Basle Committee’s initial failings were less excusable on the range of what it will accept as high-quality, liquid assets, which has now been expanded to include corporate bonds, some blue-chip equities and certain mortgage-backed securities. There is no doubt that these might even be higher-quality assets than the bonds of many governments and no less liquid. Of course this raises the question why the Basle Committee imposes higher regulatory capital charges against them: a question for another time perhaps.
It’s rather pitiful that King found it necessary to remind banks that liquidity buffers were not designed like regulatory minimum capital requirements to be maintained at all times and with additional operating buffers above them, but rather are there to be run down during times of constrained access to liquidity. This admits to a substantial failure in communication on the regulators’ part.
The most encouraging aspect of all this is regulators’ new pragmatism overcoming their instinct to hit banks hard at every turn. It makes no sense to impose liquidity requirements that were never essential to the bigger task of conserving bank solvency but that might damage a fragile economic recovery.
