Last week, everyone on the internet decided that the Basel Committee’s revisions to the LCR were the worst thing ever and another example of the power of banks over regulators and politicians. And for the most part, those people are right! The delayed implementation timeline (the 100% level is only required by 2019) is yet another victory for banks in their drawn-out effort to associate new regulation with sluggish economic growth.* Also, the changes to liquidity line and corporate deposit drawdowns are significantly less conservative, especially when put in the context of a 3-notch downgrade crisis scenario the LCR aims to cover.
But no one seems to be congratulating Basel for the positive changes - and yes, there certainly are positive changes. So let’s review those:
Derivatives - Excellent news across the board! For those frightened of the large, interconnected megabanks that create much of the systemic risk in the financial system, these changes are for you. Remember collateral upgrades, the next big hiddden risk in the financial system? Banks must now hold liquidity to cover the unwind of these trades (paragraph 122). They also need to take into account situations where counterparties have not called back excess collateral (121) or have yet to demand collateral (120).
40% Cap on Level 2 Assets - The previous cap lead to a situation where by engaging in a pair of repo transactions a firm could increase its LCR without changing its economic exposure (if anyone really wants to know how this works let me know). An arbitrage situation caught early and remedied by the BCBS.
Prime Brokerage- while the language is still unclear, paragraph 111 pushes for a harsher treatment of prime brokerage accounts. For anyone who wishes to make a smarmy comment about Lehman or Bear being able to meet the new LCR, both those firms assumed their pool of prime brokerage deposits were stable and collateral was usable, both of which have been completely disallowed by the BCBS.
Liquid Assets OK, so these were watered down, but Lisa Pollack does a good job of showing the numerous restrictions on the inclusion of these assets, which will seriously limit the amount of garbage paper appearing in liquidity buffers. Also, in most countries the newly eligible fixed income assets are accepted by central banks (equities inclusion is a whole other story), which is ultimately the only guarantee of liquidity. Finally, the RMBS inclusion is a matter of fairness - not every country is lucky enough to have an explicitly government-backed mortgage market whose assets automatically count for the buffer. If you want international cooperation on regulation, you are going to have to deal with compromises.