Fed proposes stricter liquidity rules

The new proposal, considered to be more stringent than Basel III, takes a narrower view on what can be characterized as a high quality liquid asset.   

In a move that could impact private equity firms' access to credit, the Federal Reserve proposed new liquidity requirements that go beyond those set by Basel III, according to a statement released by the central bank on Thursday.

The proposal sets a standard minimum liquidity coverage ratio for international banking organizations, which the Fed defines as those with “$250 billion or more in total consolidated assets or $10 billion or more in on-balance sheet foreign exposure”, according to a statement. The proposal requires banks to maintain liquidity in an amount equal to or greater than its projected cash outflows minus its projected cash inflows during a short-term stress period.

“Liquidity is essential to a bank's viability and central to the smooth functioning of the financial system,” Federal Reserve chairman Ben Bernanke said in a statement. “The proposed rule would, for the first time in the United States, put in place a quantitative liquidity requirement that would foster a more resilient and safer financial system in conjunction with other reforms.”

The proposal takes a narrower view of what constitutes a 'high quality liquid asset' – it suggests “central bank reserves and government and corporate debt that can be converted easily and quickly into cash,” – with a shorter transition period than that set by Basel III, according to the statement. Under the proposal, banks would have to be fully compliant by 1 January 2017.

“The accelerated transition period reflects a desire to maintain the improved liquidity positions that US institutions have established since the financial crisis, in part as a result of supervisory oversight by the Federal Reserve and other US bank regulators,” according to a statement.

The implementation of standardized liquidity requirements, with a narrower scope of what constitutes a liquid asset, will likely have a negative impact on banks’ ability to lend. The implementation of Basel III requirements has already restricted the banking industry’s ability to provide loans, especially riskier types of debt instrument, according to several market sources. As a result, private debt funds and other non-traditional lenders have seized the opportunity to provide capital that meets the unmet demand of borrowers.