2015 Series • No. 2015–3
Current Policy Perspectives
Global Standards for Liquidity Regulation 
Liquidity risk has received increased attention recently, especially in light of the 2007 - 2009 financial crisis, when banks' extensive reliance on short-term funding, maturity mismatches between assets and liabilities, and insufficient liquidity buffers made them quite susceptible to liquidity risk. To mitigate such risk, the Basel Committee on Banking Supervision (BCBS) introduced an improved global capital framework and new global liquidity standards for banks in December 2010 in the form of the new Basel Accord (Basel III). This brief offers insights from the crisis experience, identifies the problems that the new liquidity regulation aims to address, and summarizes underlying differences between the United States and Europe that may affect the ability to design and implement consistent global standards.
Key Findings
- It took a global financial and economic crisis to achieve global liquidity standards for banks. Until then, it was believed that the deposit insurance system, money markets, and central bank liquidity, in combination with capital requirements, provided adequate liquidity.
- While most banks that got into trouble during the 2007-2009 financial crisis appear to have met the regulatory capital requirements prior to, and even during, the crisis, many did not have sufficient liquid assets that, together with anticipated cash inflows, would prove sufficient to compensate for the rapid outflows that characterize financial crises.
- Basel III provides new capital requirements (including countercyclical buffers, leverage ratios, and minimum capital standards), risk coverage (counterparty credit risk), and reliance on external credit ratings, as well as new liquidity standards (the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR)), as well as a set of liquidity risk monitoring tools to measure other dimensions of a bank's liquidity and funding risk profile to ensure global consistency in the supervision of banks' liquidity and funding risk exposures.
- The new liquidity standards are expected to significantly improve the resilience of the global banking system, as long as prudential liquidity risk management is applied and transparent information is adequately accessible to supervisors and market participants.
- Recognizing that the new Basel III framework needs to be implemented consistently in order to ensure a level playing field, the United States and the European Union designed similar processes for implementing the new liquidity standards. Nevertheless, when transforming them into national law, institutional differences need to be considered, and these explain the reasoning behind jurisdiction-specific modifications.
Implications
Although the new liquidity regulation will likely reduce the occurrence of liquidity crises in the future, its effect on the money markets cannot be easily predicted. Current developments already confirm that some of the larger U.S. banking organizations are imposing fees to encourage their largest depositors to withdraw their cash. The implications will depend on a number of factors, such as the term of the transaction and the counterparty involved and whether or not transactions are secured with collateral.
Abstract
Liquidity risk has received increased attention recently, especially in light of the 2007-2009 financial crisis when banks' extensive reliance on short-term funding, maturity mismatches between assets and liabilities, and insufficient liquidity buffers made them quite susceptible to liquidity risk. To mitigate such risk, the Basel Committee on Banking Supervision introduced an improved global capital framework and new global liquidity standards for banks in December 2010 in the form of the new Basel Accord (Basel III). This brief offers several insights from the crisis experience and identifies the problems that the new liquidity regulation attempts to address. Because a consistent implementation in the G-20 jurisdictions is critical to avoiding regulatory arbitrage and because the United States and Europe differ somewhat in the way current regulation is designed and will be implemented, this brief also summarizes underlying differences between the United States and Europe in factors such as banking structure, funding models, and political processes.