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Friday, November 21, 2014

Tarullo: Liquidity Supervision to Be ‘Context Dependent’

As the prudential regulators implement the Basel III liquidity coverage ratio and write a rule next year for Basel’s net stable funding ratio, they are working on a flexible supervisory approach to minimize strains during stressful periods, Federal Reserve Governor Daniel Tarullo said in a speech.

“It is clear that liquidity regulation has the potential to generate unintended effects,” he said, noting that the Basel liquidity buffers could prod banks to hoard liquid assets during a crunch rather than using it “to relieve the funding needs of households and other firms.”

Thus, supervisors will employ “context-dependent” remedies when bank liquidity falls below regulatory thresholds. Tarullo said:

A firm that falls out of compliance with the LCR or NSFR during a period of generalized stress should not be subject to automatic sanctions, but instead given an opportunity to come back into compliance in a way that does not expose either the firm or the system to greater stress.

He noted that the largest U.S. banks have increased their high-quality liquid assets by about one-third since 2012 while the use of short-term wholesale funding has “dropped considerably.” But he warned that if nonbanks increase their use of such funding, regulators may need to apply liquidity standards “on a market-wide basis.”

Read the speech.

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