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Fed approves proposals on net stability funding ratio, qualified financial contracts

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Fed approves proposals on net stability funding ratio, qualified financial contracts

Following the OCC and FDIC's approval, the Federal Reserve approved a proposed net stablefunding ratio rule, which would require the biggest banks to have more liquidity.

Under the proposed rule, banks with more than $250 billion inassets or with $10 billion or more in foreign exposures will have to hold enoughcash to continue operating for up to a year in the event of a financial crisis.A modified version of the NSFR will apply to banks between $50 billion and $250billion in assets and would require them to hold only 70% of what they would haveto hold if the full rule applied to them.

The rule is the other half of the Liquidity Coverage Ratio, whichwas passed by agenciesin September 2014 and requires banks to hold highly liquid assets to cover a firm'soperations over 30 days.

Oliver Ireland, a partner at Morrison & Foerster, said therigidity of the rule could create unforeseen problems. For example, one of the uncertaintiesabout the liquidity capital ratio is what qualifiesas high-quality liquid assets, he said.

He said banks should be prepared for this rule, but does expectthem to reduce their short-term wholesale funding as a result of this and otherrules. If the rule is too tight, then "the banks may start to look at differentways to fund themselves," he said.

"We've seen some changes in the ways banks want to dealin the market since the liquidity capital ratio, an increased preference for termmoney for example, as opposed to money that would run off more quickly," hesaid.

Ireland said he is concerned that regulators are focused toomuch on the liquidity and capital positions of financial institutions, which couldmake it harder to redeploy capital in the event of another crisis.

"I think one of the strengths of the financial system historicallyhas been that in more cases than people may recognize, it's operated as a safetynet and has been able to keep problems from growing because of the interrelationshipsbetween large financial institutions."

Federal Reserve Board Governor Daniel Tarullo said the financialcrisis started out as a liquidity crisis and this rule, coupled with the LCR, couldhelp prevent that. The NSFR requires stable funding over a one-year time frame,"thereby mitigating the potential effects of a firm's loss of funding and creatingstrong incentives for firms to extend the maturity of their funding arrangements,"he said at a May 3 open meeting.

The NSFR rule, which takes effect Jan. 1, 2018, is defined asa ratio of available stable funding to required stable funding. Funding sourcescould include capital, long-term debt and other assets. The ratio would have tobe maintained at a minimum level of 100% and financial institutions would have toreport and file a plan if the ratio falls below the minimum. In addition, bankswould have to publicly release their NSFR on a quarterly basis.

Across the industry, there is only a 0.5% shortfall of the totalrequirement, Fed staff said at the open meeting. Staff said they do not expect regulatorycosts for banks to increase.

The public has until Aug. 5 to submit comments.

The Fed also approved a proposal that would require qualifiedfinancial contracts between globally systemically important banks and other entitiesto include an amendment that would prevent the immediate cancellation of the contractif the bank fails. These contracts, known as QFC, are used for derivatives, securitieslending and short-term funding transactions.

Fed staff said at the meeting they expected some contracts tomove to banks that are not G-SIBs as a result of the rule but would carefully monitorany potential impact on the market. Fed Chair Janet Yellen asked staff why the rulewould only apply to G-SIBs and not all large banks if the contracts would move tobanks that are not G-SIBs. Staff said they limited the rule to G-SIBs because theypose the greatest systemic threat to the financial sector.