WASHINGTON – Federal regulators are requiring big banks to keep enough high-quality assets on hand to survive during a severe downturn, the latest move under a congressional mandate to lessen the likelihood of another financial meltdown.
The Federal Reserve adopted rules on a 5-0 vote Wednesday that will subject big U.S. banks for the first time to so-called “liquidity” requirements. Liquidity is the ability to access cash quickly. Fed Chair Janet Yellen called the rules “a very important regulation that will serve to strengthen the resilience of internationally active banking firms.”
The 15 largest banks – those with more than $250 billion in assets – will have to hold enough cash, government bonds and other high-quality assets to fund operations for 30 days during a time of market stress. Smaller banks – those with more than $50 billion and less than $250 billion in assets – will have to keep enough to cover 21 days. Banks with less than $50 billion in assets and nonbank financial firms deemed by regulators as posing a potential threat to the system will not be subject to the requirements.
Separately, regulators also are proposing to give banks leeway in requiring collateral from companies that use derivatives to guard against price swings.
The liquidity rules for banks will begin to take effect in January, and the requirements will be phased in over two years.
Fed officials say the rules are stronger than new international standards for banks. Combined, the largest banks will have to hold an estimated $2.5 trillion in high-quality assets to meet the requirements. The banks already hold all but about $100 billion of that amount, according to the Fed. Banks have sharply improved their cash-ready holdings in the past few years, and about 70 percent now meet the full requirement, the Fed estimates.
The requirements were called for by Congress in the sweeping overhaul law responding to the 2008 financial crisis. They are part of new regulations intended to prevent another collapse severe enough to require taxpayer-funded bailouts and threaten the broader financial system.
Hundreds of U.S. banks received federal bailouts during the crisis. Among them were the largest financial firms, including JPMorgan Chase, Goldman Sachs, Citigroup, Bank of America and Wells Fargo. The banking industry has been recovering steadily since then, with overall profits rising and banks now lending more freely. Lending in the April-June quarter marked its fastest pace since the fourth quarter of 2007, about a year before the financial crisis struck, according to new data from the Federal Deposit Insurance Corp.
Fed officials have said that related requirements also are being considered, such as a mandate for large banks to test their liquidity under stress conditions.
The Fed also heeded urgings from state government officials and decided to consider adding some types of municipal bonds to the list of assets that banks can count as high-quality “liquid” holdings. Yellen noted during the Fed’s meeting that judging by written comments they submitted to the agency, states and municipalities “seemed quite worried” that municipal bonds aren’t included under the rules. They are concerned that banks could pull away from muni bonds as a result, potentially raising borrowing costs for local governments.
In response to questions from Yellen and other Fed governors, agency staff said they don’t expect the new requirements to have a significant negative effect on the economy or to force banks to curtail their lending.
But the head of the banking industry’s biggest trade group said the rules have “the potential for adverse and unintended consequences.” A narrow definition of high-quality liquid assets could create “a shortage in times of financial stress that could provoke panic,” Frank Keating, president of the American Bankers Association, said in a statement.
Separately, the Federal Reserve and four other agencies are proposing to give banks flexibility in collecting collateral from companies that use derivatives to hedge against price risks.
Requiring collateral such as cash or securities in derivatives trades can depend on the bank’s assessment of whether a company is a credit risk or unable to meet its obligation if the bet soured. A bank’s trading partner in a derivatives transaction can be a commercial user of derivatives such as an airline or oil company, another Wall Street bank or a foreign government, and they represent varying degrees of risk.
The aim of the proposed rules is to cut down on the kind of risky trades that contributed to the financial crisis.
Derivatives are complex investments whose value is based on a commodity or security, such as oil, interest rates or currencies. They are often used to protect businesses that produce or use the commodities against price fluctuations – but they also are used by financial firms to make speculative bets. Traded in a secretive $600-trillion global market, derivatives helped ignite the 2008 meltdown. The 2010 financial overhaul law brought the market under regulation for the first time.
The collateral rules apply to derivatives traded outside of clearinghouses, which were established by the overhaul law. Clearinghouses settle derivatives trades and their member firms must back them, so collateral is always required. Fed officials say they expect about 60 percent of derivatives trades to occur in clearinghouses.