Should Banks Be More Liquid? The Government Thinks So

In the calamity of the financial crisis, many financial institutions failed under the immense pressure or experienced traumatic hardships, mostly due to a lack of liquidity.

Under a newly proposed rule, the largest U.S. banks will have to prove that they have enough cash set aside for business operations up to a year to lower liquidity risk to reduce the chances of yet another crash.

On Tuesday, the Federal Deposit Insurance Corporation (FDIC), the Federal Reserve, and the Office of the Comptroller of Currency (OCC) unveiled details of the proposed Net Stable Funding Ratio rule.

According to the Martin J. Gruenberg, Chairman of the FDIC, the suggested regulation would "ensure that lending and investing activities of large banking organizations are sufficiently supported by sources of stable funding over a one-year horizon."

He continued, "Maintaining sufficient amounts of stable funding strengthens a bank's liquidity profile by reducing the risk of funding disruptions."

Institutions that would be covered under the Net Stable Funding Ratio rule would need to maintain sufficient levels of stable funding, including capital, long-term debt, and other stable sources over a one-year window. According to the FDIC, the stored funds will account for the liquidity risks arising from their assets, derivatives, and off-balance sheet activities.

"Institutions would be less at risk of facing funding disruptions or liquidity runs that could threaten their viability," Gruenberg explained. "The proposed rule would thereby enhance the resilience of the banking system as a whole by ensuring that banking institutions subject to this rule have sufficient amounts of stable funding."

Regulators stated that the proposed rule would apply to two types of banking organizations:

1. Banks, bank holding companies, and savings and loan holding companies with $250 billion or more in total assets or with $10 billion or more in foreign exposures; and
2. Insured depository institutions with $10 billion or more in assets that are consolidated subsidiaries of the aforementioned banking organizations.

The Net Stable Funding Ratio aligns with the Basel Committee on Banking Supervision's net stable funding ratio, which was completed in 2014.  This proposal complements the Liquidity Coverage Ratio Rule previously issued by the three federal banking agencies in September 2014.

"The proposed Net Stable Funding Ratio rule is one piece of a broader effort to increase the resiliency of the banking system and complements the liquidity rule, the agencies’ enhanced capital standards, and the OCC’s robust bank supervision," said Comptroller of the Currency Thomas J. Curry.

According to Vincent Hui, senior director, Cornerstone Advisors, the passing of the rule is just a formality for many institutions.

"The net stable funding rule is already in BASEL 3, which is on most financial institution’s radar screens, so it is not a surprise that the OCC will adopt it as part of its standards," Hui said. "Many banks, whether they are covered by the rule or not,  already have policies around liquidity risk and this will reinforce them. In summary, Financial institutions have been preparing for this and this makes it more official."