Michael Shashoua: Muddying Capital Adequacy

In November, I asked if postponements for compliance with Basel III capital adequacy rules would allow the Basel Committee on Banking Supervision to complete the regulation with sharper teeth and fewer discrepancies between jurisdictions.

In early January, the Basel Committee did take one action to clarify Basel III rules—it lowered the liquidity coverage ratio (LCR) thresholds that banks and financial firms must meet to ensure their survival, should they face another crisis. Some observers and critics are saying this action undermines the strength of Basel III.

One criticism is that the reduction of the liquidity thresholds does not mean that financial institutions will end up being more liquid, and therefore make more loans. “If you are suddenly more liquid, you may just transact more derivatives or make other kinds of investments,” says Mayra Rodríguez Valladares, managing principal of consultancy MRV Associates. “There’s no guarantee that this will mean more mortgage loans for Middle America.”

Riskier Thresholds
Under the committee’s LCR changes, corporate-debt securities and mortgage-backed securities (MBSs) with certain ratings are now included in the high-quality liquid assets category, and banks are only required to be able to survive the departure of 20 percent of certain non-operational deposits, rather than 40 percent. Another change lowers the percentages for other categories of deposits and credit facilities, as well as derivatives.

The liquidity threshold sets the level where firms have to manage their risk appetite. “Depositors with certificates of deposit (CDs) and money markets are a fairly reliable source of internal funding,” says Sinan Baskan, vice president, capital markets, at SAP. “If you’re supposed to respond to a scenario where those aren’t available, there’s a lot of the other side of the business where you thought you could do riskier investments and still have to cut down this profile, or increase reserves or capital adequacy standards.”

If the LCR has now been “watered down,” some of that excess is likely to flow to data management operations, which will have to get some more buckets ready.

Danger lurks in the inclusion of riskier securities in the threshold, according to Valladares. “It’s a lot of smoke and mirrors,” she says. “You may look like you’re liquid, but if there’s a big decline in your stocks and MBSs, there goes your liquidity.”

Leaky Rules
Paradoxically, for data management purposes, the liquidity threshold changes could make data more complex and difficult to deal with, according to Baskan. “The technology they use to come up with the right numbers, like analytics and computations that give the management the insight, is going to depend on both having more data available and having a high refresh rate for that data,” he says. “That really has to be up to date. That’s a lot of new data coming in. The calculations have to be fairly fast and robust if there are more of them and they’re more complex. You need speed in computation, data capture, data consumption, and actual raw calculation speed. It’s a lot of pressure to upgrade the technology infrastructure to collect the data and manage it.”

If, as Vallares concurs, the LCR has now been “watered down,” some of that excess is likely to flow to data management operations, which will have to get some more buckets ready.

Beyond that, however, an entire bucket brigade may be required if the change to the liquidity thresholds, in combination with the greatly extended timeline for compliance with the Basel III stipulations, ends up negating the stated purpose for updating the capital adequacy requirements in the first place.

Perhaps everyone should have known that a regulation addressing market issues that happened in 2008, but not fully implemented until 2019, even once fine-tuned and complete, wouldn’t clearly show the way to solving those issues.