Usable Liquid Assets Would Unlock More Liquidity Under Stress

Washington, D.C. –

Liquidity buffers are only useful under stress if banks don’t feel compelled to maintain their regulatory minimums and are free to use their liquid assets. Several regulatory, supervisory and market factors currently discourage banks from doing so. Modifying these factors could enable banks to provide more economic support in stressful times.

What’s happening: The Bank Policy Institute late yesterday commented on the Bank of England and Prudential Regulatory Authority’s discussion paper on the usability of liquid assets.

“Banks’ ability to utilize their stock of liquid assets to support the economy in times of stress is fundamental to the construct of the bank liquidity framework,” BPI SVP and Senior Associate General Counsel Brett Waxman wrote in the letter. 

Context: The Bank of England paper examines the degree to which banks feel comfortable using their high-quality liquid assets, or HQLA, a pool of safe assets banks must hold to allow them to meet liquidity needs in a crisis. These assets are meant to be converted easily to cash during stressful episodes, but parts of the regulatory framework deter banks from utilizing them when their liquidity coverage ratio would fall below 100 percent, even when regulators say banks should use them.

Why it matters: An implication that liquidity buffers shouldn’t be breached hinders banks’ ability to support the economy when faced with liquidity stress. Banks need clarity from regulators on their expectations for using and maintaining high-quality liquid assets when appropriate and for those expectations to be understood and accepted by the market. The economy would benefit from regulatory and supervisory adjustments that clarify banks’ ability to use their liquid assets in times of stress.

The challenges: Factors that limit HQLA usability include:

  • The requirement to notify bank supervisors if the liquidity coverage ratio falls below 100 percent and to submit a remediation plan.
  • Potential disconnects between senior regulatory officials’ remarks on HQLA usability and the actions of individual examiners on the ground.
  • Requirements beyond the LCR and net stable funding ratio that drive liquidity requirements even higher (for example, Pillar 2 add-on requirements in the U.K. and internal liquidity stress tests).
  • Potential SEC disclosure requirements triggered by an LCR falling below 100 percent.
  • Potential negative reactions from investors or ratings agencies.

What could help: Several adjustments could permit greater usage of HQLA in stress, such as:

  • Authorizing regulators to modify net cash outflow assumptions contained in the liquidity requirements in stressful periods, creating a “Stress LCR.”
  • Modifying disclosure requirements to permit banks to disclose LCR metrics in accordance with Stress LCR requirements, or increasing the lag in disclosures or the period of averaging. 
  • Freezing the time period used in the historical lookback approach in times of stress.
  • Giving banks HQLA credit for unused discount-window capacity.
  • Create committed liquidity facilities that would count as HQLA and modify the LCR’s use terms for such facilities to be less punitive.
  • Moving to a dynamic LCR, which would modify the outflow assumptions for liabilities that remain after the start of a stress period.

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About Bank Policy Institute.

The Bank Policy Institute (BPI) is a nonpartisan public policy, research and advocacy group, representing the nation’s leading banks and their customers. Our members include universal banks, regional banks and the major foreign banks doing business in the United States. Collectively, they employ almost 2 million Americans, make nearly half of the nation’s small business loans, and are an engine for financial innovation and economic growth.

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