Original Pages As noted in the Preface, a bank is a financial institution that holds insured customer deposits, borrows other resources to leverage the equity investment of its owners, and then uses the resulting resources to make loans and to acquire other financial assets. In this process, the bank borrows funds for a short term and recirculates them into the financial system through loans and other investments, most of which have a longer term. Take the simplest case: The bank has transformed very short-term funds into an asset the mortgage that has a much longer term.
Print August U. It is a financial cushion used to absorb unexpected losses to protect deposits and other liabilities. In the numerator, different capital ratios require different types of capital, such as tier 1 capital or common equity tier 1 capital.
The Basel Committee on Banking Supervision BCBSa global group of bank supervisors, strengthened capital requirements in in response to concerns that insufficient capital contributed to and worsened the financial crisis.
Regulators believed that the risk-weighted capital requirements misjudged the actual risk of certain assets, such as residential mortgages, and as a result banks did not hold sufficient capital to absorb losses.
In response, the SLR intentionally does not distinguish among assets based on risk. Because the SLR is not risk-sensitive, a bank must hold the same amount of capital against low risk assets e. Treasuries as higher risk assets e. In Septemberthe U. These revisions marginally improved the SLR, including changes to: Recognize cash variation margin in derivatives transactions; Allow netting of securities financing transactions SFTs when the securities are not re-hypothecated; Adopt a less punitive treatment of off-balance sheet commitments; and Allow daily averaging of on-balance sheet assets to reduce volatility in the SLR calculation.
Implications for Large U.
But banking organizations are already making changes to comply with the SLR given that the final rules require public disclosures beginning January 1, The Banks liquidity capital and deposits makes products and services that use the balance sheet more expensive.
That is, each banking organization must hold the highest amount of capital required by any of its capital ratios, whether risk-based or the SLR.
Custody and trust banks and broker-dealer banking organizations are more likely to be bound by the SLR because they have a relatively higher proportion of low risk assets. As a result, their capital requirements under the risk-insensitive SLR are likely to be higher than under the risk-based capital requirements.
Conversely, banking organizations with relatively higher risk assets, such as universal banks, are more likely to be bound by the risk-based requirements. The SLR has a unique impact on custody and trust banks and other business models with a high proportion of low risk assets.
Because the SLR is not risk sensitive, these low risk assets attract the same capital charge as higher risk, higher yielding assets. G-SIBs at a disadvantage compared with their foreign counterparts, although this may soon change as other jurisdictions are also contemplating heightened leverage requirements.
To manage these requirements, firms may shed assets, compress trades e.
Next Steps Firms are still evaluating the optimal asset mix to balance the liquid asset requirements of the LCR with the high capital charge of the SLR. This is a difficult exercise, and the appropriate mix remains a moving target as regulators continue to develop new capital and liquidity regulations and change monetary policy.
The Federal Reserve is contemplating an additional capital surcharge for banks that rely heavily on short-term wholesale funding and higher capital surcharges for the 8 U. In the liquidity space, there are forthcoming rules on a long-term liquidity requirement known as the net stable funding ratio.
Finally, the SLR may have less of an impact as the money supply contracts and there are fewer cash deposits in the system, leading to smaller overall balance sheets. The Basel Committee on Banking Supervision BCBSa global group of bank supervisors, developed the LCR in response to concerns that a lack of liquidity contributed to and worsened the financial crisis.
The LCR is intended to promote the short-term resilience of banking organizations, absorb shocks from financial and economic stress, and improve the measurement and management of liquidity risk. Treasuries and how to calculate cash outflows e. LCR rule was significantly more conservative than the Basel LCR, and members of the public filed over comment letters in response.
LCR rule addressed several — but not all — of the issues in the proposed rule. For instance, the final rule: Banking Organizations Banking organizations covered by the final LCR rule must meet 80 percent of the standard beginning in90 percent inand percent in As a result, U.
LCR rule did not appropriately capture stable and low risk sources of deposit funding from custody and other servicing relationships. The final rule allows a wider range of client deposits, such as cash from mutual funds and certain correspondent banking relationships, to receive LCR credit.
As a result, banks may hold less HQLA against these deposits and place them into higher yielding assets. Other types of client deposits, such as cash from hedge funds and private equity funds, continue to be expensive from an LCR perspective. For retail, universal, and broker-dealer banking organizations, the final rule improves the treatment of certain retail funding, retail brokered deposits, collateralized deposits e.
Although these changes offer some relief, the agencies did not change other major aspects of the proposal and the final rule remains more stringent than the international Basel LCR.
For example, the final rule generally does not expand the categories of assets that qualify as HQLA or further adjust the rules to recognize the unique nature of prime brokerage services. Other existing and forthcoming requirements include:Bank capital is the difference between a bank's assets and liabilities, and it represents the net worth of the bank or its value to investors.
The asset portion of a bank's . The liquidity coverage ratio rule was developed as a means of ensuring that banks maintain a level of liquidity sufficient to avoid a repeat performance of Under the new rule, all banks must.
Even the smallest banks have had to adjust to a decline in core deposits, and most banks have sought to improve profitability by reducing the size and liquidity of investment portfolios.
Thus, most banks use wholesale funding sources and off-balance-sheet sources of liquidity regularly. 1. Introduction According to the modern theory of financial intermediation, an important role of banks in the economy is to create liquidity by funding illiquid loans with liquid demand deposits (e.g.
Diamond. Liquidity reflects a financial institution’s ability to fund assets and meet financial obligations. Liquidity is essential in all banks to meet customer withdrawals, compensate for.
1. Introduction According to the modern theory of financial intermediation, an important role of banks in the economy is to create liquidity by funding illiquid loans with liquid demand deposits (e.g. Diamond.