Fed Proposes Tougher Basel III Liquidity Rules

NEW YORK ( TheStreet) -- The Federal Reserve on Thursday proposed tougher rules to serve as guidelines to implement the liquidity coverage standards introduced by the Basel Committee in 2010. Investors should be watching closely as to whether they are followed.

Investors by now have grown accustomed to the Fed's annual stress test for the nation's largest banks given each March, but the tests have only focused on banks' abilities to survive a "severely adverse" economic scenario while remaining well-capitalized.

Federal Reserve Chairman Ben Bernanke in Washington on Thursday said that "liquidity is essential to a bank's viability and central to the smooth functioning of the financial system. The proposed rule would, for the first time in the United States, put in place a quantitative liquidity requirement that would foster a more resilient and safer financial system in conjunction with other reforms."

Federal Reserve Governor Daniel Tarullo, also today, added that "since financial crises usually begin with a liquidity squeeze that further weakens the capital position of vulnerable firms, it is essential that we adopt liquidity regulations to complement the stronger capital requirements, stress testing, and other enhancements to the regulatory system we have been putting in place over the past several years."

The Basel III Liquidity Coverage Ratio is designed to ensure "that a bank has an adequate stock of unencumbered high-quality liquid assets that can be converted into cash easily and immediately in private markets to meet its liquidity needs for a 30 calendar day liquidity stress scenario," according to the Basel Committee's statement in January.

Under the Basel Committee's rules, a large bank's LCR will be required to be at least 60% when the rule is phased in beginning in January 2015, with the requirement rising to 100%, once the rules are fully implemented in January 2019. The big banks will also eventually be required to maintain a net stable funding ratio (NSFR) of 100%. The NSFR is meant to measure a banks available "stable" funding, to meet its liquidity requirements over a period of 12 months.

But the Federal Reserve said it is taking a more "stringent" approach, by "including the range of assets that will qualify as HQLA and the assumed rate of outflows of certain kinds of funding," according to the regulator's press release.

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