Basel Committee continues to reject equity for the LCR
Stefan Walter, general secretary of the Basel Committee on Banking Supervision, said that equities do not have the necessary characteristics to be included in the liquidity coverage ratio (LCR) – but some banks disagree.
“This issue is not being discussed in the Committee. While we recognise that certain equities are liquid, high-quality liquid assets in the LCR must be able to endure a period of stress without incurring large fire-sale discounts,” Walter said.
“The liquidity standards clearly outline the characteristics for high-quality liquid assets. Equities fail to meet these characteristics as they typically carry considerable credit and market risk, are often correlated with risky assets and, in times of crisis, tend not to be flight-to-quality assets.”
Other regulators also see problems.
“Putting equity in the LCR would construct a contagion line from the real economy to the banks,” said the head of financial stability at one European central bank.
“If equity markets crashed, banks could suddenly find themselves very short on the ratio. The contagion line could work the other way too – if lots of banks are trying to get rid of equity at the same time, a problem in the financial industry would spread to the real economy because share prices would drop due to the large sales,”
The LCR is designed to ensure that banks have enough high-quality liquid assets to survive a 30-day period of acute market stress. However, it has become one of the most controversial elements of Basel III, with some participants arguing there are not enough eligible assets – as it stands, heavily focused on government bonds – for domestic banks to meet the LCR requirement in certain jurisdictions.
Some banks have argued that including equities in the LCR would help resolve this problem.
“Recognising appropriate forms of equity as LCR-eligible is a necessary step. It’s all about diversification – that is a key principle of risk management,” said David Escoffier, co-head of global equity flow at Société Générale Corporate and Investment Banking in London.
“If you have all your cash-raising collateral in one asset class, such as government bonds, it will be a pretty crowded trade when there is a crisis. We need to be able to diversify and use other assets as cash providers. We would restrict the equity in the LCR to highly liquid indexes, such as the Dax, FTSE 100 or Dow Jones Eurostoxx 50, or single stocks included in those indexes. That’s one way to ensure the liquidity and price stability of the asset.”
He added that concerns over price stability could be eased by assigning suitable haircuts to any equity present in the LCR.