The Board of Governors of the Federal Reserve System
("Board"), Office of the Comptroller of the Currency
("OCC"), and Federal Deposit Insurance Corporation
("FDIC") (collectively, the "Agencies") each
recently released a joint proposed rule, Net Stable Funding
Ratio: Liquidity Risk Management Standards and Disclosure
Requirements (the "Proposal"), which would set
quantitative long-term liquidity requirements for large and
internationally active U.S. bank holding companies
("BHCs") and their consolidated bank subsidiaries in an
effort to reduce the likelihood that disruptions to normal sources
of funding will harm liquidity.1
The Proposal is the long-term liquidity complement to the liquidity
coverage ratio ("LCR"),2 the short-term
liquidity rule adopted by the Agencies in September 2014. Together,
the Proposal and the LCR rule are designed to strengthen liquidity
risk management practices and improve the liquidity positions of
large banking organizations.
Comments are due on August 5, 2016.
The Proposal is Part of a Continuing Regulatory Focus on
Liquidity Measures
During the financial crisis, some large banking organizations did
not have access to sufficient sources of liquidity due to an
overreliance upon short-term, high-risk funding, an underinvestment
in liquid assets, or both. The lack of sufficient liquidity caused
governments around the world to step in to provide support to
maintain financial stability.
Since the financial crisis, national and international regulators
have taken several significant steps to strengthen banking
organizations' liquidity risk management and positions. The LCR
rule established the first standardized minimum liquidity
requirements for large and internationally active financial
institutions. The LCR rule requires large financial institutions to
hold a minimum amount of high-quality liquid assets that can be
readily converted into cash to meet net cash outflows over a
30-calendar-day period.3
Last fall, the Board proposed a long-term debt requirement and a
total loss-absorbing capacity4 requirement that would
apply to U.S. global systemically important banking institutions
("G-SIBs") and the U.S. operations of foreign G-SIBs,
requiring them to have sufficient amounts of equity and eligible
long-term capital debt to improve their ability to absorb
significant losses and withstand financial stress.5 In
August 2015, the Board adopted a risk-based capital surcharge for
G-SIBs, which is calculated to each institution's overall
systemic risk, including its reliance on short-term wholesale
funding.6
Earlier, in March 2014, the Board adopted a set of comprehensive
macroprudential requirements mandated by the Dodd-Frank Wall Street
Reform and Consumer Protection Act of 20107
("Dodd-Frank Act") that included standards for risk
management, liquidity risk management, and stress testing for
large, internationally active BHCs.8
Like many of the standards that came before it, the Proposal is
heavily influenced by the international framework set by the Basel
Committee on Banking Supervision ("Basel Committee") and
is tailored to the systemic footprint of companies, placing more
stringent requirements on larger, internationally active firms
whose viability is most interconnected with the viability of other
financial institutions and whose distress would threaten the global
economy as a whole.
Overview of the Proposal
The Proposal would apply to large and internationally active U.S.
bank holding companies and depository institutions with more than
$250 billion in total consolidated assets or $10 billion or more in
total on-balance-sheet foreign exposures ("covered
companies"), as well as those banking organizations'
subsidiary depository institutions that have total consolidated
assets of $10 billion or more.9 The Proposal would apply
a modified version of the net stable funding ratio
("NSFR") to U.S. BHCs with less than $250 billion, but
more than $50 billion, in total consolidated assets, and less than
$10 billion in on-balance-sheet foreign exposure.10 The
Proposal would not apply to BHCs with less than $50 billion in
total consolidated assets and would not apply to community
banks.
Covered companies would be required to maintain a stable funding
profile over a one-year time horizon and to rely on stable funding
sources such as equity, deposits, and long-term debt rather than
more volatile short-term funding in order to help ensure that each
company can survive one year of financial stress.
The Proposal would require "advanced approaches"
BHCs—those with more than $250 billion in assets and more
than $10 billion in foreign exposures—to cover 100 percent of
their obligations for a year, whereas smaller companies with
between $50 billion and $250 billion in assets would be required to
cover only 70 percent of their obligations for that same time
period.
According to the Preamble to the Proposal, larger internationally
active banking organizations "tend to have larger and more
complex liquidity profiles," which require "heightened
measures to manage their liquidity risk."11 Because
these large and complex banking organizations are often
interconnected with other large and complex banking organizations,
"threats to the availability of funding to larger firms pose
greater risks to the financial system and
economy."12
Covered companies would be required to publicly disclose the
company's NSFR and the components of its NSFR each calendar
quarter, and covered companies that fall short of the requirement
would be required to submit an improvement plan.
Calculating the NSFR. The NSFR is a quantitative
metric designed to measure the stability of a covered company's
funding profile.
A covered company's NSFR would be expressed as a ratio of its
available stable funding ("ASF") (the numerator of the
ratio) to its required stable funding ("RSF") (the
denominator of the ratio). The Proposal would require a covered
company to maintain an amount of ASF that is no less than the
amount of its RSF.13 The Proposal would require covered
companies to maintain an NSFR, on a consolidated basis, that is
equal to or greater than 1.0.
A covered company's ASF amount would be a weighted measure of
the stability of the company's funding over a one-year time
horizon. A covered company would calculate its ASF amount by
applying standardized weightings, called "ASF factors,"
to its equity and liabilities based on their expected stability.
Similarly, a covered company would calculate its RSF amount by
applying standardized weightings, called "RSF factors,"
to its assets, derivative exposures, and commitments based on their
liquidity characteristics. These characteristics would include
credit quality, tenor, encumbrances, counterparty type, and
characteristics of the market in which an asset trades, as
applicable.14
The assigned ASF and RSF factors in the Proposal are generally
consistent with the assigned ASF and RSF factors in the Basel
Committee's Basel III NSFR.15 The Proposal would
assign the highest weight—a 100 percent ASF factor—to
regulatory capital elements and long-term liabilities, a 95 percent
ASF factor to stable retail deposits, a 90 percent ASF factor to
other retail deposits, a 50 percent ASF factor to certain unsecured
wholesale funding transactions and most retail broker deposits, and
a 0 percent weight to certain short-term funding from central
banks.16
The Proposal would assign a 0 percent RSF factor to certain assets
that can be directly used to meet financial obligations, such as
cash, reserve bank balances, and claims on reserve banks and
foreign central banks that mature in less than six months. The
Proposal would give a 5 percent RSF to unencumbered level 1 liquid
assets, such as U.S. Treasury securities and other assets with high
credit quality and favorable market liquidity characteristics.
Certain secured lending transactions with a financial sector entity
that mature within six months would be assigned a 10 percent RSF,
and unencumbered level 2A liquid assets, such as obligations issued
or guaranteed by government-sponsored enterprises, would be
assigned a 15 percent RSF.
Certain secured lending transactions that mature in more than six
months (but less than one year), operational deposits held at
financial sector entities, and loans to retail customers and
counterparties that mature in less than one year would be included
in the list of assets, commitments, and derivatives assigned a 50
percent RSF. Retail mortgages and certain secured lending
transactions that mature in more than one year with risk weights
lower than 50 percent and 20 percent respectively would be assigned
a 65 percent RSF. Retail mortgages and certain secured lending
transactions that mature in more than one year with risk weights
higher than 50 percent and 20 percent respectively would be
assigned an 85 percent RSF, in addition to publicly traded non-HQLA
common equity shares and commodities. Loans to financial
institutions that mature in one year or more, assets deducted from
regulatory capital, non-public common equity shares, unposted
debits, and certain trade date receivables would be assigned a 100
percent RSF.17
The Proposal Would Set a Modified NSFR for Smaller
Companies. A version of the NSFR requirements would apply
to smaller BHCs18 with between $50 billion and $250
billion in total consolidated assets and total on-balance-sheet
foreign exposure of less than $10 billion ("modified NSFR
holding company"). A modified NSFR holding company would be
required to maintain a lower minimum amount of stable funding,
equivalent to 70 percent of the amount that would be required for a
covered company.19
According to the Proposal, although modified NSFR holding companies
"generally are smaller in size, less complex in structure, and
less reliant on riskier forms of funding than covered companies,
these modified NSFR holding companies are nevertheless important
providers of credit in the U.S. economy," and therefore the
Agencies are proposing a modified NSFR that "is tailored to
the less risky liquidity profile of these
companies."20
Other than a lower RSF requirement and a longer transition period,
the proposed modified NSFR requirement would be identical to the
proposed NSFR requirement for covered companies, including the
public disclosure requirements.
The Proposal Would Establish New Disclosure
Requirements. The Proposal would require a covered company
to take several steps if its NSFR fell below 1.0, including
notifying its primary federal regulator within 10 days of the
shortfall and submitting a remediation plan.21 The Proposal would
not prescribe a particular supervisory response to address a
violation of the NSFR requirement. Instead, the Proposal would
grant flexibility for the Agencies to respond based on the
circumstances of a particular case. Potential supervisory responses
could include an informal supervisory action, a cease-and-desist
order, or a civil money penalty.22 In addition, a
covered company would be required to publicly disclose its NSFR and
NSFR components each calendar quarter to facilitate understanding
of its calculations and results.23 Disclosures could be
made on the company's website, in a public financial report, or
in a public regulatory report.
Effective Dates. The Proposal would become
effective on January 1, 2018. A company that becomes subject to the
Proposal after that date would be required to comply with the NSFR
requirement beginning on April 1 of the following year. The
Proposal uses the following example: If a BHC becomes subject to
the Proposal on December 31, 2020 because it reports on its
year-end Consolidated Financial Statements for Holding Companies
(FR Y-9C) that it has total consolidated assets of $251 billion,
that BHC would be required to begin complying with the proposed
NSFR requirement on April 1, 2021.24
The Proposal would grant a longer transition period for modified
NSFR holding companies than for covered companies. a modified NSFR
holding company that becomes subject to the Proposal after the
January 1, 2018 effective date would be required to comply with the
proposed modified NSFR requirement one year after the date that it
meets the applicable thresholds.25
The Basel Committee's Influence. Following the
financial crisis, the Basel Committee began revising its existing
capital adequacy guidelines and developed new capital and liquidity
requirements ("Basel III") designed to strengthen the
regulatory capital regime for internationally active
banks.26 In 2011, as part of the Board's initial
proposed macroprudential requirements mandated by the Dodd-Frank
Act, the Board announced that it would implement substantially all
of the Basel III capital rules.27
In October 2014, the Basel Committee published its NSFR standard,
which requires all internationally active banking organizations on
a consolidated basis, regardless of size, to retain stable funding
for 100 percent of their obligations for one year.28 The
standard could potentially apply to other banks and to any subset
of entities of internationally active banks depending on how a
jurisdiction adopts the framework. The Basel Committee's NSFR
is the longer-term equivalent of the Basel Committee's
LCR.29 In this respect, there is a clear parallel
similar to the Proposal and the LCR rule.
The Proposal is largely the same as the Basel Committee's NSFR,
except for the largest difference—the scope of companies to
which it applies. Like many of the macroprudential requirements
that resulted from the Dodd-Frank Act and the U.S. implementation
of the Basel Committee's framework, the Proposal differentiates
between the largest banks and smaller institutions. For example,
under the Proposal, the largest covered companies would be required
to maintain stable funding for 100 percent of their obligations for
one year, while smaller covered companies would be required to
cover 70 percent.
Footnotes
1 The Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation, Net Stable Funding Ratio: Liquidity Risk Measurement Standards and Disclosure Requirements, 81 Fed. Reg. 35123 (June 1, 2016) (to be codified at 12 C.F.R. part 249 (Board); 12 C.F.R. part 50 (OCC), 12 C.F.R. part 329) (FDIC)) (the "Proposal").
2 LCR is the ratio of liquid assets to projected net cash outflows. The Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation, Liquidity Coverage Ratio: Liquidity Risk Measurement Standards, 79 Fed. Reg. 61440 (Oct. 10, 2014), codified at 12 C.F.R. part 249 (Board), 12 C.F.R. part 50 (OCC), 12 C.F.R. part 329 (FDIC).
3 The LCR rule applies to all banking organizations with $250 billion or more in total consolidated assets or $10 billion or more in on-balance-sheet foreign exposure and to these banking organizations' subsidiary depository institutions that have assets of $10 billion or more. The rule applies a less stringent LCR to BHCs that do not meet these thresholds but have $50 billion or more in total assets. Id.
4 The Board of Governors of the Federal Reserve System, Total Loss Absorbing Capacity, Long-Term Debt, and Clean Holding Company Requirements for Systemically Important U.S. Bank Holding Companies and Intermediate Holding Companies of Systemically Important Foreign Banking Organizations; Regulatory Capital Deduction for Investments in Certain Unsecured Debt of Systemically Important U.S. Bank Holding Companies, 80 Fed. Reg. 74926 (Nov. 20, 2015) (to be codified at 12 C.F.R. parts 217 and 252).
5 Staff Memo to the Board, Notice of Proposed Rulemaking to Implement Liquidity Risk Standards for Certain FDIC Supervised Institutions (Apr. 26, 2016).
6 The Board of Governors of the Federal Reserve System, Regulatory Capital Rules: Implementation of Risk-Based Capital Surcharges for Global Systemically Important Bank Holding Companies, 80 Fed. Reg. 49082 (Aug. 14, 2015) (codified at 12 C.F.R. parts 208 and 217).
7 Public Law 111-203, 124 Stat. 1376 (2010).
8 The Board of Governors of the Federal Reserve System, Enhanced Prudential Standards for Bank Holding Companies and Foreign Banking Organizations, 79 Fed. Reg. 17240 (Mar. 27, 2014) (codified at Regulation YY, 12 C.F.R part 252).
9 Proposal at 35128.
10 The Proposal also applies the modified approach to savings and loan holding companies that have $50 billion or more in total consolidated assets and do not have significant insurance or commercial operations. Id.
11 Id.
12 Id.
13 Id. at 35132; 35134; 35140.
14 Id.
15 Basel Committee on Banking Supervision, Basel III: the net stable funding ratio (Oct. 2014).
16 Id. at 35135-40.
17 Id. at 35140-49.
18 The Modified NSFR would also apply to savings and loan companies without significant insurance or commercial operations that have $50 billion or more, but less than $250 billion, in total consolidated assets and less than $10 billion in total on-balance-sheet foreign exposure.
19 Id. at 35157.
20 Id. at 35157-58.
21 Id. at 35157.
22 Id.
23 Id. at 35158-61.
24 Id. at 35129.
25 Id. at 35158.
26 Basel Committee on Banking Supervision, International Regulatory Framework for Banks.
27 Board of Governors of the Federal Reserve System, Enhanced Prudential Standards and Early Remediation Requirements for Covered Companies 77 Fed. Reg. 599, 602, 634 (Jan. 5, 2012).
28 Basel Committee on Banking Supervision, Basel III: the net stable funding ratio (Oct. 2014).
29 Id.
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