Monday, June 12, 2017

BIS Issues Further LCR Guidance

Includes steps toward calibration of the LCR to address short term financing activities

Author: David Schwartz J.D. CPA

On June 8, 2017, the Basel Committee on Banking Supervision (BIS) issued a second set of frequently asked questions (FAQs) and answers on Basel III's Liquidity Coverage Ratio (LCR).[1] This latest guidance responds to questions and requests for clarification received from commenters to the Basel Committee’s January 2013 publication of the LCR standard. The June 8 release combines new guidance with the existing FAQs published in April 2016 to form a complete set of LCR interpretations to date. 


These interpretations are vital because the calculations of the ratio's numerator and denominator can require more than 300 separate inputs, and differences exist in the calculation of the ratio under Basel, U.S., and other jurisdictions. As the Office of Financial Research noted in its October 7, 2015 paper on the LCR:


"[T]here is much more to the rule than this simple summary ratio. The calculation of both the numerator and denominator are complex and involve over 300 inputs. The Basel version contains two caps in the LCR numerator to ensure asset diversification in banks’ HQLA buffers and another cap in the denominator to prevent over-reliance on cash inflows. These caps make use of min/max functions that introduce nonlinearities into banks’ LCRs and increase the complexity of forecasting and maintaining compliance, particularly during liquidity shocks. The U.S. rule contains additional min/max functions in both the numerator and denominator."


The publication’s 34 FAQ’s range from interpretations regarding the treatment in calculating the LCR of longs and shorts, liquidity facilities, special purpose entities (SPEs) and conduits, and central counterparties.  Quite a few of interpretations are relevant to securities lending and repo or touch on situations relevant to securities finance transactions in general, including:


  • Collateral treatment (Paragraphs 118–123)
  • Excess collateral (paragraph 120)
  • Unsecured securities borrowings/lending (Paragraphs 141, and 160)
  • Maturity of margin loans (Paragraph 145)
  • Secured lending transactions – reuse of the collateral to cover a customer’s short position (paragraphs 140 and 145–6)
  • Secured lending transactions – reuse of the collateral in a repo transaction with collateral substitution right (paragraphs 145–6)
  • Secured transactions collateralized by a pool of assets
  • Ability to return collateral (paragraph 148)
  • Adjustment of HQLA – relevance of rehypothecated collateral for the unwind mechanism (Annex 1, paragraph 4)


These interpretations should be read closely by all affected financial institutions. While they do not resolve all of the nuanced questions about the LCR’s application in practice, they do bring more clarity to a wide range of situations, particularly with respect to various aspects of securities financing transactions. These interpretations are valuable step toward meaningful calibration of the LCR to address short term financing activities. 



[1] The LCR requires banks and bank holding companies to hold high quality liquid assets (HQLA) at sufficient levels to meet 30-day liquidity needs in a situation of severe idiosyncratic and systemic stress. The LCR is calculated as HQLA divided by projected 30-day net cash outflows under stress; the requirement is that banks maintain a minimum ratio of 100 percent.