Can regulation make banks less safe? What has happened in the past week certainly seems to suggest so. Three large European banks –
The bosses of all three banks sung the same refrain to explain the wind-down of cash and safe assets: It will help them boost their leverage ratios, a gauge of financial soundness that measures a bank’s equity against its overall assets.
Regulators and investors across both sides of the Atlantic have stepped up pressure on lenders to reach a leverage ratio threshold of 3 per cent much earlier than the 2018 deadline agreed on by the
Depleting cash levels, government bond portfolios and holdings of other easy-to-liquidate assets is a handy shortcut for weaker capitalised banks such as
Banks’ drive to reduce their liquid holdings reverses a trend that started after the collapse of
Regulators have pushed banks to do this as part of the lessons learnt from the global liquidity crunch of 2007-09. The first-ever global liquidity standards – an early element of the Basel III rule book called the liquidity coverage ratio – require banks to stockpile enough liquid assets to sustain their operations for 30 days if faced with another crisis. After a brief period of Pavlovian opposition, bankers have long since embraced the new rules. They realised that a higher liquidity buffer gives them more credit with rating agencies, clients and investors.
However, the recent downward trend at
Of course, there are other reasons why banks would eat into their cash positions. The initial 2015 deadline to fully comply with the liquidity coverage ratio has been extended by four more years. Some, such as the
Meanwhile in the US, banks including
But even if that is the case, their key argument is worth listening to: leverage ratios do not make a distinction between liquid, non-risky assets, such as cash, on one side and high-risk, illiquid instruments, such as complex securitisation products, on the other. For leverage purposes, an asset is an asset. The main reason for Lehman Brothers’ downfall was its imprudent lack of liquidity, according to
There is certainly a rationale for a leverage ratio threshold that will make banks safer by forcing them to hold more equity in relation to their assets. But it makes no sense to persist with definitions of leverage that clash with the objectives of liquidity rules. Policy makers should overhaul leverage definitions to exclude or at least apply discounts to any assets that count towards liquidity ratios. Without change, banks will continue depleting liquidity safety buffers – with potentially dangerous consequences.
Daniel Schäfer is the Financial Times’ investment banking correspondent
Copyright The Financial Times Limited 2013