Banks agree minimum liquidity rules

Euro currency Banks around the world will now have to maintain access to certain levels of cash

Financial regulators and central bank governors from the world's biggest economies have made history by agreeing rules on the minimum quantities of cash and liquid or sellable assets that all banks must hold. It is an attempt to make banks less vulnerable to the kind of runs that shattered Northern Rock and Lehman Bros.

There is an oddity at the heart of today's historic agreement by the oversight body of the Basel Committee on Banking Supervision, which for the first time will impose new minimum requirements for the amount of cash and liquid assets that banks all over the world will have to hold.

The oddity is that most banks already hold considerably more than the new minimum requirement - but the reason they already pass this threshold is because we continue to live in strange and perilous times, with many Western economies parlously weak and the financial system still stressed.

Or to put it another way, over the past four years central banks - such as the Bank of England, European Central Bank and US Federal Reserve - have enormously increased their lending to counteract the weakness of commercial banks and of economies.

And, as a matter of definition, when central banks expand their respective balance sheets they create liquid assets for commercial banks.

So the ample liquidity held by big banks simply reflect the depressed times we live in, where banks are frequently reluctant to make loans to the real economy and deplete their liquid reserves.

Inadequate funds

To put it another way, this is the worst possible time to judge whether the liquidity reform will be useful.

More relevantly, the new rules would force banks to hold vastly more liquid assets than they did in the summer of 2007. Back then big banks barely had enough cash to meet demands for repayment from relatively small numbers of depositors and creditors.

That shortage of cash played a role in taking Northern Rock to the brink of collapse, made it impossible for HBOS and Royal Bank of Scotland to survive without emergency loans from the Bank of England, and was an important factor in the collapse of Lehman Bros.

Even so, and as pointed out by Sir Mervyn King - the governor of the Bank of England who chairs the oversight body of the Basel Committee, which is known as the Group of Governors and Heads of Supervision (GHOS) - the fundamental cause of the crises at these banks and others was that they had too little capital to absorb losses.

Their inadequate holdings of cash was more a trigger or precipitator of their woes, rather than their most basic flaw.

'Troubling paradox'

Perhaps the most striking characteristics of today's agreement - which amends a draft first published in 2010 - is that banks will be allowed to include corporate bonds, some shares and high-quality residential mortgage backed securities in their permitted stocks of liquid assets.

This goes against the grain of central banking and regulatory orthodoxy. In particular, the inclusion of mortgage-backed securities will be seen by some as odd, since these proved to be wholly illiquid and unsellable in the summer of 2007.

That said, arguably there is a much more basic and troubling paradox at the heart of the new rules. Which is that they define cash, central bank reserves and some marketable securities backed by sovereigns and central banks as the highest quality liquid assets.

If you believe that quantitative easing and the unprecedented creation of new money in much of the West - including the UK and US - risks debasing these assets over the long term, or if you believe that the credit worthiness of most Western governments is not what it was, then you would argue that banks are being encouraged to hold excessive stocks of assets that could end up becoming seriously and dangerously loss-making for them.

Robert Peston, economics editor Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 50.

    47 NewByzantium

    "Lets face it, the bankers, economists and politicians are clueless. They just don't know how to address the problems facing us ..."

    I think they know EXACTLY how to solve it, but the solution involves them parting with cash - paying taxes and all that stuff poor people have to do.

    What we see is self-interest taking control, with no regard for the consequences.

  • rate this

    Comment number 49.

    Excellent article - completely devoid of information. How much is the limit now, how much was it before the banks were allowed to make their own rules and how much are banks actually holding would all have been useful pieces of information to judge the announcement on.

  • Comment number 48.

    This comment was removed because the moderators found it broke the house rules. Explain.

  • rate this

    Comment number 47.

    Lets face it, the bankers, economists and politicians are clueless. They just don't know how to address the problems facing us and as a result come up with the same policies that caused the mess in the first place.

    Worryingly, only major events will prove the necessary seachange. Many are on the horizon.

  • rate this

    Comment number 46.

    Banks need to lend out their assets in order to stay in existence, but unrestrained lending to unsuitable applicants caused the crisis. Time to return to the 1960's and before system where the money was there if you could convince the bank manager that the money was being spent wisely and could be repaid.

  • rate this

    Comment number 45.

    We should really ask the banks themselves, what, if any, contingency plans they have.
    Think Blackadder when he asked Captain Rum about the ship's crew - Crew m'lord what crew?

    Contingency - what contingency?

  • rate this

    Comment number 44.

    So, new rules cooked up by bankers for bankers. I'm sure the bankers have our interests at heart, about as much as the politicians (who permit this fraud) do.

    This is corporatism at its most disgusting.

    We have a severe shortage of any real leaders who champion the free market, where insolvent banks would be exposed, brutally, through bankruptcy court - not bailed out upon innocent taxpayers.

  • rate this

    Comment number 43.

    Realistically, something had to be done.

    After all, paying out massive bonuses and donating to political parties isn't cheap these days.

    The real problem comes when cash flow to Party Political HQs dries up and the music has to be faced.

    ... and to think they all had the temerity to accuse unions of ruining the economy by demanding decent wages for their members!

  • rate this

    Comment number 42.

    The lunatics took over the asylum a long time ago. There may be a new head lunatic soon from the Great Asylum of GSachs - but nothing will change. 20 years of Stagflation.

  • rate this

    Comment number 41.

    @39 Don't be silly. Court is for the poor. The rich have 'inquiries' with a group of their friends.

  • rate this

    Comment number 40.

    Not my fault if people can't handle the truth.
    You may not like the world the way it is, and I'll never say it's perfect. But I will say it will keep going. Anarchists will have to wait another year I'm afraid.

  • rate this

    Comment number 39.

    Any rules are pointless because smart bankers will find a way around them and they know they will avoid prosecution. If you or I laundered money for a drug cartel we would spend time in jail while a bank pays a fine and the person that broke the law gets off free. This culture won't change unless bank misbehavior results in jail time for executives.

  • rate this

    Comment number 38.

    After 5 years and nothing has changed.

    Unbelievable that they now can keep "high-quality" MBS as security.

    This is all ridiculous and it is what you expect when Mr Print is the chairman.

    Disgusted and have no faith in banks, estate agents and sterling..

  • Comment number 37.

    This comment was removed because the moderators found it broke the house rules. Explain.

  • rate this

    Comment number 36.

    .. Just read Roberts addendum.

    I Wonder if the wunder kid Carney had anything to do with the drafting of the new accord?

    These bankers seem to believe in their own dribble.
    They really do think the sun shines from their nether region.

    And if they turn the tap on full everything will be just dandy.

    Bank failure is caused by regulations being too tight.
    In this unreal world they might be right!

  • rate this

    Comment number 35.

    In the meantime we are getting excited about a "recovery" that seems to be based on more borrowing - borrowing what from what from what being a moot point. Banks can be considered "liquid" on the basis of what they might be owed? Total stupidity and only a matter of time before it all unravels again . . .

  • rate this

    Comment number 34.

    Happy new year RP!
    So, the world keeps turning, business hasn't ground to a halt, & our 'evil capitalist' system didn't come to an end.

    Good old WOTW / Neverforget seems to have sloped away for the minute. Perhaps his prediction for 2012, (ie "ask a mayan") just applied to him?

    Blacksheep's prediction is that things will remain tough / flat, with maybe some green shoots nearer 2014.

  • rate this

    Comment number 33.

    Before the's wishing you all the best in 2013, if anyone deserves it, you do -- Back on topic: So there isn't even enough IMAGINARY money left in the world now.....?

    Oh Hum, is this saying something about the Banks, or about the (fragile bordering on evanescent) state of the Bond market? And the ongoing need to protect book valuations of retail, commercial and domestic property?

  • rate this

    Comment number 32.

    NEVER getting it back................

  • rate this

    Comment number 31.

    By the time any changes come into force they will have been watered down, or loop-holes found that they will in effect change nothing. The immediate crisis will have passed with nothing being resolved and the bubble will expand again - the insatiable greed of the finance "industry" will ensure it


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