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 Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 90.

    Presumeably this includes Australian & New Zealand Banks? Australia being the strongest country financially in the world with the strongest most stable currency from 2008. Perhaps other countries would learn alot from Australia's Reserve Bank & Government in how to manage economies currency & interest rates. They have a stable strong currency & learned to live with high food prices & exporting.

  • rate this

    Comment number 89.

    89 ~ Natalie, are assets collateral?

    86 ~ The US massively devalued their housing market bubble and provided they sort out asset flags of property for sale, distressed property and mortgaged investments, which mortgaged properties are, things will pick up nicely until housing gets up another head of steam. If long term investment picks up, they are out of fragile woods with cheap oil and gas

  • rate this

    Comment number 88.

    Basel 3. Clue in the number. Third go. Since 1988. Third go in 25 years......

  • rate this

    Comment number 87.

    If assets are not sellable, are they are assets at all?

  • rate this

    Comment number 86.

    Mortgage-backed securities as cash equivalents!? What's next? Seashells? Old socks?

    The US Fed is printing $80 bln per-month for an unlimited period and buying mortgage-backed securities with it, to prop-up the housing market, so that the suckers ... I mean, the American people, feel wealthier due to higher house prices and so spend more.

    Maybe these rules are all meant to prop-up those MBSs.

  • rate this

    Comment number 85.

    #83. down_the_rabbit_hole

    The finance system is the new religion.
    Instead of clerics ripping us off and building abbeys, cathedrals and the like - we now have whole city quarters full of bankers. All busy working out how to cleverly extract wealth from us.

    They don't actually produce anything. We have to do that. Then give it to them. For them to exist.

  • rate this

    Comment number 84.

    I have some old 1970's Monopoly money somewhere in the back of my cupboard. I've now decided to declare this as proper cash, just as the banks seem to be doing in order to protect the savings of their ruling elite.

    Actually - This is a great wheeze...

    I'm now a multi-millionaire and I own 4 hotels on Mayfair and a utility company.

    Very, very sad and typical of the whole rotten system.

  • rate this

    Comment number 83.

    @81 well since you put it like that.....

    ..I honestly find the tolerance of the financial system baffling, it's failed continually (especially in this country) for nearly a century now and what is 'our' (though not really mine or your) response? let them create their own legislation which effectively changes nothing... if saddens me but i wonder what can the average person do?

  • rate this

    Comment number 82.

    Liquid assets, hmmmm.....

    Debt default has been managed effectively since before Jesus visited Golgotha and the world economy did not bat an eyelid. Sort out the securitisation and there isn't a profit.

    The problem which remains is debt and it isn't going away, therefore this universal product must obey the laws of gravity and interest rates remain low. Debt is a means and not an end.

  • rate this

    Comment number 81.

    #79. down_the_rabbit_hole

    Wash your mouth out.

    You do realise that Nobel prizes have been given to people that can regiment the workings of the market.

    And also that learned organisations (LSE) have been established that extend knowledge to the masses.

    Better get in line quick. You know it makes sense.

  • Comment number 80.

    All this user's posts have been removed.Why?

  • rate this

    Comment number 79.

    lol I admire the banking system in a peverse way - despite complete and utter failure they have managed to walk away from the economic crisis with huge profit and no reason to change the practises that lead to economic ruin in the first place, it's incredible!...

    Although only slightly less incredible than allowing the banks themsleves to create new legislation for... themselves... eh?

  • rate this

    Comment number 78.

    The only fair banking system is one where all the profits are returned to those who invest the money in the first place.

    i.e. You and me

  • Comment number 77.

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

  • Comment number 76.

    All this user's posts have been removed.Why?

  • rate this

    Comment number 75.

    70 Eddy

    It's what Hitchcock called a McGuffin - a trick that makes the story work. If banks can satisfy the rules by referring to mortgage-backed securities, despite the fact nobody knows how much they're worth, then they will. That will make it easier for them to lend. If a bank run starts it won't matter the assets are valueless - banks' solvency is trompe l'oeil anyway.

  • rate this

    Comment number 74.

    The article below explains what has happened to our money and how banks have robbed us by using fiat money.

    Getting us back on the gold standard is something that hasn't even been discussed because banks wouldn't make as much money. This is the only solution and the government hasn't even suggested it.

  • rate this

    Comment number 73.

    People Bare in Mind ..Shadow Banking(Derivatives) were born out of Real Economy. purely through Fractional Reserve System and Speculations on Commodity all due to We the People Tax.. Now these Powers are Keeping us Hostage..Voodoo Economics For Dummies Perhaps..

  • Comment number 72.

    All this user's posts have been removed.Why?

  • rate this

    Comment number 71.

    'include...bonds, shares, mortgage backed securities... as liquid assets'

    Aren't the banks creating enough money out of thin air?


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