Federal Reserve: G.O.s may count as liquidity during financial stress

By Marisa Wong

Madison, Wis., May 21 – The Federal Reserve Board proposed on Thursday adding some general obligation state and municipal bonds to the range of assets a banking organization may use to satisfy regulatory requirements designed to ensure that large banking organizations have the capacity to meet their liquidity needs during a period of financial stress, according to a press release.

Under the liquidity coverage ratio requirement adopted by the federal banking agencies last September, large banking organizations are required to hold high-quality liquid assets that can be easily and quickly converted into cash within 30 days during a period of financial stress.

Federal Reserve studies suggest that some G.O. U.S. state and municipal bonds should qualify under the liquidity coverage ratio as high-quality liquid assets, because they have liquidity characteristics sufficiently similar to investment-grade corporate bonds and other high-quality liquid asset classes, the release said.

The proposed rule would allow investment-grade state and municipal G.O. bonds to be counted as high-quality liquid assets up to certain levels if they meet the same liquidity criteria that currently apply to corporate debt securities.

The limits on the amount of a state or municipality’s bonds that could qualify are based on the specific liquidity characteristics of the bonds.

The proposed rule would apply only to entities subject to the liquidity coverage ratio and supervised by the Federal Reserve. These include the following:

• Bank holding companies, savings and loan holding companies and state member banks with $250 billion or more in total consolidated assets or $10 billion or more in on-balance sheet foreign exposure;

• State member banks with $10 billion or more in total consolidated assets that are subsidiaries of the bank holding companies described above; and

• Bank holding companies and savings and loan holding companies with $50 billion or more in total consolidated assets, to which a less stringent liquidity coverage ratio applies.

No bank that is a subsidiary of a holding company with less than $50 billion in assets is required to meet any liquidity coverage ratio requirement, the Federal Reserve said.

The Federal Reserve commented that the recent financial crisis highlighted the need for enhanced liquidity risk-management practices at the largest financial institutions.

Financial institutions with sufficient liquidity reserves are better able to mitigate the risks of creditor and counterparty runs. The proposed rule would maintain the strong liquidity standards of the liquidity coverage ratio, while giving banks flexibility to hold a wider range of high-quality liquid assets.

Comments on the proposed rule will be accepted until July 24, the release noted.

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