International banks had reason to celebrate Monday when they received a somewhat unexpected New Year’s gift from their regulators. The central bank governors and heads of supervision that oversee the Basel Committee on Banking Supervision agreed to a very substantial softening of prospective global liquidity standards. This development is bullish for the international banks and for the global economy and markets.
These standards, first drafted in 2010 in the wake of the global financial crisis, are an important part of the so-called Basel III accord and have the objective of assuring that major banks have sufficient liquidity to weather future financial storms. Over the past two years, banks have argued strenuously that the draft standards were too strict, probably unworkable, and certain to have significant negative effects on banks’ willingness to lend and hence on economic growth. The regulators have now responded to those concerns, but the extent to which they have loosened the standards was unexpected.
The revised standards include a very welcome four-year delay in the date when they are to be fully enforced, moving it to 2019. While most of the largest banks, particularly those in North America, can meet those standards now, the delay will be valuable for weaker banks, including those that were caught up in last year’s eurozone financial crisis.
The most important, and also somewhat controversial, revisions concern the definition of "high-quality liquid assets" that banks will be required to hold as a buffer against a future crisis. The definition had been very tightly drawn, to include only government bonds, cash, and central bank reserves. Now it is much broader, including also corporate bonds rated A+ to as low as BBB-, AA-rated residential mortgage-backed securities, and even certain equities. While the earlier definition was too draconian, some are questioning whether all of the assets now included will really prove to be liquid when a crisis develops. The central banks appear to have accepted having a little more risk in the system rather than insisting on a standard that could hamper the ongoing weak recovery in the advanced economies.
The softening of the standards should ease the current problem, particularly apparent in Europe, of banks seeking to amass liquidity to meet the anticipated future regulations to the detriment of lending to businesses and consumers. Together with other adjustments in the standards, the above changes should contribute to the profitability of international banks, and the equity markets are already taking note. There should also be a positive effect on the demand for corporate bonds. Finally, the moribund securitization market looks likely to receive a kick-start. The broader positive economic effects will take time to develop and are likely to be most evident in Europe. At Cumberland Advisors our equity ETF portfolios – U.S., International, and Global Multi-Asset Class – are fully invested.