Regulation > Liquid assets

Published: 14th November 2009 by William Webster

Defining liquid assets

Two things took my eye in the FSA’s Policy Statement 09/16 - Strengthening liquidity standards. I thought I might share them with you. The first altered my opinion, the second puzzled me.

What altered my opinion? The narrow definition in PS 09/16 S.8 of liquid assets (they comprise gilts and central bank deposits).

Conventional wisdom would have cast the net wider. It’s not your traditional definition of what’s liquid and what’s not. But then what’s the buffer for?

A two week firm and market stress with no management action. And that’s where it all makes sense. It is what’s liquid in a totally dysfunctional market. Under these circumstances these assets remain liquid.

If firms want to take risk they must pay the cost - not assume central banks will immediately step in when private markets fail. It protects the taxpayer. The FSA is right.

What puzzled me? Is your firm going to replace the Bank in QE?

I think you will agree that your firm will end up holding more Gilts (Government debt).

Buried in PS 09/16 is a cost benefit analysis. According to S.13.26, the UK banking system holds about £280bn in liquidity buffers that meet the new criteria. FSA estimates of how much these buffers will increase varies. It depends on how severely the Individual Liquidity Guidance (ILG) is applied and the reduction in wholesale funding that is achieved. A mid range scenario of outcomes suggests a £180bn - £310bn liquidity buffer shortfall for the industry.

On 5^th November the Bank of England increased QE by £25bn to £200bn. The big question is when and how will this be unwound?

Does the FSA’s analysis mean that as firms start to meet their ILGs they will replace the BoE in financing government borrowing?

Does this lead to interest rates rising more slowly than they otherwise would have, whilst bank lending is restricted by the cost of liquidity? Deleverage would be more protracted but less volatile. Not a “V” or “W” but a “U” shaped recession.

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Related Documents

Regulation > Do liquid assets give you risk?

14th October 2009

This is written for anyone interested in liquidity. Here's a brief summary. Firms will be required to hold substantially more liquidity (20%); T-bills, cash and treasuries (Gilts) will be the main recipients; Gilts are not risk free; Interest rate risk can be hedged; Swap spread risk, (basis risk), can't and the risk can be large; Try the liquid asset KISS test; It's the balance sheet structure that will give you the edge (is that what individual assessments are about?)

Regulation > Consultation Paper 08/22 Strengthening liquidity standards December 2008

31st January 2009

This CP sets out the FSA's plans to reform the liquidity regime. It requires firms to undertake a much more rigorous analysis of their liquidity position. This includes the effect of stressed conditions on their business. The firm will submit what it considers to be an appropriate liquidity buffer to the regulator. The FSA will then decide whether it is sufficient. In determining the buffer the FSA will also assess the firm's systems and management. If these are considered weak the buffer will be increased accordingly. The liquidity buffer can only be held in liquid assets. The FSA's view is that this primarily means Gilts, sovereign debt or central bank deposits. The FSA makes it clear, "The responsibility of adopting a sound approach to liquidity risk management is on firms and their senior management".