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  • Writer's pictureWilliam Webster

On the buffer

In PS 9/16 and BIPRU 12 the FSA defined what a firm could count towards its liquidity buffer. This was mainly high quality government debt. For firms with Sterling balance sheets it's meant a Reserve Account, T-bills and Gilts. At the time this was sensible. If you recall Mr. Market had a near death experience and about the only thing that could be sold or repoed carried a government label. It's now time to ask whether the buffer restrictions in their current form are desirable. The widespread use of holding Gilts by banks may under certain scenarios destabilise the system. If you recall the FSA uses three liquidity stresses - idiosyncratic, market wide and a combination. In a market wide stress where UK banks seek collectively to sell or repo their Gilt holdings isn't a disorderly market the probable outcome? If this in itself isn’t enough to review what's held in bank buffers is not the intertwined nature of UK banking and the UK Government unhealthy? Rapid liquidation of Gilts by UK banks could disrupt Gilt issuance. Failure to curb public debt could also increase yields leading in some cases to losses on buffer assets. You will see I haven't addressed the cost of holding the buffer but when you buy insurance you expect it to cover your risk not potentially add to it. On balance the buffer requirements have hard wired additional instability into the system when it is under extreme stress. That obviously wasn’t the intention but now times have moved so should the rules. One problem remains, who would buy all those Gilts?

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