An Excerpt From:
K&L Gates Global Government Solutions ® 2011: Mid-Year Outlook
July 2011
Financial Services
Basel III Liquidity Standards and Other Developments
Affecting Bank Cash Management Services
In the coming months, Group of Twenty (“G-20”) nations will be implementing
new bank liquidity standards as part of the international financial reforms known
as Basel III, the third set of global regulatory standards put forward by the Basel
Committee on Banking Supervision. Together with several parallel regulatory
reform efforts, these changes will affect corporate cash management and
competition between banks and other institutions providing related services.
Basel III Liquidity Standards
Although Basel III’s new capital standards
have received more attention in the
press, Basel III also includes two liquidity
ratios to ensure that adequate funding is
available in times of stress. The liquidity
coverage ratio aims to ensure that
adequate high quality liquid assets are
available throughout a short-term period
of stress lasting thirty days. The net stable
funding ratio seeks to ensure liquidity
needs are met over a longer, 1-year
period. To meet these standards, many
banks will need to adjust by investing
a larger portion of their assets in liquid,
lower yield instruments. Given the stringent
capital requirements of Basel III and other
regulatory mandates, banks may be hard
pressed to concurrently build reserves of
liquid assets in order to meet the new
liquidity standards.
U.S. regulators expect to propose
regulations implementing Basel III
liquidity and capital standards in late
2011, with final rules to be effective
before 2013. Implementing the liquidity
standards in the United States will be
complicated by the separate regulatory
reforms discussed below.
Banks Paying Interest on Business
Checking Accounts
Effective July 21, 2011, the DoddFrank Wall Street Reform and Consumer
Protection Act (the “Dodd-Frank Act”)
repeals the long-standing prohibition on
banks paying interest on business checking
accounts. Banks and their institutional
customers may enjoy these new interest
bearing demand deposit accounts because
paying directly for these accounts would be
structurally simpler than many of the cash
sweep programs used today. However,
banks competing in this new environment
will face increased economic pressure in
the form of increased interest rate costs.
In addition, it is likely that the competition
within the banking industry will favor larger
institutions over smaller institutions because
they will be able to better absorb the higher
costs. Nevertheless, this cost pressure
will be especially acute for all depository
institutions because it comes at a time when
banks are simultaneously building their
capital and liquidity reserves.
Deposit Insurance Advantage for
Business Checking Accounts
The new interest bearing demand deposit
account for businesses presents banks
with an opportunity to compete more
effectively with money market funds
(“MMFs”), which offer a highly liquid
and secure investment with a traditionally
higher yield than the non-interest bearing
K&L Gates Global Government Solutions ® 2011 Mid-Year Outlook
15
Financial Services
demand deposit account. Banks that
can pay competitive rates on business
checking accounts will have an additional
advantage over MMFs because these
deposits will be insured by the Federal
Deposit Insurance Corporation (“FDIC”) for
up to $250,000 per depositor. Further, it
may be the case that the market will find
a way to replicate the deposit exchange
programs used in the CD arena to enable
business customers to receive $250,000
on each portion of their demand deposit,
which would be spread among multiple
depository institutions, effectively obtaining
full insurance for business deposits.
Key Definitions Being Developed
As a matter of balance sheet
management, the issue for banks
adapting to the liquidity ratios will
depend on how deposits are classified
as “stable” and “less stable” for
purposes of predicting liquidity demands
during times of stress. Basel III, however,
provides only general guidance as to
how these terms should be defined,
calling on each G-20 nation to develop
more detailed definitions during
implementation. In the United States, any
such definitions will likely depend on the
conclusions of the FDIC’s current study of
deposit classifications. The FDIC study,
required under the Dodd-Frank Act by
July 21, 2011, must assess the relative
stability of “brokered” and “core”
deposits and is expected to recommend
a new classification system that will
sort various types of deposits along a
continuum of stability.
16
In the coming months,
G-20 nations will be implementing new
bank liquidity standards.
International Influences
Conclusion
U.S. regulators have endorsed Basel III,
including its liquidity standards, and are
expected to implement it in its entirety,
but certain authorities have signaled
resistance to the liquidity standards. For
example, the European Commission’s
draft implementation rules state that the
EU will consider proposing one of the
liquidity ratios only after an observation
and review period. Similarly, Bank of
Canada Governor Mark Carney has
recently stated that global regulators may
amend the liquidity standards as part of
implementation. Foreign resistance could
increase pressure on U.S. regulators
to similarly adjust the Basel III liquidity
standards during implementation.
Adapting to the Basel III liquidity standards
may prove difficult for banks because of
simultaneous pressure to increase capital
reserves, market competition with MMFs,
and uncertainties about how each G-20
nation will implement Basel III.
K&L Gates Global Government Solutions ® 2011 Mid-Year Outlook
Rebecca H. Laird (Washington, D.C.)
rebecca.laird@klgates.com
Collins R. Clark (Washington, D.C.)
collins.clark@klgates.com
The authors acknowledge the assistance of
summer associate Nickolas G. Milonas for his
contributions to this article.
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