The Global Financial Crisis made financial regulators and credit agencies easy targets for criticism by investors and politicians alike. In the aftermath, regulators turned full circle away from deregulation towards much tougher policies to reign in risk taken by inherently leveraged institutions, especially those regarded as ‘too big to fail’.

Two years after the drafting of Basel III, the latest edition of global banking regulation standards, the regulator, consisting of global central bankers, has succumbed to pressure in favour for less prohibitive liquidity rules. A broader list of assets will now qualify as a buffer for the calculation of Liquidity Coverage Ratio (LCR), with mortgage debt and equities added to the list. Furthermore, full implementation will be delayed till 2019. But capital requirements remain unchanged.

On the liquidity front, the direction of financial regulations has been to push institutions towards holding shorter term, less risky assets. This risks restricting banks’ ability to finance an economic recovery to some extent. Significant liquid sovereign bonds holdings take away from loan growth and bank profitability, which in turn weakens the growth of the capital base longer term. Therefore, notwithstanding the moral hazard, a relaxation of these rules should help growth and eventually benefit the real economy.

Major global banks have already repaired their balance sheets in response to the GFC and in anticipation of tougher capital requirements. Regulators in Australia and New Zealand have been eager to implement requirements ahead of schedule although the focus has mostly been on capital and funding ratios, which our banks are on the whole ready for. The Reserve Bank of New Zealand is due to look into the liquidity requirements of Basel III as part of its future policy work in 2013. In any case, the latest amendment by the central body should be positive for banks at the margin. It will be interesting to see if this is the first of several concessions to come. There is also a potential read across for insurers who face a regulatory cousin of Basel III, Solvency II. The loser from the liquidity rule tweak will be sovereign debt as this asset class would have seen additional demand under the previously proposed rules.

Felix Fok

Senior Analyst