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From Banking and Finance Law Daily, September 3, 2014

Regulators adopt new rules on liquidity and supplementary leverage ratios

By Richard A. Roth, J.D.

As expected, the Federal Reserve Board, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation have adopted final rules on supplementary leverage and liquidity coverage ratios. According to the agencies, the liquidity coverage rule will create the first standardized minimum liquidity requirement for large and internationally active banking organizations. The supplementary leverage ratio rule will better capture banking organizations’ on- and off-balance sheet exposures. Both rules will take effect Jan. 1, 2015, but both will have phased-in transition periods.

Liquidity ratio rules. The final liquidity coverage ratio rule will apply to all banking organizations that have $250 billion or more in total assets or $10 billion or more in on-balance sheet foreign exposures. Covered organizations’ subsidiaries that have assets of $10 billion or more also will be covered. Smaller bank and thrift holding companies that have $50 billion in total assets will be covered by a less strict LCR requirement.

The Fed decided not to make holding companies with substantial insurance or commercial operations or nonbank financial companies the Financial Stability Oversight Council has designated as systemically important financial institutions subject to the rule. The Fed will issue separate rules for these institutions in the future.

The rule requires each covered institution to hold high-quality, liquid assets (HQLA), such as central bank reserves and government and corporate debt that can be converted easily and quickly into cash, in an amount at least equal to its projected net cash outflow during a 30-day stress period.

HQLA are divided into three categories: “Level 1 assets,” “Level 2A liquid assets,” and “Level 2B liquid assets.” The lower categories will be subject to “haircuts” of 15 percent and 50 percent, respectively. Also, a company’s required HQLA amount must include at least 60 percent Level 1 assets and no more than 15 percent Level 2B liquid assets.

Liquidity transition period. Covered companies will be required to hold an LCR of at least 80 percent beginning on Jan. 1, 2015. That will increase to 90 percent on Jan. 1, 2016. Beginning on Jan. 1, 2017, the full amount will be required. There also is a transitional period that delays when organizations must begin calculating their LCR on a daily basis.

Leverage ratio rules. The final supplementary leverage ratio rule works by revising the definition of the denominator of the supplementary leverage ratio that the agencies adopted in July 2013. The new definition takes into consideration the effective notional principal amount of credit derivatives and similar instruments, changes the calculation of total leverage exposure for derivatives and repo transactions, changes the frequency with which components of the supplementary leverage ratio are calculated, and establishes public disclosure requirements. The agencies believe it will increase the measure of exposure across the covered institutions.

The rule applies to all banks, thrifts, and holding companies that are subject to the advanced-approaches risk-based capital rules. These institutions will be required to disclose their supplementary leverage ratios beginning Jan. 1, 2014, and to comply with a minimum supplementary leverage capital ratio requirement of 3 percent by Jan. 1, 2018.

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