It’s popular to say that financial markets and regulators have extremely short memories and so let’s say it about these new Basel liquidity coverage ratio rule changes out today. But not in an annoying sneery way. I mean, in an annoying sneery way, but not the obvious one.

The story is that among the post-2008 Basel mechanisms for keeping banks out of trouble is the required “liquidity coverage ratio,” which for each regulated bank:

• tots up how much cash is likely to go out the bank’s doors in a crisis due to things like customers withdrawing deposits, derivatives counterparties terminating trades or demanding more collateral, corporate clients drawing down lines of credit, etc.; and
• requires the bank to hold liquid assets that it could sell quickly in a crisis to meet those demands on cash.¹

Virtually everything there is a term of art, but “crisis” and “liquid assets” are particularly squishy. When the LCR was first proposed it had rather harsh ideas of what sort of crisis might affect liquidity, and a rather narrow conception of what assets might be liquid enough to be sold quickly and economically in a crisis. The news today is that Basel has relaxed that approach in a number of specific ways described here and listed here; the brief version is that the types of assets that can be counted toward “high quality liquid assets” has been dramatically expanded to include a lot of corporate and RMBS debt, the assumed outflows in a crisis have been reduced, and the LCR is now being phased in from 2015-2019 instead of going into effect all at once in 2015.

A lot of people think this is a good thing, as it will reduce the already significant demands on “safe assets” and make banks a little more willing to use balance sheet to lend and stuff. As is true of everything that banks like, you can also if you are so inclined easily find people who think it’s a bad thing. There is no particularly Platonic right answer. Basically the exercise here is (1) imagine a bad situation and (2) see if the bank survives your imagined bad situation with a given mix of liquid assets; step (2) is a question of simple arithmetic while step (1) is determined entirely by the direction in which your imagination runs. There are good practical and social reasons for making your bad situation basically “2007-2008, but a little worse,” and so most of the debate is over translating that notion into liquidity outflows and asset haircuts, but if you think that that notion is conceptually suspect I can’t really prove you wrong. If aliens invaded France, SocGen’s liquidity reserve would probably not be suited to the situation.

But whatever. The jarring thing for me was this first bit of the changes to the LCR announced today: Read more »