The bone thrown by the Basel committee to the banks in relaxing the new “liquidity coverage ratio” at the weekend was largely what the industry had wanted. It was also a capitulation to good sense as much as one to sectoral interests.
The LCR requires banks to hold liquid assets at least equal to the amount of capital clients might be expected to withdraw over a 30-day period in a crisis. The collapse of Lehman Brothers – when the global financial system was brought to its knees by one bank running out of funds – showed why such a requirement is necessary.
But the draft LCR’s original definition of high-quality liquid assets was ill-designed. By treating government debt as the most liquid of assets, it echoed the earlier Basel error of treating it as risk-free. The painful lesson of the eurozone crisis is that sovereign debt need be neither. The banks were right, therefore, to push for a wider definition of liquid assets including blue-chip stocks and corporate bonds. If trading in such securities can remain liquid even when some sovereign debt markets freeze, including them – subject to proper haircuts – encourages more diversified and robust liquidity buffers.