Supervisory measures in reaction to the Corona crisis – Minimum liquidity requirements

The following blog post is part of the overview of supervisory measures in reaction to the Corona crisis: Supervisory measures in reaction to the Corona crisis – Overview.

Minimum liquidity requirements

Whereas regulatory and supervisors have enacted a number of measures to support banks’ solvency and provide relief by for example pushing implementation and reporting deadlines, the opposite is true when it comes to the topic of liquidity. One of the lessons learned from the 2007/08 financial  crisis is that in a crisis, banks fail when they run out of liquidity. Therefore, regulators and supervisors have stressed the importance of receiving timely and accurate liquidity reporting from banks and have taken measures to strengthen banks’ liquidity rather than granted relief on any liquidity-related obligations.

Banks’ liquidity during the COVID-19 crisis is under pressure due to a number of reasons. Looking at the liquidity coverage ratio (LCR) as the most important tool for the supervision of banks’ short term liquidity, both the numerator as well as the denominator are impacted. In the numerator, the market value of liquid assets is reduced by the declining asset prices. At the same time, the increased volatility of asset values makes controlling and managing the LCR more complex. Turning to the denominator, outflows may increase if depositors move to other means of storing their wealth that they consider safe in times of crisis such as gold. At the same time, liquidity inflows will be reduced as loans become non-performing due to the impact of COVID-19 on the real economy. 

Given the monthly reporting frequency of LCR and the Additional Monitoring Metrics (AMM), these will be the first reportings in which the effects of COVID-19 on banks will become apparent for supervisors. Therefore – and in contrast to the quarterly COREP and FINREP reporting – the EBA stressed in its statement from March 31st, that LCR and AMM reporting have been identified as priority and therefore no extension of reporting deadlines can be granted. At the same time, the changes to LCR reporting envisaged by DPM 2.9 has entered into force on March 31st without any postponement.

As pointed out above, there have been only few relief measures to soften the impact of the crisis on the LCR ratio. One point in case is the German supervisor’s statement on the eligibility of shares as Level 2 high quality liquid assets (HQLA). While they are generally only eligible if they withstand a liquidity shock without losing 40% of their market value, BaFin declared that even if shares exceed this threshold in the COVID-19 crisis, they remain eligible as high quality liquid assets if they are constituents of a main index and all other criteria for inclusion in the HQLA are fulfilled. Obviously, this is applicable only for German LSIs. More detailed information about the clarifications regarding liquidity risk from the German FSA (Bafin) can be found in the separate section (Supervisory measures in reaction to the Corona crisis: BaFin Q&A on the regulatory impact)

Finally, the ECB has taken measures to strengthen banks’ resilience by extending short term funding such as TLTRO measures and by stressing that banks may use their liquidity buffer during times of stress. This means to operate temporarily below the minimum LCR level of 100% in order to ensure liquidity in the system and avoid contagion effects that might trigger liquidity problems in other institutions. However, the precautions to be taken according to Art. 414 CRR when there is an (expected) LCR shortfall will be still applicable, i.e. immediate notification to the competent authorities, preparation of a liquidity restoration plan and daily LCR reporting. (please click to enlarge)

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