By Ryan Tracy and Lalita Clozel 

Regulators plan to pare back requirements that banks keep billions of dollars of cash on hand to pay short-term bills. No one knows for sure what will happen next.

The liquidity coverage ratio rule was invented to protect banks from credit freezes similar to the 2008 financial meltdown. Four years ago, the Federal Reserve began requiring banks to keep enough cash on hand--or easy-to-sell assets such as Treasury bonds--to cover expected bills for the next 30 days.

On Wednesday, under Trump-appointed regulators, the Fed proposed reducing the required ratio for four large U.S. lenders and removing it altogether for 11 others, in one of the most significant regulatory relief measures for banks since the financial crisis.

The changes would free the banks up to repurpose as much as $77 billion in assets locked up by the current rule--a small percentage of the total liquid assets held by all banks with more than $100 billion in assets, the Fed said. Nine of the largest U.S. banks would see no change under the proposal.

Some see an economic boost where banks rededicate the cash to loans, long-term securities or other higher-yielding but riskier assets.

"This regulatory relief is very important to sustain the economic juggernaut that we have going now," House Financial Services Committee Chairman Jeb Hensarling (R., Texas) said, adding that when banks makes a loan, "the cost of compliance is going to be put into that interest rate."

Critics say the change won't significantly boost lending, but that it will increase risk.

Fed officials said they tried to assess whether loosening the rules would increase lending--and couldn't find conclusive evidence either way.

Fed governor Lael Brainard, an Obama appointee who dissented from her colleagues' decision to approve the proposal, said, "I see no change in the financial environment...that would require us to substantially weaken a rule that was backed by strong analysis." She added that banks are "providing ample credit and earning ample profits" under current liquidity requirements.

In adopting the liquidity rules, Fed officials cited the 2008 crisis. Many banks then were relying on volatile funding sources that suddenly evaporated, leaving taxpayers on the hook to keep the financial system functioning.

Three lenders in the range of about $100 billion to $300 billion in assets faced deep liquidity problems during the crisis and had to be sold in emergency deals, Ms. Brainard pointed out.

The Fed said banks affected by the liquidity-rule changes have much firmer funding today. These banks' assets are about 14% liquid on average today, up from 5% for banks of that size in 2006 and 2007, according to the Fed.

Fed officials expect the impact of the changes to be modest overall. The regulator will still conduct "stress tests" of banks' liquidity, though the results won't be made public, and for some banks, those tests could be even more restrictive than the liquidity coverage ratio, officials said.

Fed Vice Chairman for Supervision Randal Quarles, who supported the rule changes, said he hopes "firms will see reduced regulatory complexity and easier compliance with no decline in the resiliency of the U.S. banking system."

Banks with assets of $250 billion to $700 billion could cut their buffers of "liquid assets" such as Treasury securities by up to $43 billion, the Fed estimated. Affected firms include U.S. Bancorp, PNC Financial Services Group Inc. and Capital One Financial Corp. An additional 11 banks with assets of $100 billion to $250 billion would be exempted from the liquidity coverage ratio entirely, freeing up liquid assets of up to $34 billion, the Fed said.

What banks will actually do with the extra cash is an open question.

William Lang, managing director at International Business Machines Corp.'s Promontory Financial Group unit and a former Fed bank supervisor, said banks should get a "substantial benefit." He said they could boost returns by converting short-term, easy-to-sell assets such as Treasury bonds into higher-yielding--and riskier--long-term assets.

The impact might be small in the context of the broader Treasury market, given that big, systemically important banks will still need to hold the debt, said Jabaz Mathai, head of U.S. interest-rate strategy at Citigroup Inc.

Wayne Abernathy, an executive vice president at the American Bankers Association, said that giving banks more flexibility around funding sources could boost profitability and allow them to make more loans. "You're taking away some of the barriers [and] allowing them to be more aggressive," he said. He added, however, that even with the changes, liquidity requirements would be too strict.

Wednesday's proposal "strikes a good balance that would allow banks to foster economic growth, better serve customers, while keeping the banking system strong," U.S. Bancorp said in a statement

PNC said the proposal "acknowledges the real differences between the business model and risk profiles of Main Street banks, like PNC, and globally systemically important banks."

Capital One didn't respond to requests for comment.

Daniel Kruger contributed to this article.

Write to Ryan Tracy at ryan.tracy@wsj.com and Lalita Clozel at lalita.clozel.@wsj.com

 

(END) Dow Jones Newswires

November 02, 2018 07:14 ET (11:14 GMT)

Copyright (c) 2018 Dow Jones & Company, Inc.
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