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Basel III liquidity rules: it’s a matter of culture

Basel III liquidity rules: it’s a matter of culture Moorad Choudhry

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As everyone by now knows, the real significant difference between Basels I and II and Basel III isn't the capital stuff, it’s the liquidity requirements. The first two regimes didn't address liquidity (one may think that’s odd, but the theoretical reason was that banks perceived as funding-weak would be shunned by customers as a home for their deposits – a market-based solution, if you like...) By contrast, Basel III is chock full of text on the subject. And, of course, we are by now very familiar, and in cases possibly slightly apprehensive, about the liquidity requirements in the Basel III regime. The acronyms themselves encompass some relatively straightforward arithmetic: for example, the Liquidity Coverage Ratio (LCR) is calculated by dividing a bank’s “High Quality Liquid Assets” by its “30-day stressed outflow cash flows”.

Of course, everything is relative. Who is to determine what is “liquid”? As for the denominator, just how much of a bank’s customer deposits and wholesale liabilities would depart from the bank if there were some sort of crisis? (And only depart in the next 30 days; any departures after that aren't a concern of LCR!) Handily, the Basel regime describes these relativities for us. Assets are grouped into Level 1 and Level 2 for liquidity, while different types of liabilities, ranging from a retail customer checking account to short-term money market deposits, are all assigned a “stress factor” which determines the cash outflow amount during a stress event.

There is scope for much interpretation. For this and a number of other reasons, it won’t be accurate to compare one bank’s LCR value with another bank’s, due to the assumptions underlying the calculation (especially the ones driving the denominator). In Europe, the LCR metric is really exercising some people, essentially those in banks who currently calculate LCR to be less than 100% (the limiting value).

Not so in Asia-Pacific banks - and the reason for this is simple: the culture of banking in the region is subtly but distinctly different. Within countries as otherwise diverse as Malaysia, Taiwan, Bangladesh and Indonesia, it would be almost unthinkable for banks to run loan-deposit ratios greater than 100%, or for them to rely excessively on short-term deposits from wholesale or financial counterparties, or to fund illiquid assets with non-stable liabilities.

In other words, notwithstanding the considerable linguistic, ethnic, cultural and other diversities in the region, if one were to generalize, one would say that banking business models are more or less unified in APAC, and adhere to a basic principle of banking which was forgotten in many European and US banks during 1999-2007: build up a customer deposit base before originating assets. This is perhaps related to the Asian economic crisis of 1997, which served as a wake-up call to the region's banks - but this is only a partial explanation at best. Western banks had encountered recessionary conditions before, but the advance of the economic cycle had made many people forget lessons learned from the past. No, the more accurate reason is simply the cultural attitude to doing business; the financial industry in APAC banks have always focused on the major principles of banking, which emphasize stable funding and no excess liquidity risk exposure. It’s a cultural thing.

That’s why LCR doesn’t really exercise banks in, for example, Malaysia, Singapore, Bangladesh, Indonesia and others… The list is much longer. When one has a robust funding structure in place already, and always has so, meeting the LCR requirement isn't an issue at all. One may as well ask the region’s banks to ensure that they run a credit check on a customer before lending it money. That’s the thing about banking: in a bull market, remember that the balance sheet has two sides to it. Unlike the well-known examples of certain Western banks, this was something that APAC banks always did remember. There’s a lesson there somewhere, certainly.


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Tags: 1997 financial crisis , APAC , Asia financial crisis , Asia-Pacific banks , asset , Basel III , capital , capital adequacy , High Quality Liquid Assets , illiquid , LCR , liquidity , Liquidity Coverage Ratio , recession
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