Liquidity is not a dry subject

written by Simon Hills on 11/01/2012

This weekend the Basel Committee on Banking Supervision – the regulator of regulators, and specifically the setter of global standards for bank capital – met to discuss the technical but vital issue of liquid assets.

Liquidity is a simple concept: the more liquid the market for an asset, the easier it is to buy or sell. Central banks require banks to hold good quality liquid assets because they can be fairly certain there will be a market for them in times of financial stress, when a bank might be required to liquidate (i.e. sell) some of its assets quickly.

The weekend meeting was a gathering of the world’s central bank governors and heads of supervision (“the GHOS meeting”). On the key point under discussion – the liquidity coverage ratio (LCR) – the meeting agreed to commission further work on what should be eligible as a liquid asset.

This is the critical point. Different central banks have different views of what should be considered a liquid asset. All are agreed that good quality government bonds (gilts in the UK) are liquid assets which can be traded readily. And many countries also consider covered bonds as liquid assets. Here in the UK we have a well-established market for residential mortgage backed securities (RMBSs) – effectively household mortgages packaged-up into tradeable form – but up to this point the Basel Committee had dismissed these from its deliberations. Now the Committee has agreed to undertake research to investigate whether other types of assets can be considered as liquid – it is important that these investigations cover RMBS too in order that an evidence based decision can be taken.

Whatever the conclusion, the banks will work to meet or surpass the internationally-agreed standards. The significance of this weekend’s decision is that the Committee has agreed to keep an open mind,. Evidence-based policy-making, transparently conducted and peer-reviewed, should be good news for all of us.