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We have responded to the Prudential Regulation Authority’s (PRA) Discussion paper 1/22 (DP) which explores why banks may be reluctant to draw on their high-quality liquid assets (HQLA) in periods of market wide liquidity stress.
Regulators require firms to hold liquidity buffers to ensure they can withstand potential market-wide and idiosyncratic stress scenarios. They are designed so that they can be utilised as the stressed outflows materialise. The Bank of England (BoE), the PRA and regulators in other countries have all reiterated that the intention of the Liquidity Coverage Ratio (LCR) Framework is to allow firms to use buffers in stress. Firms are generally unwilling to allow their LCRs to fall below 100%, even in a very severe stress. This reflects concerns over supervisory corrective actions and market reactions from disclosures, despite statements by the PRA and other regulators that supported buffer usability at such times. Read the paper here: Discussion paper 1/22 (DP)
We have put forward a recommendation to address the liquidity buffer usability conundrum – Stress LCR framework. To facilitate the utilisation of HQLA in a stress, the PRA should provide greater clarity to firms and their boards by setting out a framework for using liquidity buffer assets in a stressed market condition. The key elements of this ‘Stress LCR framework’ are:
Adjusting the LCR requirement in a time of stress: amending the factors in the LCR calculation, taking into account events have occurred and other external sources of liquidity, would lower the minimum LCR requirement, allowing firms to deploy their available HQLA to support the economy and intermediate market activity.
Declaration of stress period and timelines to rebuild buffers: a clear and co-ordinated public regulatory announcement, internationally coordinated if necessary, detailing the onset of a stress period. Regulators should have the authority to declare a “stress period” based on an assessment of macroeconomic factors and ongoing monitoring of firms’ liquidity positions through existing supervisory processes. Once regulators have determined that conditions have normalised and the economy is returning to business-as-usual environment, they can publicly provide a clearly defined time frame above a minimum period to allow firms to rebuild buffers to meet their LCR obligations.
Supervisory actions and disclosure requirements: Any supervisory or regulatory consequences and relevant disclosure requirements would then be linked to the new Stress LCR requirements.
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