The Basel Committee on Banking Supervision announced yesterday that it had finalised the rules for the Liquidity Coverage Ratio or LCR i.e. the main mechanic for regulating liquidity in the Basel III package of reforms.

The LCR requires that a bank hold a sufficient stock of “High Quality Liquid Assets” to meet its net cash outflows in a hypothetical stress scenario. The rules set out the parameters for the stress scenario, the calculation of the net cash outflow and the type of assets which can constitute High Quality Liquid Assets.

Lobbying has achieved a notable success as certain “residential mortgage-backed securities rated AA or higher” can now be included in a bank’s stock of high quality liquid assets (subject to a 25% haircut, which is lower than the haircut applied to some corporate debt securities and to the limitation that this component can form no more than 15% of the buffer as a whole). This proposal is watered down in relation to the original formulation of the LCR announced in 2010, under which Level 1 assets (i.e. the most valuable components of the liquidity buffer which are uncapped and not subject to haircuts) were limited to cash, central bank reserves and bonds issued or guaranteed by sovereigns or certain supranational organisations and Level 2 assets (which are subject to a cap of 40% of the total buffer and subject to haircuts) were limited to lower rated sovereign bonds and certain corporate bonds and covered bonds. The importance of this amendment should not be underestimated as banks will now have a major incentive to hold such RMBS. It also shows that the message has got through that securitisation is an important asset class which can contribute positively to financial stability.

The Committee also pushed back the final implementation of the proposals by four years: The LCR will be introduced as planned on 1 January 2015, but the minimum requirement will begin at 60% of the planned total, and will only reach 100% in January 2019.  Basel III will of course require implementation through local laws (such as the Capital Requirements Regulation in Europe) in order to take effect.

This follows the consultation paper published last December by the Basel Committee on the revision of the securitisation framework (see our blog) which some feel will have a very negative impact on the ability of banks to hold securitisation positions. It remains to be seen whether the committee’s new found goodwill to securitisation will extend to making these revisions more palatable.