Banks must improve liquidity management

By:
Louise Bowman
Published on:

Banks now hold more sovereign bonds than insurance companies; demand from buffers driving deals.

No piece of post-2007 financial regulation has done more to cement the doom loop between banks and sovereigns than the requirement for the former to hold a liquidity buffer in high-quality, liquid assets.

The liquidity coverage ratio is set to be introduced at the beginning of next year, but the impact on bank holdings of sovereign bonds has been dramatic: European banks have increased their holdings of sovereign debt by €550 billion since 2008, holding a total of €1.7 trillion-worth at the end of last year. Indeed, they are now more important buyers of government debt than insurance companies.

"The measure of the liquidity ratio is unprecedented," says Nicolas Gaussel, chief investment officer at Lyxor Asset Management in Paris. "The 30-day liquidity crisis buffer must be held in very high-quality liquid assets and banks therefore have trillions of euros that need to be invested in sovereigns," he says. "One of the unexpected consequences of regulation is that the most prominent holders of sovereigns are the banks themselves."

The weight of demand from the banks’ huge liquidity holding has had a profound effect on the SSA market.

"Liquidity buffers wanting to optimize returns have become a driver of deals," confirms a DCM specialist at a US bank in London. "There is definitely surplus liquidity that they are looking to employ. More and more money is parked in this space."

Gaussel argues that the sheer size of this market means that there is now a pressing need for better management of these portfolios.

Liquidity buffers wanting to optimize returns 
have become a driver of deals
DCM specialist

"Large banks have often bought these assets very quickly and now have to manage them as an asset manager. The heads of ALM are often not traditional investors, they are accounting people and they want precise investment processes. If you give this mandate to a trading floor they know how to hedge their position and they know how to generate short-term returns, but they don’t know how to manage for a two- to three-year time horizon. Banks have to steer their balance sheet. They don’t chase alpha. They are often not as ready to hold losing positions as other long-term investors."

Lyxor Asset Management has been actively targeting mandates in this space as, Gaussel contends, the management of these assets often requires particular skill.

"For a bank less yield will weigh down on ROE but more yield will add volatility," he says. "We are now managing €7 billion for the liquidity buffer – we started one year ago and this is a brand-new market. We have several mandates from European banks and are near the end of negotiations for more."