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The liquidity coverage ratio (LCR) is global regulators' ground-breaking benchmark to encourage banks to build-up large quantities of high-quality assets. Thanks to the Basel Committee's U-turn surrounding the timeline for implementation and composition of assets, some market anxiety has been dissipated but fundamental questions remain unresolved.
The LCR is the first-ever attempt by regulators to introduce a global unified framework that ensures that banks possess a pool of ostensibly liquid assets for at least 30 days during a liquidity crisis, without recourse to central bank support.
Notoriously, when the LCR was framed in December 2010, it required banks to build up large buffers of high-quality liquid assets, tightly and rather conveniently at a time of investor outflows from sovereign debt, to protect against a rapid flight of deposits and short-term funding in a crisis.
Banks complained they were being compelled to hold low-yielding and capital-consuming government debt with dubious liquidity and credit profiles, restricting earnings and organic capital building while constraining capacity to lend to the economy.
However, triggering fear and cheer, in equal measure, in January, the Basel Committee backed down to a degree, accepting that the earlier framework was excessive, and has now permitted a broader pool of assets, including ABS, and a more relaxed implementation timeline for the landmark liquidity framework.