On 31 March 2022, the PRA published Discussion Paper 1/22 ‘The prudential liquidity framework: Supporting liquid asset usability’ (DP1/22).
The Liquidity Coverage Ratio (LCR) was introduced following the 2008 global financial crisis in order to promote the short-term resilience of the liquidity risk profile of banks. A net stable funding ratio was also introduced to ensure that banks maintain a stable funding profile over a longer horizon in relation to the composition of their assets and off-balance sheet activities. The LCR requires banks to hold a large enough stock of high quality liquid assets (HQLA) to meet their payment obligations in case of a severe short-term stress. The Bank of England (BoE) also stands ready to use its balance sheet to provide liquidity insurance as appropriate.
While in normal times banks are expected to maintain LCRs of 100% or more, firms may draw down their HQLA, even if it may mean that LCRs decline below 100% in stress. However, the BoE and the PRA have been concerned for a number of years that banks may be reluctant to draw on their HQLA in periods of unusual liquidity pressures, possibly to such an extent that it is limiting the benefits of the flexibility built into the framework. In particular, during the COVID-19 stress, a range of banks in the UK and internationally took defensive actions to protect and bolster their liquidity positions. Also, in the 2019 Liquidity Biennial Exploratory Scenario banks’ submissions suggested that, on the whole, they were generally unwilling to allow their LCRs to fall below 100%, even in a very severe stress, if they could prevent them from doing so.
Therefore in DP1/22 the PRA is seeking views to continue to improve understanding of the issues around HQLA usability and whether and how the BoE and PRA could support HQLA usability. The responses will also be used to inform the PRA and the BoE’s contribution to the ongoing work by the Basel Committee on Banking Supervision on the evaluation of the Basel III reforms. The BoE and PRA may publish a summary of the comments received, in an anonymised way, to stimulate further debate.
The deadline for responding to DP1/22 is 30 June 2022.