In September 2014, the US federal banking regulators finalized the Liquidity Coverage Ratio (LCR) rules. On May 28, 2015, the Federal Reserve Board published proposed rules to allow additional liquid assets to be used to meet the ratio. Comments will be accepted on the proposed rule through July 24, 2015.

The LCR requires that certain large banking organizations maintain sufficient high quality liquid assets (HQLA) to cover cash outflows during a 30 day liquidity stress scenario that includes certain levels of deposit run-off or a reduction in wholesale funding capacity. HQLA include cash and, among other instruments, securities issued or unconditionally guaranteed by the US Treasury, and certain securities issued by US-government sponsored enterprises, but only at 85% of the dollar amount of the assets.

In the Supplementary Information accompanying the September 2014 final rule, the banking agencies noted that many commenters to the proposed LCR rule had raised concerns that US municipal securities were not considered as HQLA, even though their liquidity profile met or exceeded that of other assets classified as HQLA in the final rule. Agency staff stated their intention to study the issue and work on a new proposed regulation.

The proposed rule would treat certain general obligation state and municipal bonds as so-called “Level 2B” assets, (a category that currently includes certain investment grade corporate debt and equities) but only at 50 percent of the dollar amount of the asset. Among other criteria, these securities will have to be liquid, readily marketable and meet other criteria consistent with the corporate debt securities currently allowed as Level 2B assets. In addition, the securities cannot be obligations of a “financial sector entity” (such as an investment company or other regulated financial company) or a consolidated subsidiary of such an entity. For example, if a bond insurer insures the general obligation municipal securities of a U.S. public sector entity, those securities would not be considered HQLA.

In order to address what the proposed rule’s commentary refers to as the unique structure of the municipal securities market and to help ensure sufficient liquidity of the securities that are eligible to be considered as HQLA, additional limitations to their eligibility as HQLA would be imposed, based on the total amount outstanding of U.S. general obligation municipal securities with the same CUSIP number, on the average daily trading volume of general obligation municipal securities issued by a particular U.S. municipal issuer, and on a percentage of the institution’s total HQLA amount.

See our previous post, “US banking regulators finalize liquidity coverage ratio rules”, on the LCR final rules.