Australia: RBA measures for Basel III liquidity standards good news for asset-backed securities market

Last Updated: 19 December 2010
Article by Andrew Jinks

Today the Reserve Bank of Australia (RBA) announced measures to assist larger ADIs to meet the global liquidity standards under Basel III which are intended to come into force in 2015. The RBA's measures are likely to be a welcome boost to Australia's asset-backed securities market.

Basel III: International Framework for Liquidity Risk

On 13 December 2010, the Basel Committee on Bank Supervision (Basel Committee) announced an international framework to promote stronger liquidity buffers in the banking sector and so improve the banking sector's ability to absorb shocks arising from financial and economic stresses, such as the "liquidity shock" that occurred during the early stages of the financial crisis that began in 2007. At that time, although many banks had adequate capital levels, they nevertheless experienced difficulties because they did not have adequate liquid capital.

The Basel Committee's reforms have introduced two international minimum standards for liquidity risk supervision with the aim of ensuring banks have an adequate liquidity buffer to absorb liquidity shocks:

  • Liquidity Coverage Ratio (LCR): this is a test to promote short-term resilience of the bank's liquidity risk profile by ensuring that it has sufficiently high-quality liquid assets to survive a significant stress scenario lasting for 30 days; and
  • Net Stable Funding Ratio (NSFR): this is a test to promote resilience over a longer period by creating additional incentives for banks to fund their activities with more stable funding on an ongoing basis. The NSFR test is similar to the LCR except the period over which it is tested is one year.

Banks will have until 2015 to meet the LCR standard and 2018 to meet the NCFR standard.

High-quality liquid assets under the LCR test

The high-quality liquid assets which can be counted towards the LCR under Basel III fall into two categories:

  • Level 1 assets: These assets are limited to cash, central bank reserves which can be drawn down in times of stress and certain categories of government debt. Level 1 assets can comprise an unlimited share of the liquid asset pool for the purposes of the LCR and are not subject to a haircut under the LCR.
  • Level 2 assets: These assets include certain other categories of government debt and highly rated corporate bonds (issued by non-bank issuers) and covered bonds which have a proven track record as reliable source of liquidity in the markets. Level 2 assets may not comprise more than 40% of the overall liquid asset pool for the purposes of the LCR and will have haircuts applied to their current market value (a minimum 15% haircut must be applied to Level 2 assets).

How will Australia implement the Basel III LCR test?

Certain jurisdictions such as Australia and Denmark have relatively low government debt levels which may result in an insufficient supply of Level 1 assets to meet the aggregate demand of banks in these jurisdictions to satisfy the LCR. In addition, countries such as Australia have a relatively short supply of Level 2 assets..

To address this situation, the Basel Committee has agreed to develop alternative treatments for determining liquid assets for such jurisdictions. One alternative treatment is to allow banks in these jurisdictions to enter into committed liquidity facilities provided by the relevant central bank for a fee. Such facilities will count towards the LCR requirements.

The RBA and the Australian Prudential Regulation Authority (APRA) have today agreed that an ADI will be able to establish a committed secured liquidity facility with the RBA, sufficient in size to cover any shortfall between the ADI's holding of high-quality liquid assets and the LCR requirements.

Qualifying collateral for the facility will comprise all assets eligible for repo transactions with the RBS under normal market operations.

Eligible assets under the RBA's open market operations currently includes the following Australian denominated securities, provided they satisfy certain prescribed conditions: asset-backed commercial paper (ABCP), ADI-issued debt securities and residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS) and securities backed by auto loans/leases and credit card receivable.

This facility will only be applicable to the larger Australian ADIs (around 40 in number), as APRA has stated that it does not intend to apply the LCR requirements to smaller ADIs (which will continue to be regulated under the minimum liquid holdings regime).

APRA will require larger ADIs to first demonstrate that they have taken all reasonable steps towards meeting their LCR requirements through their own balance sheet management before relying on the RBA facility.

The RBA will charge a market-based commitment fee for its facility.

What this means for the securitisation industry, corporate bond market and covered bonds

Today's announcement by the RBA is likely to be positive news for the Australian asset-backed securities market. Once the global liquidity standards under Basel III come into force, the demand for highly rated Australian ABCP, RMBS and CMBS amongst Australian ADIs is likely to increase as the RBA will permit these assets to be repoed under the relevant ADI's liquidity facility with the RBA to satisfy any shortfall in an ADI's LCR requirement.

The Basel Committee's liquidity standards may also have positive implications for the corporate bond market to the extent such bonds are able to satisfy the Level 2 asset requirements set out in Basel III (ie. have a credit rating of at least AA- and are actively traded in the repo or cash markets, demonstrating a proven track record as a reliable source of liquidity).

In addition, the recent announcement by the Basel Committee that covered bonds will be considered as high-quality liquid assets that can be counted towards the LCR under Basel III appears to be a positive development for the Australian covered bond market (see our recent Alert Australia opens the door to covered bonds).

However, it will be interesting to see whether Australian covered bonds will, on a strict interpretation of the Basel III liquidity rules, count towards the LCR requirements. This is because under Basel III covered bonds only qualify as high-quality liquid assets if they are traded in a large, deep and active repo or cash market and have a proven record as a reliable source of liquidity in the markets during stressed conditions. It is uncertain whether a fledgling Australian covered bond market would be able to satisfy these requirements.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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