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Connexus : Issue 37
As the Basel reform process for large banks continues, mutuals can expect some recalibration of the rules for smaller ADIs. By Daniel Newlan www.abacus.org.au Connexus NEWS Australian regulators have consistently reassured smaller mutuals that it's business as usual when it comes to reforming the liquidity regulatory framework governing smaller ADIs. According to the Australian Prudential Regulation Authority (APRA), the framework -- known as the Minimum Liquidity Holdings (MLH) regime -- provided a sufficient degree of resilience during the financial crisis and therefore warranted less attention than the rules governing larger banks. Changes, however, are on the way. APRA, during recent consultations with Abacus, flagged potential changes to the underlying design of the MLH regime as part of its broader review of the liquidity prudential standards APS 210. So far, APRA has remained tight- lipped on what these changes could be, but we do know there is little appetite for any material policy changes. Instead, the standard will be updated to better reflect the economic climate ADIs are operating in and enhance the rigour of a standard otherwise seen to be light on detail. The key principle APRA wants to see better reflected in APS 210 is the notion that a liquid asset must be truly liquid. That is, in a stressed situation, an ADI must have a clear mechanism or process by which it can comfortably convert an asset to cash within 48 hours. There must also be a symmetrical alignment between the way an issuing and a holding party treat the same asset. Any undertaking by an issuing party that it will 'make good' on an asset within 48 hours must lead to that party holding extra liquidity to back its promise. APRA enforced this position late last year, with term deposits specifically singled out. It's also likely that APRA will expect to see greater diversification in the types and quantum of liquid assets held by ADIs. Balancing act APRA seems to be facing a delicate balancing act with its review. Namely, how to ensure the revised standard recognises the difference between a systemic disruption, a normal market disruption and a specific disruption to an individual institution, each of which carries a different impact on a particular asset's liquidity, perceived or otherwise. For example, it's far easier to sell a certificate of deposit (CD) to a third party during a normal market disruption than it is during a systemic crisis, which recent experience proved for many ADIs. What does this mean for mutual ADIs? While the standard may not change significantly to reflect these issues, mutuals will likely see a greater supervisory emphasis on ADIs holding the most liquid-lowest yielding rather than the least liquid-highest yielding of those assets technically allowed under the standard. Practically, this may involve ADIs scaling back their stock of residential mortgage-backed securities and increasing their stock of CDs. Both are considered liquid assets under the standard. It's difficult to predict what other aspects of the standard will change, but we know that the key components -- the MLH ratio of 9 per cent and the specific liquid asset definitions -- will be reviewed at the very least. We can expect to see some modification to allowable liquid assets, primarily to ensure they are workable and achieve harmony with the Basel Committee on Banking Supervision's liquidity principles. Abacus expects that the APS210 review will run at a much quicker pace than the global Basel reform process, with a new standard potentially in place as early as July next year. In the meantime Abacus will continue consultations with APRA on the review. Daniel Newlan is a senior adviser, policy and public affairs, at Abacus. Liquidity changes for mutuals flagged "...in a stressed situation, an ADI must have a clear mechanism or process by which it can comfortably convert an asset to cash within 48 hours."