May 06, 2020

US Banking Regulators Modify Liquidity Coverage Ratio for COVID-19 Stimulus Effects

Share

On May 5, 2020, the US federal banking regulators adopted an interim final rule to modify the liquidity coverage ratio (“LCR”) requirement to support banking organizations’ participation in the Federal Reserve Board’s Money Market Mutual Fund Liquidity Facility (“MMLF”) and the Paycheck Protection Program Liquidity Facility (“PPPLF”).[1] The modification is effective immediately, but the regulators have requested comment on whether the modification should be expanded to other types of COVID-19-related stimulus facilities.

Background

In 2014, the US federal banking regulators, in order to implement the Basel capital requirements, adopted a final rule to impose a quantitative LCR requirement on larger US banking organizations.[2] Under the LCR requirement, a larger US banking organization must maintain a sufficient amount of unencumbered high quality liquid assets to meet 100 percent of its projected total net cash outflows over a stressed 30-day period. A less stringent LCR requirement applies to certain mid-size US banking organizations. The total net cash outflow amount is calculated as the difference between outflow and inflow amounts, which are determined by applying a standardized set of outflow and inflow rates to the cash flows of various assets and liabilities, together with off-balance sheet items.

COVID-19 Response

In response to the market disruption caused by COVID-19 and to reduce liquidity pressure, the Federal Reserve Board established the MMLF and PPPLF in March and April 2020.[3] The Federal Reserve Board established the MMLF to provide liquidity to certain types of money market mutual funds (“MMFs”) by making secured, non-recourse loans to banking organizations that purchase certain assets from MMFs. The Federal Reserve Board established the PPPLF to provide liquidity to small business lenders by making secured, non-recourse loans to financial institutions that originate or acquire loans under the Paycheck Protection Program (“PPP”).

Absent a modification, under the LCR requirement, banking organizations would be required to recognize outflows for MMLF and PPPLF loans with a remaining maturity of 30 days or less and inflows for certain assets securing the MMLF and PPPLF loans. As a result, a banking organization’s participation in the MMLF or PPPLF could affect its total net cash outflows, which could potentially result in an inconsistent, unpredictable, and more volatile calculation of LCR requirements.

The modification neutralizes the effect of the LCR requirement by excluding cash flows from MMLF and PPPLF funding and assets securing such funding from the calculation of a banking organization’s total net cash outflow amount.[4] The modification will last only for such time as the MMLF and PPPLF are in operation, so banking organizations may need to consider the LCR requirement for underlying exposures with longer-dated maturities.

Additionally, the modification does not apply to the extent the banking organization secures funding from the MMLF or PPPLF with securities, debt obligations, or other instruments issued by the consolidated banking organization because there would be only a cash outflow at maturity, and therefore, no basis for neutralizing the liquidity effect. Similarly, the modification does not apply to the extent a banking organization purchase assets from an MMF or holds a loan made under PPP, and does not finance the exposure through the MMLF or PPPLF, respectively.

Takeaways

The modification is effective immediately, but the regulators have requested comment on whether the modification should be expanded to other types of COVID-19-related stimulus facilities. While other crisis facilities, like the Term Asset-Backed Securities Loan Facility, also are non-recourse, there may be other grounds for differentiating among the facilities. However, the US banking regulators have been exceptionally responsive during the pandemic, and we expect that they will promptly consider future requests for relief from the LCR requirement to address market disruption.

[1] Press Release, Federal bank regulatory agencies modify liquidity coverage ratio for banks participating in Money Market Mutual Fund Liquidity Facility and Paycheck Protection Program Liquidity Facility (May 5, 2020), https://www.federalreserve.gov/newsevents/pressreleases/bcreg20200505a.htm; 85 Fed. Reg. 26,835 (May 6. 2020). The US federal banking regulators are the Board of Governors of the Federal Reserve System (“Federal Reserve”), Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation.

[2] 12 C.F.R. pts. 50, 249, 329. See our Legal Update on the original LCR adoption: https://www.mayerbrown.com/en/perspectives-events/publications/2014/09/us-banking-regulators-adopt-final-rule-to-impose-l.

[3] See our Legal Updates on the MMLF (https://www.mayerbrown.com/en/perspectives-events/publications/2020/03/us-federal-reserve-establishes-money-market-mutual-fund-liquidity-facility-as-part-of-covid19-response) and PPPLF (https://www.retainedinterest.com/2020/04/federal-reserve-signals-progress-toward-desperately-needed-non-bank-access-to-paycheck-protection-program-liquidity-facility-ppplf/).

[4] The Federal Reserve also revised the reporting form and instructions of the FR 2052a to incorporate the modification.

***

If you wish to receive periodic updates on this or other topics related to the pandemic, you can be added to our COVID-19 “Special Interest” mailing list by subscribing here. For any other legal questions related to this pandemic, please contact the Firm’s COVID-19 Core Response Team at FW-SIG-COVID-19-Core-Response-Team@mayerbrown.com.

The post US Banking Regulators Modify Liquidity Coverage Ratio for COVID-19 Stimulus Effects appeared first on COVID-19 Response Blog.

Related Services & Industries

Stay Up To Date With Our Insights

See how we use a multidisciplinary, integrated approach to meet our clients' needs.
Subscribe