Recent banking turmoil has exposed flaws in liquidity rules, regulators say

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Global rules on how much liquid assets banks should hold need to be adjusted in response to last year’s collapse of Silicon Valley Bank and the bailout of Credit Suisse, international regulators said.

The world’s top banking watchdogs pledged in a report published on Friday to examine ways to strengthen liquidity rules for the sector, after identifying several areas where they failed in last year’s crisis.

“Liquidity supervision may need to evolve in light of recent experience,” the Basel Committee on Banking Supervision, which sets global regulatory standards for the sector, said in a report to the G20 group of industrialized nations.

Over two weeks in March 2023, banks with approximately $900 billion in total assets were closed, put into receivership or bailed out – including Silicon Valley Bank, Signature Bank and Credit Suisse. A few weeks later, First Republic Bank was closed with nearly $230 billion in assets.

The speed of the upheaval that hit the banking sector last year left regulators wondering whether the rules they agreed to prop up the sector after the 2008 financial crisis were working as intended and whether they needed improvement.

“All distressed banks during the 2023 banking crisis experienced a series of liquidity shocks,” the committee said. Even though many of the worst-hit banks were not subject to the global rules, regulators said the “turbulence raised questions about the design and calibration of Basel III liquidity standards.”

The Basel committee said last year’s turmoil also revealed “the role of social media and the digitization of finance in accelerating the speed and impact of a bank crisis.” It suggested that regulators could require banks with a “structurally high-risk liquidity profile” to report their liquidity positions more frequently.

In particular, the report said the problems at Credit Suisse before its rescue by rival UBS revealed how a bank could struggle to sell liquid assets to pay depositors when they rush to get their cash out.

The Basel regime requires global banks to hold at least enough readily salable assets – such as central bank deposits – to cover 30 days of net cash outflows during a hypothetical stress scenario.

Credit Suisse comfortably met that requirement until shortly before clients withdrew nearly a quarter of its assets in just a few days and pushed it to the brink of collapse.

The bank found itself unable to sell many of the assets it had identified to cover this requirement either because they were reserved for other purposes, such as day-to-day liquidity needs, or because they were difficult to transfer to the entity where they were needed .

The report said Credit Suisse was also reluctant to sell its liquid assets because that would have taken it below the required level and triggered the need to disclose this to investors, which could have eroded and more trust in the bank.

Another problem he identified with failed US banks such as Silicon Valley Bank was that they were reluctant to sell the many liquid assets they had to deal with potential cash outflows, as this would -would be forced to crystallize unrecorded losses.

American banks accounted for these assets, such as government bonds, based on which they would be held to maturity. This meant that they did not have to take losses when the assets fell in value, unless they were sold.

Banks seemed to assume they could cash in on the assets through the repo markets – where they are pledged as collateral for a loan. But the report said that “under such scenarios, repo markets could cease to function smoothly”, making them “an unreliable source of contingent liquidity”.

The Basel Committee said it would continue to “prioritize work to strengthen the effectiveness of supervision and identify issues that may merit additional guidance at the global level.”