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CEBS Consultation Paper on Liquidity Buffers & Survival Periods - Summary

Core Content

The Austrian Federal Economic Chamber, representing the entire Austrian banking industry, has provided detailed feedback on the CEBS consultation paper regarding liquidity buffers and survival periods. The comments focus on the implications of a narrow definition of eligible assets for liquidity buffers, the potential economic impacts, and the challenges related to cross-border collateral management.

Main Views and Key Information

1. Eligibility of Assets for Liquidity Buffers

• Restrictive Definition Concerns: A narrow definition of liquidity buffers that limits eligible assets to those highly liquid in private markets and central bank-eligible could lead to a shortage of such assets, especially government bonds, and increase their concentration and cost.
• Market Liquidity in Stress Situations: The assumption that highly rated government bonds will remain liquid in stress scenarios is questionable, as previous experiences show that even these may not be continuously tradable.
• Central Bank Eligibility as Priority: Central bank eligibility should be the primary criterion for determining the composition of liquidity buffers, as it ensures flexibility during financial crises.
• Impact on Less Liquid Assets: Assets not meeting the narrow criteria may become less liquid and should be held to maturity, which could distort the market and increase operational costs.

2. Potential Pressure Points

• Inconsistencies in Collateral Valuation: There could be inconsistencies between the liquidity value of eligible collateral and the liquidity value used in net cash outflow calculations.
• Cash Flow Considerations: In repo transactions or when selling liquid assets, a 1-day cash flow buffer must be considered to ensure operational continuity.

3. Conditions for Applying a Narrow Definition

• Transition Period: A transition period of a couple of years is necessary to allow the sector to adjust to the new criteria without causing undue market distortion.
• Liquidity Manager Flexibility: A narrow definition may reduce the flexibility of liquidity managers, which could be detrimental to the institution's ability to respond to stress scenarios.

4. Macroeconomic and Business Impact

• ROE Impact: A narrow definition will likely lead to a significant negative impact on return on equity (ROE), as the yield on eligible assets may be lower than the cost of funds.
• Lending Capacity and Financing Costs: The increased buffer requirements could restrict lending capacity and raise financing costs for borrowers, especially for institutions with lower ratings.
• Business Model Adjustments: While the core business model may not change, the altered cost structure could affect profitability and lead to different managerial responses across institutions.
• Competitive Imbalance: Insurance companies and investment funds may face particular challenges due to the yield impact of investing in highly liquid assets.

5. Impact on Interbank Market and Funding Costs

• Negative Implications for Interbank Trading: Guidelines may block collateral used in interbank repo transactions for liquidity buffers, reducing available liquidity in the money market.
• Funding Costs Increase: The proposed guidelines may lead to higher funding costs, especially if they reduce access to cheap funding sources.
• Confidence and Funding Costs: While guidelines that encourage higher liquidity holdings may improve confidence in the interbank market, they alone are not sufficient to restore it. A better economic environment is essential.

6. Cross-Border Collateral Management

• Survival Period Definition: The liquidity buffer should be designed to cover the survival period under business-as-usual conditions for the short- to medium-term, and for stress scenarios, at least the short survival period.
• Challenges with Cross-Border Collateral Use: Collateral management within cross-border banking groups is complicated by local regulations, which hinder efficient liquidity and collateral management at the group level.
• Need for Centralized Management: A more centralized approach to liquidity management, similar to the ECB area, would improve efficiency and allow for better responses to market stress.

Additional Remarks

• Guideline 5 and Austrian Banking Act (BWG): The current provisions of sec 25 BWG for second-degree liquidity may conflict with the use of eligible assets during stress scenarios, as these assets are also used for central bank financing.
• Cross-Border Collateral Use: The industry believes that a more harmonized approach to cross-border collateral use would enhance liquidity management and support the financial system during crises.
• Overall Economic Impact: The proposed guidelines could have significant economic implications, including higher funding costs and reduced liquidity availability, which may require broader regulatory and political actions to mitigate.

Conclusion

The Austrian banking industry supports the idea of central bank eligibility as a key criterion for liquidity buffers but warns against the potential negative impacts of a too narrow definition. A balanced approach with a sufficient transition period and consideration of macroeconomic effects is essential to ensure the stability and efficiency of the financial system.