Rule will require banks to neutralize effects under LCR of participating in some COVID-19 emergency facilities

Banks and their organizations will be required to neutralize the effect under the liquidity coverage ratio (LCR) rule of participating in new emergency facilities set up by the Federal Reserve to deal with the impact of the coronavirus crisis under an interim final rule scheduled to take effect upon publication Wednesday.

Tuesday, the three federal banking agencies (the Fed, Federal Deposit Insurance Corp. [FDIC], and the Office of the Comptroller of the Currency, [OCC]) also said the rule – which will take effect upon publication in the Federal Register – will be subject to a 30-day comment period.

In March and April, the Fed set up a number of facilities to help the financial system face the impact of the coronavirus crisis. Among them: the Money Market Mutual Fund Liquidity Facility (MMLF) and the Paycheck Protection Program Liquidity Facility (PPPLF). To use those facilities, “and to ensure that the effects of their use are consistent and predictable” under the LCR rule, the agencies said they were issuing the interim final rule.

According to the agencies, the LCR rule requires banks and other covered companies to calculate and maintain an amount of high-quality liquid assets (HQLA) sufficient to cover their total net cash outflows over a 30-day stress period. The LCR is the ratio of a bank’s HQLA amount (LCR numerator) divided by its total net cash outflows (LCR denominator).

The agencies noted that 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.

“Absent the interim final rule, under the LCR rule, covered companies 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,” the agencies said. “As a result, a covered company’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 across covered companies.”

Further, the agencies said, as a result of applicable inflow and outflow rates in the LCR rule, transactions for the two facilities could receive a non-neutral liquidity risk treatment. “Moreover, after these loans are extended and upon their maturity, the associated inflows and outflows could unnecessarily contribute to volatility in LCRs,” the agencies said.

But the agencies noted that, under the terms of the MMLF and PPPLF, banks and other covered companies use the value of cash received from posted or pledged assets to repay the MMLF or PPPLF loan, respectively, “and in no case is the maturity of the collateral shorter than the maturity of the advance.” Also, the agencies said, because the advance from the Federal Reserve Bank is non-recourse, the banking organization is not exposed to credit or market risk from the collateral securing the MMLF or PPPLF loan that could otherwise affect the banking organization’s ability to settle the loan.

“For these reasons, the agencies believe that it is appropriate to provide predictable and consistent treatment for participation in the MMLF and PPPLF by neutralizing the effects of participation in the MMLF and the PPPLF on covered companies’ LCRs,” the agencies said.  “Absent this interim final rule, the agencies believe that the treatment of covered companies’ transactions with the MMLF and PPPLF under the LCR rule would not be consistent across transactions or facilities and would not accurately reflect the liquidity risk associated with funding exposures through these facilities.”

Liquidity Coverage Ratio Rule: Treatment of Certain Emergency Facilities

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