FS1/23 – The prudential liquidity framework: Supporting liquid asset usability

Following the launch of a Discussion Paper in March 2022 as regards the motivation of financial institutions to keep a large inventory of high quality liquid assets (HQLA) even in times when there’s an acute need for cash to service credit markets, the Prudential Regulation Authority (PRA) has now published a Feedback Statement on the issue. Therein, the PRA summarizes the responses it has received to the Discussion Paper which are briefly outlined below.
As far as institutions‘ reluctancy to a reduction of HQLA positions is concerned, most respondents confirmed this evidence. As a possible cause for such behavior institutions commented that they fear „regulatory (re)actions“ by the PRA when their liquidity coverage ratios (LCRs) fall below certain levels. Such reactions may include enhanced supervisory oversight or enhanced reporting requirements of institutions with small LCRs. Additionally, banks fear the reaction of the financial market, as institutions with low LCRs are considered to be experiencing liquidity stress. Also, some institutions noted that they fear regulatory stress as far as the period is concerned that it may take to rebuild HQLA positions.
Concerning possible improvements of this situation, there was a wide range of views, including the following, among others:
– Some banks noted that it would be helpful to have regulatory guidance at hand that describes circumstances when it appears to be acceptable by the regulator to fall below 100% LCR. This particularly holds true for a possible alignment of the internal target LCR, which is always based on regulatory requirements and reflects decision makers‘ due diligence and prudence concerns.
– Some institutions noted that it would be desirable to have guidance pertaining to the time frame within which a LCR lower than 100% must be restored.
– A large number of respondents suggested more effective communication by the PRA as to the „extent to which banks’ LCRs can fall without regulatory consequences“.
– Again a large number of respondents noted that they assume the regulatory disclosure requirements as regards liquidity coverage ratios to be a key driver of institutions‘ reluctancy to a reduction of HQLA positions. As LCR levels below 100% are not perceived well by the market, institutions are highly reluctant to give up large positions of HQLA due to the fact that such „low“ HQLA will be publicly available.
– Many institutions suggested a recalibration of the LCR during times of high liquidity pressures to take into account the high cyclicality of the LCR.