The FSA has today published a discussion paper reviewing liquidity requirements for banks and building societies, following the freeze in liquidity which led to Northern Rock's near collapse.
The FSA says it still believes the principles-based approach to regulation is right, but say some form of quantitative liquidity requirements are still necessary.
The discussion paper recommends that banks should take a ‘belt and braces’ approach to liquidity issues.
The ‘belt’ is a view of all the possible demands for funds that a bank could face, such as a mass withdrawal of deposits, as well as a plan to meet any demands.
Meanwhile, the ‘braces’ are defined as cash, or assets that can be turned into cash at short notice, even under difficult market conditions, giving banks additional liquidity to carry on their business.
The paper also analyses lessons that can be learnt from how banks and building societies coped with the recent credit crunch. In addition, the paper identifies liquidity risks in newer investment structures, such as SIVs and off balance sheet arrangements.
The FSA says the review is not one-sided, with the regulator challenging its own policies, as well as the liquidity management within firms.
Lastly, the paper recommends changes to stress-testing among firms, after Northern Rock’s management revealed that their stress-test did not account for a total freeze in liquidity.
Thomas Huertas, acting managing director of wholesale markets at the FSA, says: “We already know, following the events of the late summer, that individual firms' stress testing and contingency funding plans need improvement, and our ongoing supervision is addressing this. Banks and building societies need to achieve a higher level of resilience to funding stress.”
The closing date for responses to the discussion paper is 31 March 2008 and the paper will be followed by a consultation on firm proposals in summer 2008.
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