Board of Governors of the Federal Reserve System

The financial crisis provided a devastating reminder that liquidity distress at a large bank can quickly metastasize into broader fire sales and run dynamics. To address this systemic risk, the post-crisis regulatory framework introduced two complementary liquidity requirements. The liquidity coverage ratio is intended to ensure a bank has sufficient high quality liquid assets to cover short-term cash outflows in a stress situation. By requiring that banks hold stable funding matched to the maturity profile of their assets out to a one-year horizon, the net stable funding ratio (NSFR) is intended to guard against the risks associated with funding higher-yielding long-term assets with cheaper and less stable short-term wholesale funding. Given that the largest banks were generally in compliance with the NSFR by early this year in anticipation of its finalization, along with other post-crisis requirements, the resilience of the banking system during the COVID-19 crisis can be seen as a validation of the new capital and liquidity framework.

I supported the NSFR proposed rulemaking in 2016. I also support exempting banks with assets in the range of $50 to $100 billion from the modified 70 percent NSFR requirement in the proposed rule, consistent with the requirements of S.2155. Unfortunately, the final NSFR rule goes beyond the statutory requirements and weakens the NSFR relative to the proposed rule. The NSFR requirement is reduced from 100 percent in the proposed rule to 85 percent in the final rule for almost all banks in the asset size range of $250 to $700 billion, despite the clear lesson from the crisis that liquidity stress associated with maturity mismatches for large banks in this size range poses serious contagion risk. Similarly, for almost all banks with assets between $100 to $250 billion, the NSFR is eliminated entirely, as compared with a modified 70 percent NSFR requirement in the proposed rule.

Finally, although I would have supported some moderation of the required stable funding (RSF) for Treasuries and Treasury reverse repos relative to the Basel standard, the decision to eliminate the requirement entirely is not prudent. A small RSF requirement is warranted to mitigate systemic fire-sale risks and reduce the need for central bank emergency intervention at times of stress.