Liquidity, XVA and the Libor transition

LIQUIDITY, not capital, should be key for supervisors

XVA costs come under concerted pressure from banks

LIBOR replacement may face legal problems, industry fears

COMMENTARY: Flowing away

Regulators dropped the ball before the 2008 crisis by focusing their attention on capital levels at the expense of studying liquidity. They freely admit it, and that is one of the reasons why after the crisis rule-makers have spent so much effort on ensuring financial institutions are both adequately capitalised and able to survive a sudden drop in liquidity.

This week, senior regulators expressed concerns that the reformed fixed-income market could be at higher risk of a liquidity shortage. While many in the industry have blamed higher capital requirements for the shortfall in bond market liquidity, regulators are less sure – pointing to structural factors, such as greater participation by mutual funds and the associated redemption risk, as the real cause of illiquidity. The FSB's Svein Andresen, for his part, points out that, ironically, the stability of the bond market in recent months may be to blame, as it reduces the profits market-makers can reap from steadying the market, and so keeps a lid on activity and liquidity.

However, liquidity stress testing is no easy matter, even when dealing with a single institution. And regulators such as the Netherlands' DNB are becoming increasingly certain that market-wide stress tests – far more complex and lengthy – will also be vital in preserving financial stability in years ahead.

QUOTE OF THE WEEK
"Capital is – and should be – there to serve as a disincentive for insurers to engage in activities prone to a systemic element. But in a stressed situation, it won't be the element of capital that will ‘save the world'. It's all the other preventative measures, such as intensified supervision, that are the most relevant" – Eiopa chairman Gabriel Bernardino

STAT OF THE WEEK
The Financial Stability Board estimates that TLAC shortfalls across global systemically important banks could be as high as €1.1 trillion ($1.2 trillion) when the stricter standard of 18% comes into force in 2022.

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