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EBA Consultation on Currencies with Constrained Liquid Assets Summary

Core Content

The European Banking Authority (EBA) has issued three consultation papers (EBA/CP/2013/37, EBA/CP/2013/38, and EBA/CP/2013/39) regarding currencies with constrained availability of liquid assets. These papers aim to define which currencies are considered to have a shortage of liquid assets and how banks should handle such currencies under the Capital Requirements Regulation (CRR). The Banking Stakeholder Group (BSG) of the EBA has submitted a detailed response to these consultations, highlighting several key concerns and suggesting improvements to the EBA’s approach.

Main Views and Key Points

1. Alignment with European Liquid Asset Definition

• The EBA is expected to release its report on constrained liquid assets before the delegated act on Liquidity Coverage Ratio (LCR) is published in June 2014.
• The BSG urges the EBA to retain the flexibility to update its analysis once its own recommendations on the definition of liquid assets are known.
• The BSG criticizes the EBA’s decision to classify Norwegian covered bonds as illiquid, arguing that this assessment is not appropriate in a broader European context.

2. Identification of Currencies with a Shortage of Liquid Assets

• The EBA has only analyzed DKK (Danish Krone) and NOK (Norwegian Krone) for potential shortages of liquid assets.
• The BSG emphasizes that the final determination of whether a currency is considered to have a shortage of liquid assets should rest with national supervisors.
• It also suggests that the EBA should provide clearer guidance on how such shortages should be addressed.

3. Additional Haircuts on Derogations

• The BSG is concerned about the additional 8% haircut applied to foreign currency denominated liquid assets.
• They argue that this is overly harsh and not appropriately calibrated.
• The BSG highlights that currency risk can be hedged through financial instruments such as cross-currency swaps, FX swaps, forwards, and options.
• They also point out that there is a correlation between local liquidity stress and foreign exchange rates, which can reduce the risk for banks holding foreign currency assets.

4. Methodology for Estimating Liquid Asset Shortfall

• The EBA uses its own estimation of liquid asset shortfall to determine the use of derogations.
• The BSG notes that the methodology leads to a wide range of results, from 47% to 83% in the case of NOK.
• They argue that this variability makes the criterion for derogation use unreliable.
• Public data from Norway indicates that the share of government bonds owned by foreign investors was close to 50% as of June 2012, suggesting that the EBA’s assumption of 20% is too conservative.

5. Classification of Norwegian Covered Bonds

• The BSG disagrees with the EBA’s classification of Norwegian covered bonds as illiquid.
• They highlight that the covered bond market in Norway has grown significantly, surpassing the government bond market in size.
• The market is characterized by lower volatility and less price impact from bond trades.
• The BSG argues that the EBA’s analysis is overly reliant on low trading volumes and fails to consider the improved supply-side liquidity and the development of the repo market.
• Therefore, the BSG recommends that Norwegian covered bonds be classified as liquid assets under the LCR.

Conclusion

The BSG’s submission underscores the need for a more nuanced and comprehensive approach to assessing the liquidity of currencies and assets. They advocate for greater alignment with European standards, more accurate methodologies, and a reconsideration of the classification of Norwegian covered bonds as illiquid. The group emphasizes that banks operating in jurisdictions with liquidity constraints should not face a competitive disadvantage and that the EBA should take into account the broader context and hedging capabilities when applying haircuts and derogations.