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BNP PARIBAS SUMMARY OF RESPONSE TO CEBS CONSULTATION PAPER 28 (July 2009)

Core Content

BNP Paribas has responded to CEBS Consultation Paper 28, which outlines proposed implementation guidelines for Liquidity Buffers and Survival Periods. The bank supports CEBS's objective of promoting a harmonised approach to liquidity risk management across European supervisors and enhancing the efficiency of liquidity allocation. However, it also raises concerns about the potential adverse effects of overly restrictive definitions of eligible assets for liquidity buffers and the need for a more flexible and coordinated regulatory framework.

Main Points and Key Views

1. Liquidity as a Key Risk Management Element

• Liquidity is essential for the survival of financial institutions during both idiosyncratic and systemic crises.
• A Liquidity Buffer should be seen as a planned resource that allows firms to anticipate liquidity needs under stress, rather than requiring additional liquidity during a crisis.
• The buffer should ensure that institutions can access high-quality liquid assets and central bank facilities when needed.

2. Critique of the Proposed Eligible Assets Definition

• The narrow definition of eligible assets (e.g., only central bank-eligible and highly liquid assets) may lead to:
  • Concentration risk in the market as institutions hold large amounts of similar assets.
  • Market illiquidity if all banks simultaneously liquidate the same asset classes during a crisis.
  • Tiering of the securities market, where eligible assets trade at a premium while non-eligible ones freeze or discount.
• A wider range of assets should be considered for the buffer to avoid unintended market effects and maintain market continuity.

3. Importance of Supervisory Harmonisation

• CEBS should avoid fragmented rules across jurisdictions and instead promote supervisory harmonisation at the European level.
• A common language for liquidity and reporting is needed to facilitate understanding and coordination between firms and supervisors.
• Interoperability of collateral between central banks, especially at the Eurozone level, is crucial for efficient liquidity management and to prevent competitive imbalances.

4. Impact of Liquidity Buffer Requirements

• Potential impact on lending capacity: Liquidity buffer requirements may lead to a reduction in credit availability and an increase in funding costs, which could affect the real economy.
• Competitive imbalance: Restrictions on the free flow of liquidity within international banking groups could lead to trapped liquidity pools and higher operational and legal costs.
• Effect on ROE: The return on equity may be negatively impacted due to lower yields on government bonds and increased funding costs.

5. Support for Principles-Based Regulation

• BNP Paribas supports the principles-based approach and flexibility in liquidity management, as it allows for tailored solutions based on individual firm characteristics.
• A dialogue between supervisors and firms is essential for the effective implementation of liquidity buffers.

6. Suggestions for Implementation

• A phase-in period is necessary to allow for the transition to new liquidity standards and to replace non-eligible assets with qualifying ones.
• Macro-prudential impact assessment should be conducted by the Basel Committee to ensure that the cumulative effect of all regulatory changes is proportionate and does not harm bank lending or market efficiency.

Key Questions and Responses

Q1: Shortage or Concentration of Eligible Assets

• Government bonds are abundant due to increased public deficits, but concentration risk may arise in the long term.
• Banks may deteriorate less liquid assets in value due to lack of eligibility, while liquid assets may see increased demand.
• Rating differences between EU Member States could lead to a squeeze in available highly liquid assets, especially for banks in lower-rated countries.

Q2: Pressure Points from Inconsistent Definitions

• Inconsistent definitions of liquidity value for eligible collateral may create pressure points in liquidity planning.
• CEBS's answer to the London hearing has been satisfactory in this regard.

Q3: Conditions for a Narrow Definition

• A narrow definition of eligible assets could lead to asset reallocation and cherry-picking.
• A long transition period is necessary to allow for the replacement of non-eligible assets and to maintain market diversity.

Q4: Macro-Economic Impact of Narrow Definitions

• A narrow definition could lead to sub-optimal allocation of resources and wrong incentives, especially in government bond markets.
• It may reduce lending capacity, increase funding costs, and jeopardize interbank markets.

Q5: Impact on Business Models

• The proposals may influence business models, especially for institutions dealing in illiquid assets.
• Knock-on effects on collateral policies and loan strategies are possible.
• Time horizon for survival periods should remain a management option aligned with the institution’s risk appetite.

Q6: Confidence in Interbank Markets

• CEBS guidelines may help restore confidence if implemented in incremental steps and with realistic impact analysis.
• However, immediate implementation without considering the cumulative effect could downsize interbank markets and increase funding costs.

Conclusion

BNP Paribas supports the CEBS initiative but stresses the importance of flexibility, harmonisation, and macro-prudential impact assessment to ensure that liquidity buffers do not lead to unintended systemic risks or adverse market effects. It calls for a broader definition of eligible assets, interoperability of collateral, and a coordinated regulatory approach at the European level.