What future for banks bonds ?

11.3.2011 par Gilbert Issard.

One of the consequences, though indirect, of the new Basel liquidity regulation is that it will profoundly change the bond market.

No bond issued by a bank is eligible to the liquid assets buffer, even if it is has a state guarantee. Paragraph 40 of the latest BCBS paper  on page 14 is quite clear :

40. Level 1 assets are limited to:
(a) cash;
(b) central bank reserves, to the extent that these reserves can be drawn down in times of stress;
(c) marketable securities representing claims on or claims guaranteed by sovereigns, central banks, non-central government PSEs, the Bank for International Settlements, the International Monetary Fund, the European Commission, or multilateral development banks and satisfying all of the followi ng conditions:

. assigned a 0% risk-weight under the Basel II Standardised Approach;

. traded in large, deep and active repo or cash markets characterised by a low level of concentration;

. proven record as a reliable source of liquidity in the markets (repo or sale) even during stressed market conditions; and

. not an obligation of a financial institution or any of its affiliated entities.

The same restriction is explicitely mentioned for level 2 assets, in paragraph 42.

Apparently, even a bond issued by a bank and guaranteed by a country (as is the case for some german banks for example) is not eligible to the liquid assets buffer. Will there be an active bond market for banks bonds ? Hedge funds, customers, mutual funds will buy these bonds but will it be sufficient to maintain a market ?

More worrying might be the next consequence of such a restriction, namely that given the level of the liquidity shortfall to meet the NSFR obligation banks will have difficulty to raise the long term cahs.  the results of the QIS done by the Basel Committee. indicated on page 29 :

“QIS results show that banks in the sample had a shortfall of stable funding of €2.89 trillion at the end of 2009, if banks were to make no changes whatsoever to their funding structure.”

This shortfall in stable funding should be met by long term new funding, mostly bonds issuance, over 1 year at least. But if a bond issued by a bank is not eligible to the liquidity buffer, will there be a liquid market for such bonds ? Will there be buyers ?

We might be in a catch 22 situation, were banks must raise huge amount of new funding in a no longer liquid market. They could have difficulties in meeting the new regulatory constraint.

This intrinsic contradiction in the new NSFR regulation should be adressed quickly to avoid putting banks in an inextricable situation.

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