House Financial Services Committee approves Messer-Maloney bill to protect key source of funding for states and cities

Nov 4, 2015
Press Release
Bill allows investment grade municipal bonds to be included in bank liquidity buffers

WASHINGTON – The House Financial Services Committee today approved legislation (H.R. 2209) authored by Reps. Luke Messer (R-IN) and Carolyn B. Maloney (D-NY) to protect financial institution investment in local communities by including investment grade municipal bonds in bank liquidity buffers. The bill is in response to a recent federal regulation that would force investors to exclude municipal bonds from the Liquid Coverage Ratio, which would end up strongly discouraging investment in municipal bonds.

“A lot of times, it seems like bank regulations have very little impact on our day-to-day lives,” said Congressman Messer.  “But, that’s just not the case, here.  By excluding all municipal securities from HQLA-eligibility, financial institutions are discouraged from holding municipal debt. This has a real-world impact.  It could raise borrowing costs for state and local governments to finance infrastructure projects and forced municipalities to reduce, or even stop, projects that are financed with municipal bonds. We can’t allow Federal bureaucrats to promote policies that disincentivize investment in our local communities.”

“Municipal bonds are some of the safest investments in the marketplace and states and cities rely on them to finance critical infrastructure, build schools, and pave roads,” said Congresswoman Maloney. “That is why it makes no sense for federal regulators to discourage financial institutions from investing in communities by forcing investors to treat municipal bonds differently from corporate bonds of the same size and maturity. Our legislation will level the playing field for our states and cities by ensuring that municipal bonds are treated fairly by the regulators.”

New York City Comptroller Scott Stringer said: “New York City relies on our highly-rated municipal bonds to fund critical infrastructure projects, including schools, water, roads, public safety and more.  With annual bond sales over $10 billion, the City needs a large and diverse base of investors to finance the capital program at attractive interest rates.  I want to thank Congressmember Carolyn Maloney for helping secure the House Financial Services Committee’s passage of this important legislation, which will benefit municipal issuers nationwide as well as here in New York.”

H.R. 2209 requires banking regulators (The Federal Reserve, Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation) to treat liquid municipal bonds — i.e., those that meet all of the liquidity criteria in the Liquidity Coverage Ratio (LCR) rule — as “High-Quality Liquid Assets” (HQLA).

Background:

Following the financial crisis, federal financial regulators imposed new capital requirements on financial institutions to ensure that they have enough High-Quality-Liquid Assets to cash outflows for 30 days. Unfortunately, under these rules, municipal bonds were considered HQLAs and therefore could not be counted towards an institution’s LCR. This would end up strongly discouraging investment in municipal bonds and cut off critical funding for states and cities.

While the Federal Reserve and FDIC have made progress to ensure fair treatment of municipal bonds, the OCC has thus far refused to act, necessitating the Messer-Maloney legislation.

H.R. 2209: This bill would level the playing field for states and cities by requiring the banking regulators to treat municipal bonds that meet the liquidity criteria in the LCR rule as Level 2A assets.

Liquidity Coverage Ratio (LCR) Rule: The LCR rule requires banks to hold enough cash and highly liquid securities to survive for 30 days without access to any of its normal funding. In other words, the LCR ensures that banks have enough liquidity to continue operating even if everyone stops lending to the bank for 30 consecutive days.

High-Quality Liquid Assets: The LCR requires banks to hold a minimum amount of “High Quality Liquid Assets” (HQLA) — that is, assets that can quickly and easily be sold for cash in times of stress. In order to count as HQLA, assets must meet certain liquidity criteria laid out in the rule. The rule divides HQLA into three categories of assets: Level 1, Level 2A, and Level 2B.

1.      Level 1 assets include cash and U.S. Treasuries, as the Treasury market is widely regarded as the most liquid financial market in the world.

2.      Level 2A assets include U.S. agency securities, such as securities issued by Fannie Mae and Freddie Mac (the GSEs), as well as mortgage-backed securities (MBS) guaranteed by the GSEs. Level 2A assets are subject to a 15% haircut under the LCR (so if a bank owns a $100 agency security, only $85 counts towards its total HQLA).

3.      Level 2B assets include certain corporate bonds and equities that meet the rule’s liquidity criteria. Level 2B assets are subject to a 50% haircut.

Municipal Bonds: Notably, state and municipal bonds are categorically excluded from HQLA — even municipal bonds that meet all of the liquidity criteria in the rule. This means that even if a municipal bond is objectively more liquid than a corporate bond, using the LCR’s own liquidity criteria, the rule would still treat the corporate bond as “liquid,” but not the municipal bond — purely because the municipal bond was issued by a state or municipality, rather than a corporation.

Fed vs. OCC: The Federal Reserve has already recognized that some municipal bonds are just as liquid as corporate bonds, and has proposed an amendment to its LCR rules that would allow certain municipal bonds to be treated as HQLA. The OCC, however, still refuses to amend its LCR rule — which governs all nationally chartered banks — to allow liquid municipal bonds to count as HQLA.