Rep. Maloney Cheers Fed Board Announcement Providing Relief for Municipal Bonds

Apr 1, 2016
Press Release

WASHINGTON, DC – Congresswoman Carolyn B. Maloney (NY-12) heralded the Federal Reserve Board’s announcement today that they have finalized a rule allowing for the inclusion of investment grade municipal bonds in bank liquidity buffers. The Congresswoman co-authored a bill with Rep. Luke Messer (R-IN) earlier this year to allow for the inclusion of these bonds in the Liquid Coverage Ratio to protect financial institution investment in local communities.

“This is a positive step forward, and I applaud the Fed for taking action to level the playing field for cities and states by ensuring that liquid municipal bonds will be included in banks’ liquidity buffer. Municipal bonds are critically important — they allow cities and states to finance infrastructure projects, build schools, and pave roads. The OCC should follow the Fed’s lead and offer similar relief in order to protect the municipal bond market, and cities and states across the country,” said Rep. Maloney.

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 not considered HQLAs and therefore could not be counted towards an institution’s Liquidity Coverage Ratio. 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 (also known as Government Sponsored Enterprises, or 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.

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