On the Economics of Committed Liquidity Facilities

As part of the regulatory response to the recent global financial crisis, the Basel Committee on Banking Supervision (BCBS) announced a new international regulatory framework for banks, known as Basel III. One important component of Basel III is the Liquidity Coverage Ratio (LCR), which aims to ensure that banks hold a more liquid portfolio of assets and rely on the central bank for funding only as a last resort. Specifically, the LCR requires each bank to hold a sufficient quantity of highly liquid assets to survive a 30-day period of market stress; this requirement is scheduled to be phased in gradually beginning in January 2015. In the process of designing and calibrating the LCR rules, it became clear that some jurisdictions do not have sufficient high-quality liquid assets (HQLA) for their banking system to meet this new requirement. Australia and South Africa are cases in point, as both have limited amounts of sovereign debt and other qualifying securities; see Debelle (2011), Heath and Manning (2012) and South African Reserve Bank (2012). In such jurisdictions, the regulation offers the central bank the option of providing, for an up-front fee, contractual committed liquidity lines that count toward a bank’s stock of liquid assets. Stein (2013) argues that such lines have the potential to be a useful safety valve in other situations as well, since they can place an upper bound on the cost of the liquidity regulation.