US banks are seeking assurances from the Federal Reserve that they will not be penalised if they temporarily breach liquidity rules because of emergency lending to clients stricken by the coronavirus crisis.
Lenders are pressing the central bank to flesh out its promise not to sanction those who run down their liquidity buffers to aid the economy, and are also exploring other ways the Fed and banks can work together to boost lending without banks taking on too much risk.
The news follows statements from the Fed designed to get banks lending, including publicly encouraging them to reduce their capital and liquidity buffers to minimum levels and take funding from a crisis-era liquidity facility known as the discount window.
“There’s been a lot of dialogue and it’s been very constructive,” said a senior executive at one large bank. Peers confirmed that talks between the Fed and banks over boosting lending had been going on for several weeks, resulting in public announcements setting the tone for banks to do more lending.
“Our message to everybody is we need to keep the funds flowing to get the economy going. That is job one,” said Patrick Harker, president of the Philadelphia Fed. “The shock that’s hit our society and our economy is severe. So we need to do whatever it takes, all of us, not just the Fed, but everybody, to get the money to where it’s needed now.”
The Fed wants banks to step up lending to companies whose businesses will be starved of cash because of enforced shutdowns during the coronavirus pandemic. Workers face layoffs or reduced hours as normal life is suspended across entire cities for an indefinite period of time. Severe turbulence in financial markets means that bigger companies are also demanding more support from banks, including drawing down emergency funding lines and asking for new facilities.
A Fed statement last week allowing banks to run down their capital and liquidity buffers was intended to do just that, but senior executives say it fell short of the mark, prompting further discussions,
The buffers refer to the highly liquid assets such as cash and T-bills banks hold above their regulatory obligation to carry high quality liquid assets equal to at least 100 per cent of net cash outflows over a 30 day period of stressed conditions. The requirements were put in place after the 2008 financial crisis to ensure the banks could survive another meltdown.
One senior executive said that regulators had given “clear” guidance allowing the banks to dip further into their capital buffers without having to halt dividend payments or bonuses.
On liquidity, the Fed said regulators would “support” banks that use their liquidity buffers “to lend and undertake other supportive actions in a safe and sound manner”.
The first senior executive said there was still some work to be done to convince banks to get their liquidity levels down to those minimum levels instead of the 120-140 per cent of 30-day outflows that they traditionally maintain.
“There could be days when you would fall below that based on how the market moves” we want to make sure if we’re below that some days we don’t get penalised because we’re doing what we’re being asked to do,” he added.
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A Q&A document designed to clarify the Fed’s approach said firms that dip below the 100 per cent most submit a plan to its supervisor which was “appropriate to the circumstances . . . and the economic environment for getting back above it”.
“I’m a little worried about going below 100 per cent,” the first executive said, adding that while he “trusts” the Fed not to penalise banks, he feared backlash from media and other third parties if banks were known to have breached their minimum levels.
The government is also canvassing Wall Street on the mechanics of how to get public money to small businesses in an effective way.
Banks have also been clear in their discussions with the Fed that while they will increase lending, there are limits to their support, even though the large banks who attract the highest level of Fed supervision have more than doubled their capital and liquidity over the past decade.
“We can’t take on inordinate amounts of risk,” said a senior executive at a third big US lender, adding that while it might be popular to make a lot of loans now, “we also have to collect”.
“If the Fed expects us to bail out small businesses they are wrong,” said a banker at one of the largest US banks by assets. “We are not going to take undue risks . . . we see things much more closely than the Fed so we are not going to risk everything because they want us to do so. It’s not going to happen.”
Other bankers said the institutions did not want to launch support schemes for particular industries, and would not make rescue loans to strategically important companies who are unlikely to be able to repay their debts.
Two executives said that they will continue to provide credit lines to large companies that have longstanding relationships with their banks but they were less likely to support smaller businesses that are expected to be hard hit by the lockdowns imposed to limit the spread of the virus.